Pillar Two, the new global minimum tax: ten matters CFO’s and Tax Directors should know (and may be questioned on)

1. What is Pillar Two?

Pillar Two is a new top-up tax for multinational enterprises and large domestic groups (further simply referred to as MNEs or MNE) underpaying corporate tax per jurisdiction, which is likely to be introduced in several countries, following an initiative of the OECD.

2. Why?

Introduction of a minimum tax aims to end the global “race to the bottom” in corporate tax rates to ensure that MNEs pay their fair share of corporate tax. 

3. How does it work?

MNEs with an annual revenue exceeding EUR 750 million must pay a minimum corporate tax of 15% on income earned in each jurisdiction in which they operate. If the effective tax rate (ETR) in a jurisdiction is below 15%, the new top-up tax may be levied. Pillar Two will apply in more than 140 countries as of 1 January 2024.

4. Who is in scope?

In essence, MNEs exceeding the EUR 750 million turnover threshold. Pillar Two, however, does not apply to so-called Excluded Entities that may include the following entities (conditions apply):

• Government entities
• International organisations
• Non-profit organisations
• Pension funds
• Investment funds that are an ultimate parent entity
• Real estate investment vehicles that are an ultimate parent entity.

In certain specific cases, entities that are subject to the Pillar Two rules and owned by an Excluded Entity may themselves qualify as Excluded Entities. 

Excluded Entities are not taken into account for the purpose of calculating the jurisdictional ETR, any top-up tax payment, and compliance requirements.

5. How is the EUR 750 million threshold determined? 

The EUR 750 million threshold is determined on the basis of the consolidated financial statements of the ultimate parent entity of the MNE. The EUR 750 million threshold has been met if the turnover is at least EUR 750 million per financial year in:

• at least two of the four financial years immediately preceding the relevant financial year; or 
• if less than four financial years have preceded the financial year, in at least two of the financial years immediately preceding the financial year.

The turnover of Excluded Entities should be taken into account to determine whether the EUR 750 million threshold has been met.

6. How is the underpayment of corporate tax determined? 

In principle, the ETR should be determined per jurisdiction and is calculated by dividing all Covered Taxes on a jurisdictional basis by the Global Anti-Base Erosion income (GloBE income) based on the financial accounts that are used for the preparation of the MNE Group’s Consolidated Financial Statements, prior to the elimination of intra-group items (financial accounts):

• Covered Taxes are determined as follows: 
  
  • The starting point is the current tax expense as shown in the financial accounts, which includes deferred tax adjustments and the tax benefit of any losses. Covered Taxes include, in short, taxes on income and profits, not being a top-up tax;
  • Certain adjustments should be made for temporary differences and losses. Adjustments are required for example for:
    
    • Covered Taxes that are not recorded in the current tax expense
    • Taxes that do not related to the GloBE income or loss 
    • Temporary differences
    • Tax credits 
    • Certain cross-border taxes (allocation)
    • Post-filing adjustments 
• GloBE income (or loss) is calculated as follows: 
  
  • The starting point is the net income or loss as shown in the financial accounts;
  • Then adjustments should be made to align the tax base with what is typically applied for local tax purpose. Adjustments are required for example for: 
    
    • The net amount of certain tax expenses (including tax credits)
    • Excluded dividends
    • Excluded equity gains or losses
    • Included revaluation method gains or losses
    • Gains or losses from disposition of certain assets and liabilities
    • Asymmetric forex gains or losses
    • Policy disallowed expenses (such as fines)
    • Prior period errors and changes in accounting principles
    • Accrued pension expenses
    • Transfer pricing adjustments and intra-group financing
  • On a jurisdictional basis, the GloBE income jurisdiction should be reduced by the GloBE loss. If the GloBE income is negative (loss), no top-up tax may be levied. 

If the resulting ETR is below 15%, a top-up tax should be applied (15% minus ETR). Please note that the level of substance in a specific jurisdiction will be of relevance for the actual top up tax.  

7. In case of underpayment, in what ways can the top-up tax be levied? 

There are three ways to levy the top-up tax:

1. the qualified domestic minimum top-up tax: top-up tax on a jurisdictional basis in case an entity (or entities) is (or are) not subject to an ETR of 15% within that jurisdiction. 
2. the income inclusion rule: a CFC-like measure which, in principle, is levied at the
   level of the ultimate parent entity on low-taxed group entities in which an interest is held.
3. the undertaxed payments rule (backstop rule): allocates an under-tax profit surcharge to the countries in which (1) group entities of the multinational group are located and (2) where an under-tax profit measure is applicable. The corporate tax is allocated in proportion to the number of employees and tangible assets of the MNE in those countries. The undertaxed payments rule will apply as of 1 January 2025.

These measures are applied in a hierarchical order, depending on the circumstances of each group and jurisdiction.

8. Are there any exceptions?

To reduce the administrative burden and complexity of Pillar Two, the following exceptions have been introduced:

