We explain why it is important for multinational entities (MNEs) to understand the interaction of Pillar Two and US tax principles – and how that affects UK intermediate entities.
Some of the largest property and casualty insurers are headquartered in the US and the EU. Last December, the EU Minimum Tax Directive was transposed into the respective jurisdiction tax codes and hence Pillar Two group considerations are expected to be led by the EU parent entity.
Within the last decade, the US have introduced minimum tax like measures but have yet to adopt Pillar Two. Under the Trump administration, the 2017 Tax Cuts and Jobs Acts brought in:
- Base erosion and anti-abuse tax (BEAT) which imposes a minimum tax of 10% rising to 12.5% in 2026 on certain deductible payments made to related non-US corporations.
- Global intangible low-taxed income (GILTI) – taxation on shareholders of controlled foreign companies at a rate of between 10.5% and 13.125% to discourage the movement of intangible assets and its related profits to jurisdictions with tax rates lower than the 21% US corporation tax rate.
Under the Biden administration, the latest measure is the Inflation Reduction Act which includes a new corporate alternative minimum tax (CAMT). This imposes a minimum tax equal to the excess of 15% of an applicable corporation’s adjusted financial statement income (AFSI) over its regular tax liability, plus any BEAT for the taxable year. The CAMT applies to US-parented groups whose average AFSI for the last three years exceeds US$1bn. However, this tax only applies to US operations and is based on net income rather than turnover and hence is not compliant with Pillar Two.
GILTI and BEAT also fall short of the Pillar Two requirements. GILTI is not aligned with Pillar Two on account of this being calculated using a global average rather than a jurisdiction by jurisdiction minimum tax. BEAT tax does not allow for foreign credits – this leads to double taxation and is therefore inconsistent with the Pillar Two single tax principle.
Until US legislation implements Pillar Two, the administrative burden of performing Pillar Two calculations and meeting its compliance obligations may fall to UK subsidiaries of US-headed MNEs if such subsidiaries are considered the intermediate parent entity.
Pillar Two recap
MNEs within the scope of Pillar Two rules must calculate their effective tax rate (ETR) for each jurisdiction in which they operate. They are liable to pay a top-up tax for the difference between their ETR for each jurisdiction and the 15% minimum rate of tax.
The OECD introduced this requirement in December 2021 as part of its Pillar Two global minimum tax model rules.
A qualifying MNE is broadly one with annual revenues above €750m in at least two of the previous four accounting periods, as per the consolidated financial statements of the ultimate parent entity.
If the ETR domestically is 15% or more, no top-up tax is payable. Pillar Two rules have the following components:
- An income inclusion rule (IIR), which imposes a top-up tax on the ultimate parent company in respect of the low-taxed income of a constituent entity. Where an entity’s ETR in jurisdiction is below the minimum 15% rate, the ultimate parent is primarily liable for a top-up tax to bring it up to 15%. If the ultimate parent’s jurisdiction has not implemented the Pillar Two rules, an intermediate parent entity is liable instead.
- A jurisdiction may also choose to implement a qualified domestic minimum top-up tax (QDMTT) alongside the IIR. A QDMTT ensures any top-up tax which would otherwise flow overseas is collected in the jurisdiction in which the profits are generated. In the UK, UK activities of in scope companies or groups that have an ETR under 15% are taxed under the QDMTT.
In the UK, Pillar Two is now included in the Finance (No.2) Act 2023 and comes into effect for accounting periods beginning on or after 31 December 2023. For most insurance groups, the first applicable period will be year end 31 December 2024. The enacted legislation includes the IIR and the QDMTT.
- An undertaxed profits rule (UTPR), which will require subsidiaries to collect top-up taxes if a parent entity is in a jurisdiction that has not implemented the IIR.
Last September the UK Government published draft legislation that would prevent the UTPR from being implemented before 31 December 2024. So, for insurance groups with a 31 December year end, it would be applicable for year ends 31 December 2025.
To reduce the compliance burden on companies in their early years, UK legislation includes various transitional safe harbour provisions and groups should consider the availability of these. Most are calculated using country-by-country report (CbCR) data and are explained in our separate article on transitional safe harbour test.
Pillar Two tax breakdown
The order of precedence of Pillar Two taxes in the UK is as follows:
- UK activities of in-scope companies or groups with an ETR under 15% will be taxed under the QDMTT
- Foreign activities of in-scope UK group companies with an ETR under 15% will generally be collected under the IIR
- Foreign profits taxed at an ETR under 15% which are outside the scope of the IIR can be taxed in the UK under the UTPR.
Whilst BEAT, GILTI and CAMT are not fully aligned with Pillar Two, they reduce but do not eliminate the risk of non US jurisdictions like the UK from applying UTPR to say, US group entities. However, because of a transitional safe harbour and the US having a corporate tax rate of 21%, the UTPR may not apply to companies that are headquartered in countries such as the US with a statutory corporation tax rate above 20% until 2026.
Next steps
Although the US has not yet implemented an IIR under Pillar Two rules, the Biden administration’s Green Book includes proposals to:
- align the US global intangible low-taxed income (GILTI) rules with Pillar Two
- bring in measures to qualify the CAMT as an IIR under Pillar Two by increasing the ETR and switching to calculations on a jurisdiction-by-jurisdiction basis
- replace BEAT tax with the UTPR.
No changes are expected until after the November US presidential election. Therefore, until the US implements Pillar Two / aligns the US tax code with Pillar Two, there may be instances where UK subsidiaries of US-headed MNEs will be the group’s responsible member for Pillar Two. For a 31 December year end, the UK responsible member will therefore need to make the first registration which will be due by 30 June 2025, with the first return filing and payment of top-up tax due by 30 June 2026. This will include calculating IIR and accounting for it to HMRC.
If you would like further information or advice relating to the issues covered by this article, please contact Mimi Chan.
