Pillar Two – the OECD model rules and UK implementation

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The “Pillar Two” model rules are part of the OECD’s “Two Pillar Solution”, which aims to address the tax challenges posed by the digitalisation of the economy. However, the scope of the rules enacting Pillar Two extend far beyond traditionally “digital” businesses, to most high-revenue multi-national enterprises.

As is obvious from the name, the OECD plans to reach agreement on two “Pillars”, and the requisite level of international consensus on scope, design and implementation needed to publish model rules has first been reached on Pillar Two. Pillar Two has two components:

  1. The adoption of an effective global minimum 15% corporate tax rate; and
  2. A “subject to tax” rule, which allows developing countries to impose a top-up withholding tax on certain outbound payments between related parties which are taxed at a nominal rate of less than 9%.


The Pillar Two rules will apply to groups:

  1. who are “multi-national enterprises” (broadly, they have a foreign presence); and
  2. whose global consolidated revenues are greater than €750m in at least two of the preceding four fiscal years.

There is a de minimis exclusion for jurisdictions where the group has revenues of less than €10m and profits of less than €1m. As such, only the largest worldwide businesses will be caught.

Importantly, the rules will not apply to certain exempt entities, broadly including pension funds, and ultimate parent entities (and most asset holding companies) of investment funds and real estate investment funds. However, these exemptions are complex and will require careful review in individual cases. The OECD framework notes that this is in recognition of the shared tax policy to tax investors as if they held underlying assets directly.

The proposed criteria for such entities reflect this intent; for example, the definition of a “Real Estate Investment Vehicle” is widely drawn, requiring that the entity achieves a “single layer of taxation either in its hands or the hands of its interest holders…provided that the person holds predominantly immovable property and is itself widely held”. It is hoped that most domestic real estate investment regimes (including the UK’s increasingly popular REIT regime) should benefit from this exemption.

How do the rules work?

While the need to account for a myriad of circumstances means that the application of the rules can become extremely complex, the basic premise is simple.

In order to apply the effective minimum 15% corporate tax rate rule, the taxpayer must:

  1. Calculate the effective tax rate for each jurisdiction in which they operate. This involves:
    1. Calculating the income per jurisdiction (this is based on the financial accounts, subject to certain adjustments to reconcile differences between tax and accounting measures of profit, and note that certain income including most dividends and equity gains derived from subsidiaries will be left out of account); and
    2. Calculating the tax attributable, per jurisdiction, to that income. The effective tax rate includes corporate income taxes (such as UK corporation tax) and withholding taxes, but will not include indirect taxes, property taxes or payroll taxes;
  2. If that rate is less than 15%, pay a “top up” tax per jurisdiction where the effective tax rate is less than 15%. In calculating the “top up”, a fixed percentage return on tangible assets and payroll expenses in that jurisdiction should first be deducted. The fixed percentage return starts at 8% for tangible assets and 10% for payroll expenses, tapering each fiscal year until 2033, where it will remain at 5%; and
  3. (Generally) pay that “top up” tax in the jurisdiction where the ultimate parent of the group is resident. Note, however, that:
    1. the model rules envisage that countries may decide to introduce a domestic minimum tax rate to ensure that the tax revenue of profits generated in a subsidiary jurisdiction stays within the jurisdiction (rather than going to the jurisdiction of the parent entity). As per HMRC and HM Treasury’s joint consultation published earlier this year, the UK is considering implementing such a domestic minimum top up tax; and
    2. the model rules plan for situations where the jurisdiction of the ultimate parent does not abide by the minimum 15% rules, by providing that in this circumstance, the top up tax will be due from other group entities, in proportion to the tangible assets and employees in that jurisdiction (known as the “undertaxed profits rule”).

It is important to note that the rules operate by reference to effective tax rates, not headline tax rates. Effective tax rates may be lower than 15%, notwithstanding higher applicable headline rates, as a result of, for example, reliefs or timing differences. A significant compliance burden is therefore likely to arise.

The “subject to tax” rule

Ancillary to the adoption of the global minimum 15% tax rate is the “subject to tax” rule.

This has been included at the insistence of developing countries (and may only be used by them), who feel that they are disadvantaged by their current international tax arrangements. Broadly, the “subject to tax” rule requires that bilateral tax treaties are amended to provide for a minimum 9% withholding tax on certain outbound payments (such as royalties and interest) originating in developing companies and which are made between related parties.

Recent developments

While the publication of the model rules in December 2021, which were approved and agreed by delegates from over 130 countries, was heralded as a consensus on scope, design and implementation, recent developments suggest that we may yet see significant changes to the regime.

For example, in January 2021, the Business at OECD group (BIAC) published an open letter to the OECD critical of the model rules in their current form. The letter took aim not only at the complexity of the calculation rules, but also at failures to meet certain policy intent. Given that the BIAC is recognised by the OECD as the voice of businesses, and works closely with the OECD on policy development, changes to the model rules seem likely.

UK proposed implementation

The release of HMRC and HM Treasury’s consultation on the implementation of the Pillar Two model rules demonstrates the UK government’s commitment to the project. The consultation is clear that, as it stands, the UK government is fully behind the model rules published by the OECD. Their view is that political consensus has been reached, and the consultation’s primary focus is implementation and administration, with the stated aim being to implement as closely to the OECD model rules as possible.

It is currently intended that domestic legislation implementing the “top up” charge where the UK is the jurisdiction of the ultimate parent entity (or in certain circumstances where the UK is an intermediate parent entity jurisdiction) is effective from 1 April 2023, with legislation implementing the undertaxed profits rule to come into force in 2024.

As set out above, the UK government intends to implement a domestic minimum tax of 15%, in order to prevent tax revenue from UK subsidiaries of foreign headquartered companies being diverted overseas to be taxed in the jurisdiction of the ultimate parent company. Again, it is not expected that the legislation introducing these rules will be effective until 2024.

The government has, however, decided against a general extension of the “top up” tax to groups headquartered in the UK with revenues below €750m (although note that the threshold for in-scope groups looks at whether the group’s consolidated financial revenues are greater than €750m in at least two of the preceding four fiscal years – so where a group’s annual revenue falls below €750m, this will not automatically take it out of scope). While the model rules do not prevent other jurisdictions from doing so, this policy decision has been taken on the basis of proportionality, and to ensure the UK’s attractiveness as a parent company jurisdiction.

Given the tight timescales, and the complexity of the proposals, the consultation closes for comments on 4 April 2022. Whether the UK has “jumped the gun” in releasing the consultation before the OECD commentary remains to be seen – with such commentary hopefully providing further key details.