OECD – BASE EROSION & PROFIT SHIFTING (BEPS) – PILLAR TWO
Key terms & Abbreviations
| BEPS | Base erosion and profit shifting |
| CbCR | Country By Country Report |
| ETR | Effective Tax rate |
| IIR | Income Inclusion Rule |
| GloBE rules | Global Anti-Base Erosion rules (referred to for IIR and UTPR) |
| LTCE | Low Tax Constituent Entity |
| MNEs | Multinational enterprises (those with global turnover of over €750 million) |
| MNTT | Multinational Top-up Tax |
| OECD | Organisation for Economic Cooperation and Development |
| QDMTT | Qualified Domestic Minimum Top-up Taxes |
| STTR | Subject to Tax Rule |
| UTPR | Undertaxed Profits Rule |
Background
Base erosion and profit shifting (BEPS) is where multinational enterprises (MNEs) shift profits between group companies to low or no-tax jurisdictions or erode tax bases through interest or royalty payments. The OECD believe this costs countries $100-240 billion in lost revenue which is equivalent to 4-10% of global corporate income tax revenue. There are over 145 countries and jurisdictions which are now members of the OECD/G20 framework on BEPS.
The OECD Pillar Two framework for BEPS is an important development in international tax which effects countries across the world. The framework is designed to reform the global tax system to ensure large MNEs pay a minimum tax charge on profits in each tax jurisdiction which they operate.
The rules
The rules apply to MNEs with annual consolidated turnover of at least €750 million and imposes a top-up tax on profits where the effective tax rate (ETR) of a jurisdiction is below 15%.There are three core rules for Pillar two which are an Income inclusion Rule (IIR), an Undertaxed Profits Rule (UTPR) – collectively known as the ‘GloBE rules’, and the Subject to Tax Rule (STTR).
1. Income Inclusion Rule (IIR)
The UTPR will apply after the IIR and serve as a backstop to the IIR.
Where the ultimate parent entity jurisdiction has an ETR below 15%, the UTPR applies and therefore enforces a top-up tax to be collected by the countries in which other group companies are located.
This is a treaty-based rule and is different to the IIR and UTPR. The STTR may override treaty benefits in existing treaties for certain payments where those payments are not subject to a minimum level of tax in the recipient jurisdiction.
Where the STTR applies, treaty relief that would otherwise have been provided may be denied, with the maximum applicable withholding tax being 7.5% to 9%. The STTR applies before the IIR and UTPR and any tax collected under the STTR should be factored into the global minimum tax calculations used for the purposes of the IIR and UTPR.
Qualified Domestic Minimum Top-up Taxes (QDMTT)
Both IIR and UTPR subject profits of entities in a ‘low taxed territory’ to tax in another jurisdiction. The Inclusive Framework recognised that such jurisdictions may wish to tax such profits themselves, and, in some cases, the GloBE rules could subject profits of an entity which is in a jurisdiction not usually thought of as ‘lowly-taxed’ to tax. For these reasons, the GloBE rules recognise the concept of a QDMTT.
A QDMTT is deducted from Top-up Tax arising for a jurisdiction under the general GloBE rules, usually meaning that no further Top-up Tax should be paid outside the jurisdiction which has applied the QDMTT. The UK has introduced a QDMTT for periods beginning on or after 31 December 2023 (Domestic Top-up Tax, DTT).
How its calculated
In short, for a jurisdiction, all Constituent Entities located in that jurisdiction for a Fiscal Year are aggregated.
If the ETR is below 15%, the jurisdiction is a Low-Tax Jurisdiction (LTJ) for that Fiscal Year. The difference between the ETR and 15% is the ‘Top-up Tax percentage’ and this percentage is applied to the aggregate Globe Income. The result is the Top-up Tax which is allocated to Entities in the in proportion to their Globe Income in the jurisdiction.Certain Constituent Entities will have their ETR calculated on a standalone basis or pooled with similar entities (this relates mainly to Investment Fund/REIT/Insurance Investment Entities and Minority-Owned Entities).
The first Fiscal Year in which an MNE Group comes under the scope of the GloBE rules for a jurisdiction is called the ‘Transition Year.’ Note that if a Ultimate Parent Entity is resident in a jurisdiction that implements the rules before a subsidiary resident jurisdiction, the transition year for the sub is the same as the Ultimate Parent Entity.
Exclusions and Transition
There are some excluded entities and various transitional reliefs available for the commencement of the framework including those that already prepare calculations under the Country-by-Country Reporting (CbCR).
Six types of Entities are identified as Excluded Entities:
1. Governmental Entities.
UK Measures and Timeline
In June 2022 the UK government announced Pillar Two would be introduced for accounting periods beginning on or after 31 December 2023 – i.e. effectively from 1 January 2024. This is in-line with the EU’s proposed introduction date. Legislation is included in Finance (No.2) Act 2023 Part 3 to implement the IIR of Pillar Two for accounting periods beginning on or after 31 December 2023.
The UK government has indicated the UTPR will be introduced at a later date (not before the end of 2024). Draft legislation for the UTPR was published in July 2023.
The government has also introduced legislation in Finance (No.2) Act 2023 Part 4 for a Qualified Domestic Minimum Top-up Tax as part of the Pillar Two implementation.
