On 23 March 2023, HM Treasury published draft legislation and an explanatory note in respect of the UK’s domestic implementation of an income inclusion rule (‘multinational top-up tax’) and a qualified domestic minimum top-up tax, in line with the G20/OECD Inclusive Framework’s global minimum tax (‘Pillar Two’) rules.

This follows the statement on the components of global tax reform, agreed by more than 135 members of the G20/OECD Inclusive Framework (‘OECD Inclusive Framework’ or ‘OECD’) in October 2021, and the subsequent publication by the OECD Inclusive Framework of Model Rules for Pillar Two, commentary, safe harbours and administrative guidance.

OECD Pillar Two rules

The OECD Pillar Two global minimum tax rules are set out in the OECD Model Rules published in December 2021, along with subsequent agreed OECD commentary and guidance. The OECD Model Rules apply to large multinational groups with annual consolidated group revenue of at least €750 million and have the following 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%.
• An 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 where the group operates which have adopted the undertaxed profits rule based on a formula.
• The OECD Model Rules also allow countries to introduce a qualified domestic minimum top-up tax (QDMTT) aligned with Pillar Two. Top-up taxes in respect of any low-taxed profits of a group’s entities in a country are paid to the local tax authority under a qualified domestic minimum top-up tax, rather than to other countries under the income inclusion or undertaxed profits rules.
  
  

Multinational top-up tax (income inclusion rule)

The draft legislation includes clauses on the charge to tax; qualifying multinational groups; the calculation of the effective tax rate, adjusted profits and covered taxes; calculating and allocating top-up taxes; adjustments including for group restructurings; special rules for certain types of entity (e.g. joint venture groups); definitions; and transitional rules.

Qualified domestic top-up tax

The draft legislation includes a UK qualified domestic minimum top-up tax which will impose a top-up tax in the UK on low-taxed UK profits. This applies to the UK profits of both UK-headed and non-UK headed groups, including wholly domestic UK groups and standalone UK entities, above the Pillar Two revenue threshold (i.e. revenue per annum in excess of €750 million).

The qualified domestic top-up tax rules utilise the multinational top-up tax rules for calculating the effective tax rate, adjusted profits and covered taxes; top-up taxes; other adjustments including group restructurings; and special rules for certain types of entity (e.g. joint venture groups); with consequential modifications e.g. to remove circularity.

Wholly domestic UK groups may elect to calculate their profits using UK GAAP (rather than the accounting standard used in the ultimate parent company consolidated financial statements).

Safe harbours

Both the multinational top-up tax and the qualified domestic top-up tax rules include clauses to implement the transitional safe harbour in line with the implementation package published by the OECD Inclusive Framework on 20 December 2022. It applies for accounting periods beginning on or before 31 December 2026 (i.e., three years for most groups).

The transitional safe harbour uses information from a business’s qualifying country-by-country (CbC) report and/or financial statements to determine whether its operations in a country meet any of three tests:

• Threshold test – the business has aggregate revenues of less than €10 million and profit before income tax of less than €1 million on its CbC report for a country.
• Routine profits test – the business’s aggregate profit before income tax in a country is equal to or less than the ‘substance-based income exclusion amount’.
• Simplified effective tax rate (ETR) test – the business has a ‘simplified ETR’ for a country that is equal to or greater than transition rates beginning at 15% and increasing to 17% by 2026.
  
  

UK reporting process and administration

The proposed UK reporting processes for the multinational top-up tax and UK qualified domestic top-up tax will include:

• A one-time requirement for in-scope groups to register with HMRC when they first come into scope of the rules.
• An annual UK self-assessment return to provide HMRC with details of entities’ UK top-up tax liabilities.

These requirements will apply alongside OECD 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. (The OECD is continuing to work on information return filing requirements and the administrative framework, including the exchange of information between tax authorities.)
• 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.

The filing deadline for the UK self-assessment return and Pillar Two information return (or overseas notification return) is 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).

Next steps

The draft legislation is included in Finance (No.2) Bill which is proceeding through Parliamentary processes.

The multinational top-up tax and qualified domestic top-up tax will have effect in the UK in respect of accounting periods beginning on or after 31 December 2023.