OECD Pillar Two Rules Explained

OECD Pillar Two Rules addresses the tax changes arising from the digitalisation of the economy by establishing a global minimum corporate tax standard.

The Organisation for Economic Co-operation and Development (OECD) Pillar Two Rules are addressing the tax changes arising from the digitalisation of the economy by establishing a global minimum corporate tax standard. These rules ensure that a 15% effective minimum tax rate is charged on multinational enterprises’ profits in each tax jurisdiction through additional taxation with top-up tax.

For entities that are making a loss, it is also possible for top-up tax to arise.

Despite UK tax rates being higher than the minimum tax rate of 15%, the top-up tax is based on financial accounting rather than tax computations and hence timing and other computational differences in a particular year may result in the effective tax rate being below 15% thereby creating a top-up tax liability.

The Pillar Two Rules apply to accounting periods commencing on or after 31 December 2023.

Top-up Tax is charged under the following three key components of Pillar Two:

• Qualified Domestic Minimum Top-up Tax (QDMTT)
• Income Inclusion Rule (IIR)
• Undertaxed Profits Rule (UTPR)

There are very limited exceptions from the rules for certain entities such as non-profit organisations, provisions covering companies entering and leaving the groups which could lead to rules being applied differently.

Multinational Top-up Tax (MTT)

MTT is a top-up tax that will be charged to members of multinational groups in scope of MTT where they do not meet the minimum effective tax rate of 15% in each territory that they operate in.

The scope of Multinational Top-up Tax (MTT)

A group will be within scope of MTT if both of the following conditions apply:

• It has at least one member in the UK and one member outside of the UK
• It meets the revenue threshold test (if the group has revenue more than €750 million in two of the four previous periods of their consolidated accounts).

Where an accounting period is less than 12 months, the threshold of €750m will be reduced proportionately. Special rules apply to corporate restructurings and other specific rules for holding structures such as Joint Venture investments.

Domestic Top-up Tax (DTT)

DTT is separate from MTT and is a top-up tax on UK members within a domestic or multinational group that will ensure any top-up tax due on UK profits is collected in the UK for those that are in scope for DTT. A top-up tax will therefore be charged when the group’s profits arising in the UK are taxed below the minimum effective rate of 15%. DTT is designed to be treated as a QDMTT as noted above, any DTT liability will be offset against any Pillar Two liabilities that may arise in other jurisdictions.

The scope of Domestic Top-up Tax (DTT)

A group or UK entity will be within scope of DTT if both of the following conditions apply:

• It has a UK presence
• It meets the revenue threshold test

As per the revenue threshold test noted for MTT, this is the same test applied for DTT.

Next steps for companies in scope of MTT and/or DTT.

• Register for MTT and DTT with HM Revenue and Customs.
• Calculation of top-up tax that will be imposed under QDMTT and/or IRR and/or UTPR.
• Prepare for MTT and/or DTT self-assessment return and filing.

Key Takeaways

• Pillar Two aims to ensure a standardised and international level of corporation tax of 15% is charged with use of ‘top-up tax.’
• Entities must meet conditions such as the revenue threshold test of €750m for the previous four accounting years to aid in determining their exposure to MTT and/or DTT.
• Details for each entity in the group must be identified to allow for calculations of any top-up tax liable to be completed.
• By identifying any potential top-up tax liable this will allow for entities to incorporate any top-up tax in their budgets for management purposes.

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