Phil Smyth Phil heads up The Consultancy Group’s Tax division across all industry sectors. With over 11 years of recruitment experience, Phil has built a network of best-in-class tax professionals, delivering on mandates from the newly qualified level to the Global Head of Tax – both on a permanent and interim basis.

Pillar Two Tax Reform and its Implications for UK Businesses

6 min read

Navigating the Global Minimum Tax Rate and the UK’s Response to OECD’s Initiatives

The digital revolution has not just transformed how businesses operate; it has also reshaped the very foundations of global taxation. In this era where digital enterprises can operate almost anywhere without significant physical presence, the age-old paradigms of tax competition are being challenged. Countries worldwide are reassessing how to ensure equitable corporate tax distributions, especially in the face of tech giants and multinational corporations that often traverse traditional tax boundaries.

Enter the Organisation for Economic Co-operation and Development (OECD).

Recognising the gaps and challenges of this new landscape, the OECD has crafted an innovative two-pillar tax reform solution to address these pressing concerns. While both pillars are crucial in their right, this article spotlights Pillar Two. Our aim is to demystify its intricacies and underscore its profound significance in establishing a global minimum corporate tax rate, fostering a fairer and more transparent tax environment for all.

What is Pillar Two?

Pillar Two Tax Reform

Pillar Two emerges as a beacon of hope in the turbulent waters of international taxation. Its overarching objective is simple yet transformative: to counteract the tax avoidance strategies adopted by globe-trotting multinationals. By ensuring these giants pay a fair share of tax, regardless of where they’re headquartered, Pillar Two aims to rectify inequities in the current system.

The inception of Pillar Two tax reform is a response to the evolving digital economy and the challenges it presents. Traditional tax rules often fall short of adequately addressing the complex structures of modern multinational corporations, leading to gaps where profits could go untaxed or taxed at extremely low rates. Pillar Two seeks to plug these gaps.

Pillar Two becomes even more relevant in the context of the Organisation for Economic Co-operation and Development’s inclusive framework. It’s not just about tax revenues but about fostering fairness and creating a level playing field. A scenario where every multinational, irrespective of its location or the intricacies of its operations, is held to the same tax standard.

With the EU and other major global players taking note, the scope of the Pillar extends beyond standard tax rules. It’s a statement, a commitment to redefining how we perceive and implement corporate taxation in the age of digital globalisation.

OECD GloBE Rules

At the heart of Pillar Two tax reform lies the GloBE rules. These aren’t just ornamental guidelines but robust mechanisms designed to fill the gaps. When the effective tax rate of a jurisdiction dawdles below the recommended global minimum tax rate, the GloBE rules jump into action, imposing necessary top-up taxes to balance the scales.

What Happened in April?

April marked a significant juncture in the world of taxation. With the spring budget approaching, the UK’s stance on the Pillar Two tax reform framework was eagerly awaited. A series of discussions in April and June sowed the seeds of agreement and change, setting the stage for the latest developments.

Global Minimum Corporate Tax Rate

Have you ever wondered about the ethos behind a global tax rate? At its core, it’s a battle against the shadows of base erosion and profit shifting. By instituting a universally accepted tax rate, the goal is to level the playing field. No longer would countries undercut each other, vying for the attention of multinationals through tax competition. This rate safeguards, ensuring no entity escapes its fiscal responsibility.

Top-Up Tax Calculations

Navigating the intricacies of top-up tax can seem daunting. However, its essence is straightforward. This tool ensures multinationals meet the established threshold of the global minimum tax. Entities must introspect, assessing if they fall short, especially when their effective tax rate lurks below 15%. Those that do are liable, and the top-up tax ensures they contribute their rightful share to the global coffer.

What is the Aim of Pillar Two?

Pillar Two tax reform is more than just a tax concept; it’s a robust movement towards global fiscal fairness. The primary goal? Ensuring that multinational entities (MNEs), with their vast global footprints, pay a minimum level of tax.

No longer can these entities hide behind the walls of tax havens or shift their profits to dodge their due.

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At the centre of Pillar Two are two innovative mechanisms crafted to enforce this fairness:

  • Income Inclusion Rule (IIR): As the name suggests, this rule is about including income. It ensures that if MNEs’ income is not taxed at the minimum rate in any of their operating jurisdictions, it gets included in the parent entity’s jurisdiction, thus making them liable for the shortfall.
  • Undertaxed Payments Rule (UTPR): Targeting payments that escape the minimum tax rate, UTPR takes aim at any undertaxed payments made to related entities, effectively denying deductions or imposing a source-based withholding tax.

By introducing these mechanisms, Pillar Two aims to level the playing field and usher in an era of transparent, equitable taxation. The focus isn’t just about revenues; it’s about trust. In a global economy where public perception and corporate responsibility play an increasingly pivotal role, Pillar Two sends a clear message: Every entity, regardless of size or reach, should contribute its fair share to the societies in which it operates.

Beyond the technicalities and the mechanisms lies a vision of a more harmonised global tax system. One where loopholes are closed and aggressive tax planning strategies are curtailed. By seeking to reduce the gaps and mismatches in tax rules that can artificially reduce a company’s tax obligations, Pillar Two underscores a broader aspiration: a world where businesses thrive based on their innovative prowess and market strategy, not their ability to exploit tax gaps.

