At Home and Abroad - UK publishes draft legislation for domestic top-up tax

You could be forgiven for thinking there may have been a collective sigh amongst multinational tax departments when the latest installment of the UK’s implementation of the OECD’s Pillar Two project was published as part of the Spring Finance Bill 2023.

The Finance Bill included an updated draft of the UK’s Income Inclusion Rule (IIR) legislation, (first published in July 2022), as well as the first draft of legislation for a UK domestic top-up tax (DTT).

The implementation of Pillar Two rules in the UK is fast approaching, and at first glance an additional set of rules in the form of a DTT could have presented a further challenge for multinational groups that are already in a race against time to prepare for the necessary requirements of the Pillar Two regime. However, the DTT rules have minimal departures from the IIR rules, and limited additional data points are required for the calculations, which will be a welcome development for groups within scope.

Why are domestic top-up taxes needed in a Pillar Two world?

The OECD model rules included provision for jurisdictions to introduce a Qualified Domestic Minimum Top Up Tax (QDMTT) as part of their local implementation of the Pillar Two rules. The basic premise is to enable tax authorities to collect any incremental tax arising under the Pillar Two rules from domestic activities in their own jurisdiction, rather than such tax revenues being payable to tax authorities overseas under the IIR or UTPR (together the ‘GloBE rules’).

The intention is for a domestic top-up tax to be computed on broadly the same basis as the GloBE rules, such that it is considered ‘qualifying’ and can operate to prevent further tax being levied (or calculations being required) under the GloBE rules.

As with all things Pillar Two, the devil is in the detail and in practice there are expected to be divergences (both in substance and interpretation) in many jurisdictions’ local introduction and implementation of QDMTT, meaning further work will inevitably be required, but on the home front, at least this is kept to a minimum.

What is included in the UK DTT?

The good news is that the UK DTT appears to largely follow the UK IIR rules and is effective for the same periods beginning on or after 31 December 2023. There are some specific adjustments that are required in order for the UK rules to ‘qualify’ as a QDMTT. Importantly, the draft legislation confirms that for the purposes of calculating the DTT there is no allocation to the UK of taxes paid on UK profits under overseas CFC regimes, and no allocation of overseas head office taxes to UK branches. Similarly, taxes paid in respect of overseas profits under the UK CFC regime are fully excluded from the calculations.

Another difference is the ability for UK groups to perform the calculations using UK GAAP accounts (even if the UPE uses a different accounting standard), although this may have a relatively narrow application given it is limited to groups with no overseas entities.

Like the GloBE rules, the effective tax rate is calculated on a jurisdictional basis and if necessary ‘topped-up’ to an effective tax rate of 15%.

What does this mean for compliance?

The filing requirements broadly mirror those required under the UK IIR. The ‘filing member’ has a ‘one time’ registration requirement with HMRC within six months of the end of the first accounting period that it is within the scope of the DTT rules. The filing member is the ultimate parent entity of the group, unless a nomination is made in respect of another group company. Any such nomination must apply for the purpose of both the UK IIR and the UK DTT.

Both an information return, and a self assessment return must be filed (and top-up tax paid) within 15 months of the end of the accounting period (18 months for the first period). As with the IIR, an information return is not required in the UK if a return has already been submitted to an overseas tax authority which has an information sharing agreement with HMRC.

What about the transitional safe harbour?

The draft legislation confirms that the transitional safe harbour provisions will apply to the UK DTT. This is important as it means that detailed DTT calculations will not be required if one of the three safe harbour tests are met in respect of a group’s UK operations.

Critical to the application of the safe harbour is the requirement for an MNE group’s CbC Report to be ‘qualifying’, and in practice we expect this may require changes to many groups’ existing processes and methodology for CbCR preparation and reporting. The potential to reduce Pillar Two compliance obligations, as well as the forthcoming EU public CbCR disclosures mean that a group’s country-by-country report will become central to the group’s Pillar Two compliance strategy as outlined here.

What are the practical implications of the DTT for MNEs operating in the UK?

Given the similarity in calculation methodology, the additional layer of complexity introduced by the UK DTT is limited in the context of Pillar Two as a whole. The biggest win for MNEs with operations in the UK is that calculations prepared under a compliant QDMTT have the potential to prevent further calculations being required under an overseas IIR or UTPR regime. The OECD are working towards a QDMTT safe harbour which is intended to have such an effect.

For non-UK headed groups, it will be important to identify any differences between the UK DTT rules and any applicable IIR rules of a parent entity, to determine whether any additional data points will be required in order to perform the calculations. A similar exercise will be required for UK-headed groups in respect of local QDMTTs introduced by jurisdictions in which they have subsidiaries.

The UK’s implementation of the Pillar Two rules is fast approaching and groups within scope should take action now to understand the potential impact on their group, as well as ensure their current data model, systems, technology and processes are able to deal with the requirements of the new regime.

Where do you start?

The biggest challenges we see group’s facing are: the gathering of the significant number of incremental datapoints, outside of business as usual compliance and reporting, that are required for the Pillar Two calculations; operationalising Pillar Two compliance and reporting; and allocating already thinly stretched resources to accomplish this.

Identifying the data requirements and developing a comprehensive data strategy should be one of the first steps a group undertakes on its journey to be #PillarTwoReady. PwC’s Pillar Two Data Input Catalog sets out the necessary datapoints that are required to perform the Pillar Two calculations and provides insights on building a data strategy and achieving operational readiness.

Technology and transformation will be critical to delivering on compliance and reporting. Each group will face it’s own unique challenges and there is no one size fits all solution but there is a connected approach that can be applied by leveraging as much as possible from a group’s existing technology, data gathering and compliance processes and then enhancing this with targeted technology such as automations of existing processes and PwC’s Pillar Two Engine, a quantitative analysis and compliance tool. Through our Connected Compliance approach group’s can fully automate the process reducing disruptions and giving precious time and resource back.

To discuss the contents of this article, or any other points relating to Pillar Two, please contact the authors of this article directly, or speak to your usual PwC contact.

Contact us

Giorgia Maffini

Giorgia Maffini

Director, PwC United Kingdom

Tel: +44 (0)7483 378124

Matt Ryan

Matt Ryan

Partner, Tax, PwC United Kingdom

Tel: +44 (0)7718 981211

Andy Blundell

Andy Blundell

Director, PwC United Kingdom

Tel: +44 (0)7753 463818

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