• Minimis exception: the minimis exception applies when in a jurisdiction the average qualifying turnover of all group entities resident that jurisdiction is less than EUR 10 million and the average qualifying income (or loss) is less than EUR 1 million (or a loss). If the minimis exception is applicable, the top-up tax will be nil for the group entities resident in that jurisdiction. The exception applies per jurisdiction and per year, based on a three-year average of turnover and income. Stateless and investment entities are excluded. Stateless entities could for example in certain specific cases be: flow-through entities or permanent establishments of which the income attributable to such permanent establishment is exempt.
• Safe harbour rules: the safe harbour rules allow eligible groups to avoid the complexity of the full Pillar Two analysis.
  • Temporary safe harbour rules
    • Qualifying CbCR for FY 2024-2026: if the temporary safe harbour is applicable, the top-up tax in a jurisdiction is deemed to be nil if the Country-by-Country Report (CbCR) is ‘qualifying’ and one of the following conditions are met:
      • CbCR minimis: the total income of the group entities in a jurisdiction is less than EUR 10 million and the amount of profit is less than EUR 1 million;
      • CbCR ETR test: the effective tax rate of the group entities in a jurisdiction is at least equal to the transitional rate applicable for that reporting year based on a simplified calculation; or
      • CbCR routine profits test: the amount of profit of the group entities in a jurisdiction is equal to or less than the amount of excluded income based on real presence in that jurisdiction.
    • The undertaxed payments rule FY 2025-2026: no top-up tax will be levied based on the undertaxed payments rule with respect to group entities located in the jurisdiction where the ultimate parent entity is resident, in case this jurisdiction has a statutory corporate income tax rate of 20% or more.
  • Permanent safe harbours:
    • Simplified calculations: the permanent safe harbour allows the use of simplified income, revenue and tax calculations. The simplified calculations will not be based on CbCR information, but rather on the financial reporting data that is required under Pillar Two. These simplified calculations can be applied in case at least one of the following conditions are met:
      • Simplified minimis test: the average qualifying turnover of all group entities resident in that jurisdiction is less than EUR 10 million and the amount of profit is less than EUR 1 million or there is a qualifying average loss;
      • Routine profits test: the qualifying income in a jurisdiction is equal to or less than the amount of excluded income based on real presence in that jurisdiction (the routine profit test); or
      • Simplified ETR test: the effective tax rate is at least equal to the minimum tax rate (15%).
    • Qualified domestic minimum top-Up tax: this safe harbour ensures that an MNE does not have to make a (second) calculation for a jurisdiction if a qualified domestic minimum top-up tax applies in that jurisdiction and that no further top-up tax based on the other measures may be levied. The calculation made in that jurisdiction is then the only calculation made. This safe harbour can be applied in case of the following conditions are met:
      • Qualifying accounting standard
      • Consistency standard
      • Application standard

Please note that if an MNE applies one of these exceptions with respect to a jurisdiction, it still has to meet certain requirements. For example, information must be included in the information return listing the jurisdiction where the decision has been made to apply a safe harbor rule.

9.  What are the relevant compliance aspects?

The compliance aspects in relation to Pillar Two should be distinguished between (i) the information return (and notification obligation) and (ii) the tax return.

• The information return: group entities that fall under the scope of Pillar Two must file an information return for each reporting year, unless this information return for that year is filed in a certain jurisdiction and the other countries receive the information through the exchange of information. In the latter case, group entities should notify the tax authorities. The information return (or notification) must be filed no later than fifteen months after the last day of the reporting year. For the first reporting year, the deadline is eighteen months. Information that should be provided in the information return, is e.g. general information about the group, information about the corporate structure, entities, ETR and top-up tax calculations and allocations.
• The tax return: if any top-up tax is due based on the qualified domestic minimum top-up tax, the income inclusion rule and/or the undertaxed payments rule for the reporting year, a tax return must be filed and the tax due should be paid. The tax return must be filed, and the tax due must be paid no later than seventeen months after the last day of the reporting year. For the first reporting year, the deadline is twenty months.

For a reporting year beginning January 1, 2024 and ending on December 31, 2024 the deadlines are:

• June 30, 2026 for the information return; and
• August 31, 2026 for the tax return and payment. 

It should be noted that for accounting purposes the Pillar Two positions may be important at an earlier stage. 

10. What is the impact on MNEs and and how to navigate such impact in practice?

Pillar Two compliance goes beyond tax departments. Boards, C-level leaders, accounting teams, legal teams etc. must ensure that their organisations are prepared for the complex data collection and reporting mandates. 

MNEs must adopt a new approach to data gathering. Robust systems are needed to collect and analyse financial and operational data across jurisdictions. This data will drive compliance and strategic decision-making. Organisations need to rethink their decision-making processes. 

Remember, the introduction of Pillar Two is a transformative moment for MNEs. It requires proactive planning, collaboration, and strategic alignment, which may also affect other taxes and obligations such as VAT and DAC6, as well as areas beyond tax such as employment. Pillar Two introduces a fresh perspective on tax strategy and risk management.

As such, consider how Pillar Two affects your business. As a first step, start with a kick-off impact assessment by reviewing your tax governance, structure chart and the financial accounts. We would be happy to facilitate a Pillar Two kick-off workshop and start the discussion on Pillar Two scoping with a goal to stay ahead of the curve. 

Final comments

Barbara den Exter, Associate Tax at Bird & Bird, says: “Pillar Two is not just a tax reform. It’s a global tax revolution that will disrupt the business landscape and will require new levels of tax strategy from CFO’s and Tax Directors.”

Willem Bongaerts, Co-Head Tax at Bird & Bird, adds: “Remember, the introduction of Pillar Two is a transformative moment for MNEs. It requires proactive planning, collaboration, and strategic alignment.”

Pieter Camps, Of Counsel Tax at Bird & Bird, underscores: “It is important to have cross-functional collaboration. By engaging not only tax professionals but also accounting, legal, finance, and operational teams, MNEs can navigate the complexities of Pillar Two effectively.”

Arnoud Knijnenburg, Partner Tax at Bird & Bird, concludes: “As we navigate this critical shift, MNEs must recognise the magnitude of Pillar Two. It’s a call for innovative approaches, informed decision-making, and adaptability.”

So, CFOs and Tax Directors, brace yourselves for this tax revolution! Collaborate, strategise, and stay ahead in the ever-evolving tax landscape.

Please contact Barbara den Exter, Willem Bongaerts, Pieter Camps, Arnoud Knijnenburg or your regular Bird & Bird contact to discuss Pillar Two for your business.