New and far-reaching legislation will come into effect on 1 January 2024 for enterprises that operate internationally. Additional top-up tax may be charged at several levels if an effective tax rate of less than 15% applies in another jurisdiction. Since this Pillar Two legislation is expected to be implemented worldwide, it is very important to determine the implications of the new rules for your taxation, reporting and business model. In this article, we will detail the scope of Pillar Two and the principal rules.
Pillar Two: A global minimum tax rate
The idea of a minimum tax rate has been on the table for years, fueled, among other things, by a desire to combat tax-base erosion at an international level. A broad international consensus to set a lower limit for the effective taxes on profit paid by large multinationals was reached in 2021. In late 2022, a European directive was approved to implement these rules. All EU Member States are required to transpose this Directive into national law by 1 January 2024. The Dutch draft legislative proposal for the Minimum Tax Act 2024 was submitted for online consultation year. The actual proposal has now been published, and will need to be further discussed and approved this year.
What enterprises does Pillar Two apply to?
Although Pillar Two focuses primarily on large multinationals, it could certainly also affect (smaller) group companies. The Dutch legislation uses the consolidated (worldwide) group revenue as a basis for determining the scope. If the consolidated group revenue is € 750 million or more, all individual group entities are, in principle, subject to this legislation. This means that even relatively small Dutch companies that are part of a corporate group could potentially be affected by this legislation. Pillar Two provides for a limited number of exceptions, for example for governmental entities and pension funds, and group companies with actual economic activities or limited revenues and profits.
What additional requirements may Dutch entities face?
The Pillar Two legislation provides for the collection of a top-up tax if the effective tax rate of another group company is below the minimum rate of 15%. In order to accurately map the tax positions of the other group entities, all qualifying Dutch group entities are required to file an annual top-up tax information return. The top-up tax information return is a form requesting detailed information about the multinational group. Under certain conditions, it is possible to have a single entity submit this information on behalf of all group entities established in the Netherlands. The top-up tax information return must be submitted to the Dutch Tax Authorities within 15 months of the last day of the financial year.
If the top-up tax information return is not filed, or not filed in time, or filed incorrectly, or filed incompletely, this may result in a penalty of up to €900,000. In addition, the required information is both detailed and substantial, and relates to more than just the Dutch entity. It is therefore important to be aware of this requirement at the earliest possible stage.
What are the specific consequences of Pillar Two?
In a nutshell, the legislation aims to ensure that the group’s profits are charged at a minimum of 15% everywhere. This is determined at the level of the individual jurisdiction rather than at a group level. Therefore the taxable profits (based on the financial reports, and after applying a number of tax adjustments) and the resulting effective tax rates are determined for each individual jurisdiction in which the group operates. The top-up tax may be applied in three different ways:
Income Inclusion Rule (IIR)
The IIR is a top-up tax at the level of the (ultimate) parent entity. Once it has been established that there are foreign entities within the group which are subject to an effective tax rate of less than 15%, the difference may be charged in the country where the (ultimate) parent entity is a tax resident.
Qualified Domestic Top-up Tax (QDMTT)
At the level of the subsidiary, a top-up tax may also be imposed if the company is subject to an effective tax rate of less than 15% (and if the relevant country has also implemented Pillar Two). If domestic top-up taxes are charged in a specific country based on the QDMTT, the Netherlands provides a tax credit in the IIR, so that in principle, no double taxation should occur.
Under Taxed Payment Rule (UTPR)
In some cases, the IIR (along with the QDMTT) does not yet lead to the desired minimum taxation, for example if the (ultimate) parent entity is established in a low-tax country that does not apply the IIR. In such cases, countries which have implemented Pillar Two including the UTPR could charge top-up taxes on the profits earned by low-tax companies elsewhere in the group. This means the UTPR is a backstop for cases in which Pillar Two is not applied in all countries concerned.
Example of calculation
We will demonstrate the IIR based on a highly simplified calculation example.
The ultimate parent entity, M BV, is established in the Netherlands. The company makes a profit of 2,000 and pays 500 in tax. This brings the effective tax rate to 25%.
Its subsidiary D Co, established in a low-tax country that does not apply the QDMTT, makes a profit of 10,000 and pays 500 in taxes. This brings the effective tax rate to 5% (i.e. 10% lower than the minimum rate).
Under the IIR, a ‘top-up tax’ is imposed in the Netherlands of 1,000, i.e. the profit made by D Co, multiplied by 10%. This ‘top-up tax’ is paid to the Dutch Tax Authorities.
In reality, the structure of a qualifying group will often be significantly more complicated. In addition, the legislation provides for all sorts of adjustments and specific exceptions, and it is also important to take into account any interaction with foreign tax laws. The process of mapping these communicating vessels requires thorough analysis.
Monitoring & advice
Our experts are happy to help you map the implications of this new legislation for your business and your international group. We can discuss the principal rules and exceptions, the consequences and obligations, as well as the impact of this system on your business operations, accounts and reporting. If needed, we can liaise with local specialists within our worldwide Baker Tilly International network, providing you with a clear picture of the local requirements applicable to the countries in which your company operates.
If you have any questions about the latest developments regarding Pillar Two or would like to know how we can help you at every stage of the process, our advisors would be happy to discuss these matters with you.
The legislation and regulations in this area may be subject to change. We recommend that you discuss the potential impact of this with your Baker Tilly consultant.