As US and foreign multinationals prepare for Pillar Two and the application of a global minimum tax on their earnings starting in the 2024 tax year, there continues to be more questions than definitive answers. GTM addressed a number of those questions and provided guidance for preparing for Pillar Two in our recent webinar, Pillar Two is Here: What You Need to Know.
In this article, we respond directly to additional questions from tax professionals to provide practical guidance around many of the nuances of Pillar Two.
Pillar Two Timing
Q: Is there any concept of timing when it comes to Pillar Two? For example, if one year you pay UTPR and in subsequent years you are over 15%, what happens?
A: There is no “credit” concept for top-up tax under Pillar Two. The top-up tax computed under the undertaxed profits rule (UTPR) is an annual computation, and thus not impacted by the prior year’s liability or lack thereof. Jurisdictions subject to UTPR in one year cannot carryforward (or carryback) covered taxes from other years.
Pillar Two Inclusions/Exclusions
Q: Can a FIN 48 tax accrual be included in covered taxes?
A: No. Accruals for an uncertain tax position (UTP) are included as covered taxes only upon future payment/settlement of the UTP.
Q: How will income tax audit settlements be included in covered taxes?
A: An increase to a constituent entity’s covered taxes as a result of an audit settlement are treated as an increase in covered taxes in the current year (i.e., the FY in which the audit adjustment is settled/paid). However, a “material” reduction in tax due to an audit settlement requires both (a) redetermination of the covered tax and GloBE Income for the prior year(s) and (b) the effective tax rate (ETR) and top-up tax of the impacted prior year(s) to be recomputed to determine if additional top-up tax is due for the jurisdiction. The Model rules permit an election for “immaterial” decreases (defined as less than EUR 1 million in adjusted covered taxes for the jurisdiction’s FY) to be taken into account in the FY when the adjustment it made instead of adjusting the prior year. This election is available on an annual basis.
Pillar Two & Transitional Safe Harbour
Q: Does the Transitional Safe Harbour test reduce the compliance burden?
A: The goal of the Transitional Safe Harbour was to exclude multinational enterprise (MNE) group operations in low-risk countries from the compliance obligation of preparing the full Pillar Two calculation of GloBE income and covered taxes. As this only requires information to be pulled from a MNE’s CbC report and/or financial statements, we believe this will provide for streamlined calculation/reporting of a MNE’s top-up tax for many jurisdictions.
Q: Does the deminimus rule for Pillar Two include dividends?
A: The deminimus rule for the Pillar Two Transitional Safe Harbour applies the same definitions of Revenue and Profit Before Tax (PBT) as the relevant local CbCR rules. As noted in IRS CbCR Instructions for Form 8975, as well as OECD’s Oct 2022 Guidance on the implementation of CbCR (Section 7.1), “consistent with the definition of Revenues, profit/loss before tax excludes payments received from other constituent entities that are treated as dividends in the payer’s tax jurisdiction.”
Q: How would a valuation allowance impact the Transitional Safe Harbour?
A: First, a jurisdiction which discloses a pre-tax loss in its CbCR would automatically qualify for the Transitional Safe Harbour, as its Substance Based Income Exclusion amount (a positive number) would exceed the jurisdiction’s profit before tax (a negative number). However, newly profitable jurisdictions that continue to record a full or partial valuation allowance against its deferred tax assets (DTAs) may be in a position for certain years where the Simplified ETR (per the Transitional Safe Harbour rules) remains at or near 0% and the other two safe harbours are not met.
Pillar Two Reporting & Calculations
Q: Does the income per entity come before intercompany eliminations?
A: Yes, income before intercompany eliminations is the starting point, subject to a few adjustments.
Q: For dividend withholding taxes, for example, a Hong Kong parent pays dividend withholding tax (WHT) for distributions from its China subsidiary, should the tax be included in China’s ETR calculation or Hong Kong’s ETR calculation? And should the dividend itself be excluded from Hong Kong’s GloBE income?
A: Per OECD guidance [Article 3.2.1.(b)] both dividend income and associated WHT are excluded from the income/tax of the payee (HK parent). The WHT should be included in the covered taxes of China sub (payor).
Q: Is the GloBE ETR going to be part of IFRS reporting?
A: While it is not envisioned that GloBE jurisdictional ETRs will be reported for IFRS (or US GAAP) reporting, all associated Pillar Two top-up tax liabilities will be included in the multinational’s total income tax expense reported under IFRS or US GAAP.
Q: Can you speak to how a domestic loss-making company would be impacted by the UTPR or QDMTT?
A: Pillar Two rules/reporting would only apply if the multinational group (assuming US is ultimate parent entity) has consolidated revenue of >750M Euros in two of the last four years. So for a company’s 2024 tax year, it would only be subject to Pillar Two taxes (including UTPR and qualified minimum domestic top-up taxes or QDMTTs) if consolidated revenues during 2020-2023 exceeded 750M Euros (~$815M USD) in at least two of those four years. The existence of a US (domestic) loss would not exempt the company from being subject to Pillar Two compliance.
Q: If a foreign entity is allowed a share scheme deduction as in the UK, which reduces taxable income, could this impact the deferred tax and potential for deferral to spread those deductions not below a minimum 15% ETR?
A: The deferred tax implications will depend on the deduction recognition rules for UK tax purposes versus the financial accounting standards of the ultimate parent entity. In general, if a share-based tax deduction (recognized upon share vest or exercise) is at a higher/lower value than the previously recorded deferred tax asset per the financial statements, that windfall (or shortfall) tax deduction would impact covered taxes at the local statutory rate in the year of recognition. In the event of significant windfalls, this could indeed reduce a constituent entity’s GloBE ETR below 15% in the year such excess stock comp tax deduction is recognized.
GTM Can Help Your Multinational Address Pillar Two
GTM’s International Tax Services practice is here to help you prepare for Pillar Two. We are already engaged with prominent multinationals helping them determine the potential for Transitional Safe Harbour exemptions, define interaction with U.S. corporate AMT and GILTI provisions, calculate GlobE income and covered taxes (current and deferred), and more. For additional guidance on Pillar Two and other International Tax topics, visit GTM Tax Insights or Contact Us.