Advisers and businesses would be wise not to hold out for finality and certainty before engaging with these highly complex and evolving rules. The first instalment of the UK legislation to implement Pillar Two was enacted in July as Part 3 (multinational top-up tax (MTT)) and Part 4 (domestic top-up tax (DTT)) of Finance (No. 2) Act 2023. But this is still work in progress with further provisions and amendments to be included in the next Finance Bill and there’s also a time-limited power to make changes by regulation in order to ensure the UK legislation corresponds to the global anti-base erosion (GloBE) Model Rules and OECD commentary and guidance thereon.

The MTT and the DTT are scheduled to apply to in scope groups/entities for accounting periods beginning on or after 31 December 2023 so that doesn’t leave long for those groups and entities which will be caught by these rules in 2024 to get to grips with them and the additional compliance obligations they impose. Smaller groups should not be too complacent, however, if they are not yet in scope, as this could change within a year or two, particularly if group revenue increases suddenly, for example, following an acquisition.

There are important choices to be made and some of them will be lost if not made from first application of the rules to the group/entity. This post looks at some of those choices currently in the UK legislation or proposed legislation and at further elections expected to be made available by the time the rules commence.

In or out of scope?

This question differs for MTT and DTT. Taking MTT first, a multinational group with at least one group member in the UK will be within scope of the MTT if the threshold test is met and the rules will then apply to group members which are not taxed under the hierarchy of the Model Rules under another territory’s income inclusion rule (IIR), unless they are excluded. A standalone UK entity which otherwise would not be a member of a multinational group, but which has one or more permanent establishments (PEs), will be treated as a group because a PE is treated for these rules as separate from the main entity.

The MTT is payable in respect of members of multinational groups located outside the UK where their effective rate of tax (ETR) in another territory is less than 15%. However, another territory’s domestic top-up tax will, if qualifying, be credited against the UK’s MTT or, if the qualifying domestic top-up tax (QDMTT) safe harbour applies to that other territory’s domestic top-up tax, there will be no need to do the UK’s MTT calculation in the first place.

For DTT, there is no need for the group to be multinational, or even for there to be a group. Indeed, a single UK entity, unless excluded, will be in scope if it meets the threshold test. DTT is payable in respect of in scope entities which are located in the UK and have an ETR on their UK profits of less than 15%.

It is important to note the backward-looking nature of the threshold test. For the test to be met in an accounting period, you have to look at the annual revenue for the four previous accounting periods. Taking the example of a group with a calendar year accounting period, the threshold test will be met if the group has an annual revenue in excess of €750m in at least two of the previous four accounting periods. So, in order for the rules to apply in 2024, the group must have had annual revenue in excess of €750m in at least two of the accounting periods for 2020, 2021, 2022 or 2023. Given that this covers the period of the pandemic, some smaller groups may find that the new taxes will not apply from 2024 because they will not have clocked up two years of requisite revenue by the end of 2023, but, depending on their circumstances, they may reach the threshold test in 2025 or later.

Elections, safe harbours and reliefs

Part of the complexity of the UK rules stems from the flexibility the Model Rules, together with the commentary and guidance, permit. Accordingly, the rules are peppered with elections. Elections made for MTT purposes (or elections made under a foreign IIR in an information return which is shared with HMRC), which would be relevant in calculating DTT, apply also for DTT purposes.

Some elections are annual and apply to the relevant accounting period only, some are long-term and apply until revoked, but cannot be revoked for 5 years and some, if revoked, cannot be made again in future, or cannot be made again for a number of accounting periods. Some elections are specific to members of a group in a particular territory, others are specific to a particular entity.

Many of the elections provide simplifications to, or workarounds for, the calculations of adjusted profits and covered tax balance, others feed more directly into the determination of top-up amounts. For example, the election to apply the de minimis rule in section 199 to treat the top-up amount for a territory as nil where the group has revenues in that territory of less than €10m and profits of less than €1m. Or the section 195(2)) election not to calculate the substance based income exclusion for a territory for an accounting period (with the consequence that the exclusion is nil) to save the expense of doing so where the benefit of the relief for that period is not enough to make it worthwhile.

Other elections simplify the administration of the rules, for example the section 271 election to make one member of a group liable for DTT on behalf of the group, or the election to be included in the next Finance Bill to make one UK member of a group liable for any untaxed amounts under the new undertaxed payments rule (UTPR) to be inserted as Chapter 9A Finance (No. 2) Act 2023 from a date to be confirmed in regulations, but not before 2025.

