As we approach the end of the calendar year many finance teams will also be preparing for the end of the financial year, and for those with a tax remit, this will also mean making sure that any last-minute accounting entries are made to ensure the transfer pricing policies are being implemented as intended.
This also marks the first period Pillar 2 may be in point.
For those not in the know, Pillar 2 is part of an international tax initiative led by the Organisation for Economic Cooperation and Development (“OECD”) to prevent base erosion and profit shifting (“BEPS”). In particular, Pillar 2 was developed as a response to the new commercial realities of wide-spread digitalisation, and the recognition that most international tax regimes developed for bricks-and-mortar operations were failing to keep pace.
Pillar 2 sets a requirement for a minimum 15% tax rate in each territory that large (750 million euro or more revenue) multinational groups operate in. Broadly, where a multinational group is operating in a territory and paying less than 15% tax on its profits in that territory, there will be some top-up tax to pay. This could be collected by:
- the jurisdiction of the ultimate parent of the group under Income Inclusion Rules; or
- the jurisdiction of a sister company under backstop rules referred to as Under Tax Profits Rules (for example because the ultimate parent is in a territory that has not implemented Pillar 2); or
- the jurisdiction where the effective tax rate was below 15% in the first instance.
The OECD is not itself a lawmaker, but the guidance for Pillar 2 was developed in collaboration with the G20 under the ‘Inclusive Framework’. Model rules were proposed in 2021 and have been updated and supplemented following input from a multitude (over 135) of tax authorities, the result is that there are relatively granular rules, intended to be adopted on a consistent basis across different tax authorities. There has been widespread adoption but not all jurisdictions that contributed to the model rules have actively implemented laws to adopt Pillar 2.
In the UK, Pillar 2 was legislated in Finance (No. 2) Act 2023, and updated in Finance Act 2024. HMRC has also helpfully provided guidance, along with a dedicated email address (pillar2mailbox@hmrc.gov.uk), to help those impacted by the new requirements prepare for the changes to come.
Many tax authorities, including the UK, have implemented a domestic top-up tax to ensure that where UK businesses are subject to a top-up tax, it is collected by HMRC rather than an overseas territory. This is referred to in the OECD guidance as a Qualified Domestic Top-Up Tax (“QDMTT”).
Though ostensibly a ‘simple’ test of checking that a minimum 15% tax has been paid in the respective territories, the application of the rules is complex and is likely to require data that won’t be at the fingertips of many tax teams – particularly for groups operating across lots of territories. A number of adjustments are required to accounting results (including, inter alia, calculating deferred tax, adjusting the impact of uncertain tax positions and adjustments in respect of taxable distributions) and careful consideration is required in the event of mergers and demergers during a given period.
To ease into the process, there are some administrative safe harbours available for periods starting before 31 December 2026 and ending on or before 30 June 2028 (so for calendar year groups2024, 2025 and 2026); under these transitional safe harbours, qualifying companies will be able to rely on the data already provided through the Country-by-Country Report (“CbCR”). This is likely to be substantially less time-consuming than preparing ‘full’ effective tax rate calculations.
Qualifying for the transitional safe harbours does not exempt reporting entities from compliance obligations: registration and annual reporting will still be required in most territories that have adopted Pillar 2 rules. In the UK, a one-time registration is due within six months of the end of the first period in scope (so 30 June 2025 for a 31 December 2024 year-end) and annual returns are due 15 months after the end of the period (18 months for the first period, so 30 June 2026 and 31 March 2027 respectively for accounting periods ending 31 December 2024 and 31 December 2025).
Where the group has prepared a “qualified” CbCR for a given period, one of three tests must be satisfied in order to qualify for the transitional safe harbour:
- A revenue and profits test (less than 10mn euros revenue and 1mn euro profit in the territory);
- An effective tax rate test (15% minimum for 2024, 16% in 2025 and 17% in 2026); or
- A routine profits test – where the aggregate profit before tax is not greater than the qualified substance-based income exclusion for the territory (these are separate calculations based on fixed asset values and payroll).
It is important to note that the transitional safe harbours operate on a “once-out, always out” basis. As such, groups seeking to take advantage of the reduced compliance obligations under the transitional safe harbour should ensure that they will have a qualified CbCR, and that the necessary notifications and elections are made to HMRC for the first qualifying period – the safe harbours do not automatically apply.
UK-headed groups, or groups headed outside the UK but having nominated their UK entities as reporting entities will need to consider the results of all territories within the group, and the varying degrees of territorial legislation to ensure that compliance obligations are being met, and where necessary, additional tax has been collected and settled. A group need not operate internationally in order to be within the scope of the rules; wholly UK groups that meet the revenue threshold are still required to register and file reports.
If you would like support preparing for Pillar 2 or managing your transfer pricing obligations, please do get in touch with us.
If you want to sign up for our newsletters, please click on the ‘subscribe to our newsletter’ icon on our Homepage.
Claritas is one of the UK’s leading, full-service tax advisory and compliance practices. By combining our extensive practice and industry experience, we’re able to ensure you receive the very best tax and transfer pricing advice, whether that be in helping you establish new policies, supporting you with compliance, reviewing your existing policies and procedures to ensure they are still fit for purpose, or helping you through transactions and post-transaction implementations.
