Multinational top up tax

On 20 July 2022, HMRC published draft legislation and an explanatory note in respect of the UK’s domestic implementation of an income inclusion rule, which forms a key part of the G20/OECD Inclusive Framework’s minimum tax (‘Pillar Two’) rules. The government also published its responses to feedback received from businesses as part of the consultation earlier in 2022.

This follows the political agreement on the components of global tax reform, agreed by more than 135 members of the G20/OECD Inclusive Framework (‘Inclusive Framework’) in October 2021, and the publication by the Inclusive Framework of model rules for Pillar Two in December 2021 (‘model rules’) and commentary in March 2022. 

Background – the income inclusion rule and undertaxed profits rule

As a reminder, the OECD Pillar Two global minimum tax is set out in OECD model rules published in December 2021 and subsequent OECD commentary published in March 2022. The OECD model rules, on which the UK draft legislation is based, apply to large multinational groups with annual consolidated group revenue of at least EUR 750 million. The OECD model rules have two key components:

An income inclusion rule (IIR) applies on a top-down basis such that in most cases any tax due is calculated and paid by the ultimate parent company to the tax authority in its country. The tax due is the "top up" amount needed to bring the overall tax on the profits in each country where the group operates up to the minimum effective tax rate of 15%.

The undertaxed profits rule (UTPR, sometimes referenced as the undertaxed payments rule) will apply as a secondary (backstop) rule in cases where the effective tax rate in a country is below the minimum rate of 15%, but the income inclusion rule has not been fully applied. The top up tax is allocated to countries which have adopted the undertaxed profits rule based on a formula, and is to be implemented by countries either by denial of a deduction for payments or by making an equivalent adjustment.

For more details on the OECD model rules please see our previous alert.

UK draft legislation

The global political agreement by the Inclusive Framework is such that countries adopting the Pillar Two rules must do so on a consistent basis. The UK government has therefore focussed on how the model rules should be implemented and reflected in UK domestic legislation, with an overall approach to closely follow their intent but to adapt the structure and drafting in places in ‘an attempt to ensure the rules are as clear and understandable…as possible.’

The draft legislation contains the income inclusion rule (referred to as the ‘multinational top up tax’), including scope, determination of covered taxes and the tax base for the effective tax rate calculation, the calculation of top up tax amounts, and (relatively brief) administration rules.

The draft legislation reiterates the application of the income inclusion rule to accounting periods beginning on or after 31 December 2023.

The draft legislation does not contain clauses to implement the undertaxed profits rule (UTPR). The government is preparing to introduce such clauses, with an update on the timing and design to be released at a later date.

Domestic minimum top-up tax

The government maintains that there are strong arguments in favour of implementing a UK domestic minimum top-up tax which would impose a top-up tax in the UK on low-taxed UK profits (including those of UK-headed groups). If implemented, it is expected to apply to both UK-headed and non-UK headed groups, and only to groups above the Pillar Two revenue threshold (i.e. turnover per annum in excess of EUR 750 million). The government is considering the costs and merits of its application to wholly-domestic UK groups.

Covered taxes

The government is not proposing to produce a comprehensive list of covered taxes worldwide for the purposes of calculating the effective tax rate. However, there is express confirmation that the UK digital services tax (‘DST’) is not a covered tax, and a statement that the UK’s diverted profits tax (‘DPT’), UK tax payable under the offshore receipts in respect of intangible property (‘ORIP’) rules, and the US’s federal excise tax will all be treated as covered taxes.

Wider reforms of existing UK tax measures

Once the impact of the implementation of the Pillar Two rules has become clear, the government accepts it would be appropriate to review existing corporate tax measures to identify opportunities for reforms which could simplify the UK tax system and reduce compliance burden, if this could be done without exposing the UK tax base to significant risk.

UK reporting process and administration

The proposed UK reporting and payment processes for the income inclusion rule will include:

• A one-time requirement for in-scope groups to register with HMRC when they first come into scope of the minimum tax rules.
• An annual short domestic return to confirm entities’ UK top up tax liabilities, to be filed with HMRC via a digital service outside of the corporation tax return. This will be due by the same date as the group’s Pillar Two information return/notification (see below) - 15 months after the end of the accounting period, extended to 18 months in respect of the group’s first return period.
• Payment of the UK top up tax liability will be required in a single instalment due 15 months after the end of the accounting period (18 months in respect of the first return).  

These requirements will apply alongside Inclusive Framework compliance processes, including:

• The ultimate parent company (or a designated group member) will need to file a Pillar Two information return with its tax authority, who will then exchange the return with other tax authorities where a qualifying competent authority agreement is in place.
• Businesses relying on the filing of information returns overseas will need to notify HMRC annually of the group member filing the Pillar Two information return and in which country it is located. This will enable HMRC to link information returns received through international exchange with the correct UK taxpayer records.

Next steps

Comments on the draft legislation are invited by 14 September 2022.

Work continues at the Inclusive Framework level in respect of an implementation framework and other components of the Pillar Two rules, including safe harbours for the global minimum tax and design of the separate subject to tax rule applicable to categories of intra-group payments from developing countries.

Deloitte’s EMEA Dbriefs series will hold a webcast in early autumn 2022 to discuss the latest developments in relation to Pillar Two. For more information, and to subscribe for updates on upcoming webcasts, please visit our website.