Once out, always out

Some elections are required to benefit from the safe harbours which have been agreed internationally. Some safe harbours are transitional, others are permanent. It is important to note that two of the safe harbour elections are “once out, always out” which means they have to be made in respect of the first accounting period for which the rules apply to the relevant members or to members in the relevant territory, depending on the safe harbour, and if not made in that accounting period, cannot be made in a later period. The first is the non-material members safe harbour (to be added in the next Finance Bill) which will simplify calculations for the specified non-material member. This is a permanent safe harbour although the Safe Harbours and Penalty Relief guidance on which it is based notes that the methodology used for the simplified calculations will be reviewed by the Inclusive Framework no later than 2028 to evaluate whether the integrity of the GloBE Rules is undermined. 

The second is the transitional CBCR safe harbour in Finance (No. 2) Act 2023, Schedule 16, paragraph 3.  The draft HMRC guidance at MTT15910 explains (in the context of the CBCR safe harbour but equally relevant to the non-material members safe harbour too) that the 'once out, always out' approach applies because the purpose of the safe harbour is to reduce the compliance obligations of the group when preparing systems for MTT compliance when first entering the regime. Where the conditions are satisfied and an election is made for a territory for an accounting period in the transitional period, the effect is that there are no top-up amounts for that accounting period for the relevant members in that territory. The CBCR safe harbour will apply to the UTPR as well as to the MTT and the DTT so is well worth considering in preference to other applicable safe harbours. 

Relief from UTPR for early stages of international expansion

There are some reliefs that do not require an election, such as the temporary relief from the UTPR (to be added by the next Finance Bill to Finance (No.2) Act 2023, Schedule 16 as Part 3) which will apply in certain circumstances to groups in their initial phase of international expansion. To qualify, a group must not have members in more than six territories and must hold no more than €50m of tangible assets outside the country in which it has the largest tangible asset base. This relief no longer applies after the group has been in scope of the Chapter 9A UTPR rules for 5 years.

Finally, bear in mind that there are two further elections provided for in the second tranche of the OECD Administrative Guidance published in July 2023 which are not yet included in UK legislation or draft legislation.  Although it is expected that these will be included in due course, it requires a leap of faith to build them in to the modelling and planning before they become law.

QDMTT safe harbour

The first of these is the QDMTT safe harbour which will be a permanent safe harbour. Unfortunately, it does not bring as much simplification as I had hoped for! It would operate to deem the GloBE top-up for the relevant jurisdiction to be nil, meaning that, for the jurisdiction, the group would have to undertake only the QDMTT, and not also the IIR calculation. 

Without the safe harbour, the QDMTT is applied as a credit against top-up tax due under an IIR. It’s obviously a good thing not to have to do both calculations, but the QDMTT calculation itself is not simple. For example, the UK’s domestic top-up tax, which is drafted so as to be a QDMTT under the Model Rules, applies the same calculation rules as for the MTT (with some modifications) to calculate the DTT. 

In fact, the QDMTT safe harbour can be seen as bringing in even more complexity because not every QDMTT will qualify for the safe harbour! Because of the greater latitude afforded to jurisdictions in the design of their QDMTTs (as compared to their implementation of the GloBE Rules), the guidance sets out three additional criteria that QDMTTs will need to meet in order to qualify for the safe harbour which will be assessed pursuant to a peer review process by reference to the relevant legislation and its practical administration.

According to the Administrative Guidance, the QDMTT safe harbour would need to be elected into, and the election will only be available where the QDMTT would have otherwise reduced an IIR top-up. Where a QDMTT charge is challenged, for instance on the basis of its being unconstitutional or contrary to a tax stabilisation agreement, the Administrative Guidance envisages that the QDMTT cannot reduce the IIR top-up. So, in those circumstances, the QDMTT safe harbour would be unavailable as well.

Transitional UTPR safe harbour

The second election yet to be provided for in the UK is the transitional UTPR safe harbour which will deem top-up amounts to be zero for an ultimate parent’s jurisdiction that has an applicable corporate income tax rate of at least 20% for the transition period (fiscal years, no longer than 12 months, beginning before 1 January 2025 and ending before 31 December 2026). As this safe harbour looks at the headline rate of tax as shown on the OECD’s Statutory Corporate Income Tax Rates list, not at an effective rate, it provides certainty as to which jurisdictions can benefit from the safe harbour. It is partly political but also makes practical sense because the UTPR is supposed to operate as a secondary, or backstop rule but would, in the absence of the safe harbour, apply more often in the early years while jurisdictions implement IIRs and QDMTTs.