Financial Reporting & ESG

Navigating the Pillar Two rules

Navigating the Pillar Two rules

June 4, 2024

The OECD has published its outline for a new global minimum tax of 15%, and the EU has decided to implement this in its member states starting in 2024, along with several other nations.

The Global Anti-Base Erosion Model Rules GloBE, also known as the Pillar Two rules, provide a system of taxation for large multinational groups to ensure that a minimum tax level of 15% is achieved on a jurisdictional basis. A top-up tax is levied if the effective tax rate on profits is below the minimum rate.
The Pillar Two rules are coming, and soon! Large multinationals should assess whether they are affected by these complex new regulations, and if so, it is definitely the time to prepare for implementation in the near future.

If you’re looking for a solution to tackle the challenges represented by Pillar Tow, we have a custom-built application for it. Pillar Two – Tax is tailored for the nuanced demands of Pillar Two tax reporting.

Who does Pillar Two apply to?

The Pillar Two rules will apply for all constituent entities that are members of a multinational enterprise group that has an annual revenue of EUR 750 million or more in their consolidated financial statements of the Ultimate Parent Entity in at least two of the four fiscal years immediately preceding the tested fiscal year. Governmental entities, international organizations, Non-Profit organizations, pension funds and investment funds are excluded.

What should those who may be affected by these rules do now?

The simple answer is to prepare for the coming rules. How should we do this? Start by evaluating how the rules will affect the group. Determine how GloBE income should be calculated and which taxes are relevant to the calculation of the covered tax. How should existing systems support the requirements of the new rules? Is there a need to evaluate new systems? How to ensure that the rules are correctly followed?

When will this happen?

According to the initial timeline released by the OECD, these rules are scheduled to take effect this year (2023), with the exception of UTPR, which is scheduled to take effect next year (2024).

Components

  • GloBE Rules
    • Income Inclusion Rule (IIR)
    • Undertaxed Payments Rule (UTPR)
  • Switch-Over Rule (SOR)
  • Subject To Tax Rule (STTR)

Income Inclusion Rule (IIR)

The income inclusion rule, which is part of the GloBE rules, is the primary mechanism.

The Income Inclusion Rule has a top-down approach to the application of the top-up tax. This means that it is the ultimate parent entity (UPE) that should pay the top-up tax equal to its allocable share. However, if the UPE is located in a jurisdiction where IIR isn’t required, the next level parent will be required to pay the top-up tax instead.

To complicate matters further, Partially Owned Parent Entities (POPEs) should pay the top-up tax unless it is wholly owned by another Partially Owned Parent Entity (POPE), regardless of whether the UPE or any of its parents higher in the group hierarchy qualifies for IIR. In order to avoid double taxation, an offset mechanism is used.

In addition to the complexity of who should pay what and how to account for it, affected groups must also determine their GloBE income and covered taxes on a jurisdiction-by-jurisdiction basis (not all taxes are to be included and the same goes for income).

Undertaxed Payments Rule (UTPR)

The undertaxed payments rule (UTPR) is the second mechanism of the GloBE rules. The UTPR should kick in, if the calculated top-up tax has not been covered by the income inclusion rule (IIR). UTPR is a back-up, that raise the effective tax directly on subsidiaries by demanding an adjustment, for example by denying deductions or increasing the taxable income. To calculate the subsidiaries’ allocable share of the remaining top-up tax, UTPR uses the proportion of FTEs and total value of tangible assets for the subsidiary compared to the total for the entire jurisdiction.

Switch-Over Rule (SOR)

Tax treaties could potentially block IIR when applied. The Switch-Over Rule (SOR) will remove treaty barriers by allowing a switch from the exemption method to the credit method. The reason for this is to ensure that profits attributable to permanent establishments, that would be exempt from IIR taxation aren’t.

Subject to Tax Rule (STTR)

The Subject to Tax Rule exists to prevent payments that pose a high risk of base erosion (covered payments/profit shifting). This includes interest, royalties and a defined set of other payments that pose BEPS risks because they relate to mobile capital, assets or risks.

Conclusion of Pillar Two rules

In conclusion, the introduction of the Pillar Two rules marks a significant shift in the global tax landscape, aiming to ensure that large multinationals pay a minimum of 15% tax on a jurisdictional basis. This new framework, set to take effect in 2023 with certain components such as the UTPR to follow in 2024, requires immediate attention and preparation from affected entities.

Multinationals must carefully assess their current systems, calculate GloBE income, and determine covered taxes to comply with the complex requirements. Leveraging custom-built applications such as our Pillar Two – Tax solution can ease this transition and ensure accurate and efficient reporting. As the implementation date approaches, staying informed and proactive will be crucial to ensure compliance and avoiding potential pitfalls in this new era of global tax regulation.

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