UK Corporate Tax Changes: Who Does Pillar Two Affect?

Not all entities find themselves under the microscope of Pillar Two tax reform. The primary target? MNE groups with a revenue of at least €750m. However, revenue isn’t the sole criterion. For an entity to be affected, it must have its operations in at least two or more jurisdictions, underlining its multinational status.

Interestingly, an October review highlighted the role of the inclusive framework, an initiative that broadened the scope of the pillar to ensure a comprehensive approach. The EU, too, has been actively engaged in discussions, emphasising the importance of adapting these rules within its member states.

Excluded Entities Explained

In light of the new tax rules, businesses have also been keen to understand the implications related to deferred tax and potential issues of double taxation. While Pillar Two aims to standardise the income tax mechanism globally, it’s essential for companies to strategise effectively to prevent undue burdens.

As for exclusions, while Pillar Two casts a wide net, there are specific entities that escape its grip. Some entities, based on their nature, structure, or operations, are deemed “Excluded Entities.” The categorisation is not arbitrary; it stems from a detailed analysis of an entity’s functionalities. For instance, entities with genuine local operations or those benefiting from country-specific exemptions might be excluded, ensuring a balanced and fair framework. The rules also offer solace to businesses worried about double taxation, ensuring no entity is unduly taxed for the same income in different jurisdictions.

Steps UK-based Organisations Need to Take

Navigating Top-Up Tax Calculations

For UK-based MNEs, top-up taxes are more than just another line item. They’re central to the broader Pillar Two tax reform framework. Here’s the deal: every organisation has an effective tax rate (ETR) – basically, what they’re actually paying in taxes as a percentage of their profits. If a company’s ETR in any jurisdiction falls below the global minimum (currently set at 15%), they’re on the hook for the difference. That difference? It’s the top-up tax. So, organisations have to crunch the numbers, comparing their ETR against the global minimum in each place they operate. If there’s a shortfall, it’s time to top up.

Substance-Based Carve-Out

This might sound complex, but let’s break it down. Imagine a company with genuine, on-the-ground activities in a country, creating real value – maybe they’re manufacturing products or developing software. The substance-based carve-out means that profits from these genuine activities can be ‘carved out’ or exempted when calculating the minimum tax. Why? It’s all about fairness. It’s making sure companies aren’t penalised for real, tangible economic activities.

UK’s Domestic Considerations

It’s not just about the global scene. The UK is contemplating bringing its own flair to the party. Even though the OECD offers a global blueprint with Pillar Two tax reform, individual countries have the autonomy to tweak and adjust. The UK is mulling over introducing a domestic top-up tax. In simple terms, this would be a made-in-the-UK solution that complements the broader global initiative, ensuring UK MNEs play by the rules both at home and abroad.

Administrative Burdens and Preferences

Change, especially in the world of tax, is rarely smooth sailing. With Pillar Two’s introduction, there’s talk about the potential complexities it could introduce. Specifically, the UTPR – a mechanism to ensure payments between parts of the same company are fairly taxed. For many UK businesses, this rule can seem like a tangled web. That’s why there’s a growing preference for the IIR, which is seen as a more straightforward way to achieve the same goal. The bottom line? Companies need to be prepared, but they also have options on how to navigate this new landscape.

Timeline: When will the GloBE Rules Affect UK Businesses?

OECD’s Ambitious Timelines and the UK’s Stand

The OECD, with its global vision, set out ambitious deadlines for the implementation of the GloBE rules under Pillar Two. These deadlines were aimed at bringing about a cohesive global response, but individual countries have their own national considerations to bear in mind.

For UK businesses, there’s been a watchful eye on how the nation responds. While the initial timeline suggested a quicker implementation, the UK has charted its own course. Recognising the complexities and the need for more robust preparations, the UK has opted for a delay.

Implementation Delay Until 31 December 2023

The big news for UK corporations is the announcement of an implementation delay for the GloBE rules. Now, UK businesses have until 31 December 2023 to align with these new requirements. This provides a vital window for businesses to understand, adapt, and prepare for the new tax landscape.

A New Era for UK Businesses

The introduction of Pillar Two and the GloBE rules herald a new era for UK businesses, especially multinational entities. With the emphasis on creating a level playing field and ensuring every corporation pays its fair share, the significance of these reforms cannot be understated.

Stay Informed, Stay Prepared.

In this rapidly shifting tax scenario, knowledge is the true currency. UK businesses must stay informed and up-to-date with these changes, not just to comply but to thrive. It’s not just about understanding the new rules, but also about being prepared for their implications and strategic opportunities.

Navigating Tomorrow’s Tax Challenges? We’re Here to Help

Stay ahead in the changing tax landscape. Navigating these reforms might seem daunting, but you don’t have to go it alone. Let The Consultancy Group be your compass in this journey. From hiring the best tax experts to providing personalised advice and insights, we’ve got you covered. Contact our tax experts today and ensure you’re not just compliant but also competitive in the new tax era.

Phil Smyth Phil heads up The Consultancy Group’s Tax division across all industry sectors. With over 11 years of recruitment experience, Phil has built a network of best-in-class tax professionals, delivering on mandates from the newly qualified level to the Global Head of Tax – both on a permanent and interim basis.