Pillar Two - Minimum 15% Effective Tax Rate
The Finance (No.2) Bill 2023 (“FB23”), one the largest Finance Bills put forward in some time, runs to 98 sections and 270 pages this year, primarily due to the implementation of the EU Minimum Tax Directive and the OECD Model Rules with regard to Pillar Two. Pillar Two seeks to ensure that large groups (i.e. groups with a turnover of €750m or more in at least two of the last four years) incur a minimum 15% effective tax rate (“ETR”) on a jurisdiction by jurisdiction basis. The tax rate is broadly based on the overall tax reported in the financial statements, so tax authorities will now bring an increased focus to deferred taxes as well as current corporation tax.
The implementation of Pillar Two via a new Part 4A, which is to be inserted into the Taxes Consolidation Act 1997 (“TCA97”) has been lauded as one of the biggest shifts in Irish corporation tax rules and policy since the move to the 12.5% headline tax rate back in the late 90’s.
The implementation of the 15% ETR is one that aligns with all EU jurisdictions and numerous other countries around the world after the OECD brokered their historic deal; however, the vast majority of Irish domestic businesses and many growing multinational groups will remain within Ireland’s existing corporation tax regime with trading profits continuing to be subjected to the 12.5% headline rate.
Whilst the 15% ETR will apply to periods commencing on or after 31 December 2023, the first payment of tax will not occur until 2026. However, financial statement disclosures and data gathering requirements mean that in-scope groups need to act quickly if not already analysing the impact Pillar Two has on them.
Pillar Two Implementation
Pillar Two contains a number of new concepts that interlink in order to achieve the minimum 15% ETR on a jurisdictional basis. Group entities in jurisdictions that incur tax at less than the 15% ETR will incur a top-up tax either in that jurisdiction or elsewhere in the group.
The main charging provisions are:
- A Qualified Domestic Top-up Tax (“QDTT”), and
- An Income Inclusion Rule (“IIR”),
- An Undertaxed Profit Rule (“UTRP”)
Qualified Domestic Top-up Tax
As Ireland’s existing tax rate of 12.5% is below Pillar Two’s minimum 15% ETR, it makes sense that the option to apply a QDTT has been included in the legislation. In essence, this ensures that Irish-based in-scope group entities should pay any top-up tax due to the Irish exchequer under Pillar Two rather than having such undertaxed profit picked up in a group entity outside of Ireland.
QDTT paid in Ireland should be creditable against any IIR or UTRP liability that may arise elsewhere in the group or otherwise place Ireland’s regime into the safe harbour dealt with further below. Irish Local Financial Accounting Standards are to be used to prepare the calculations for QDTT.
Income Inclusion Rule
The IIR is the primary Pillar Two rule and requires the Ultimate Parent Entity (“UPE”) in the group to determine whether or not the constituent entities have paid the ETR on a jurisdiction-by-jurisdiction basis for the relevant period. If the tax paid in a given jurisdiction is under the ETR, the UPE will pay additional taxes in its jurisdiction in order to meet the overall group-wide test to get to the 15% ETR.
Where the UPE is located in a jurisdiction that has not adopted the Pillar Two rules, the obligation moves down the chain in the group in order to find the most senior entity in the group that is tax resident in a jurisdiction that has adopted the Pillar Two rules. Such entity is then referred to as the Intermediate Parent Entity (“IPE”).
Undertaxed Profit Rule
The UTPR is the secondary rule for the collection of taxes under Pillar Two. UTPR is a backstop to the IIR for circumstances in which the UPE is not tax resident in a Pillar Two jurisdiction. The UTPR rule works by requiring an adjustment (such as a denial of a deduction) that increases the tax at the level of the subsidiary. The UTRP is not expected to come into effect until 2025, one year after the IIR rule commences.
Given the significant compliance burden that Pillar Two presents for in-scope taxpayers, a number of safe harbour provisions have been included in the legislation to help ease the transition.
Qualified Domestic Minimum Top-up Tax
Where a constituent entity is in a jurisdiction with a qualifying QDTT, the top-up tax outside of that jurisdiction is reduced to zero. The Irish QDTT is expected to qualify for the safe harbour; however, clarity on this matter will only occur once the OECD peer review process is carried out.
Transitional Country-by-Country Reporting Test
Between 2024 and 2026, if one of the following tests is met, the entity/entities in a given jurisdiction qualify for the safe harbour, and the top-up tax for that jurisdiction will be deemed to be zero for the period:
- De minimis test. The group’s Country-by-Country Report (“CbCR”) revenue in the tested jurisdiction is less than €10 million, and the group’s CbCR profit (or loss) before tax is less than €1 million.
- Simplified ETR test. The tested jurisdiction has an ETR that is more than the transition rate for the fiscal year (15% in 2023 and 2024, 16% in 2025, and 17% in 2026).
- Routine profits test. The group’s CbCR profit (or loss) before tax in the tested jurisdiction is equal to or less than the substance-based income exclusion (“SBIE”) amount. The SBIE amount is computed based on the payroll costs and tangible assets in the jurisdiction.
The immediate action for all large groups should be to assess their group against the safe harbours alongside their data-gathering requirements.
Transitional UTPR Safe Harbour
The Transitional UTPR Safe Harbour allows relief from the application of a UTPR to the jurisdiction of a UPE, where that jurisdiction has a statutory corporate tax rate of at least 20 per cent for fiscal years which are no more than 12 months in duration that begin on or before 31 December 2025 and end before 31 December 2026 (referred to as the transition period).
In-scope groups will need to register with the Irish Revenue Commissioners and will be required to file a GloBE Information Return (“GIR”), which will be separate from the current standard corporation tax filing, the CT1. The first GIRs will be due in 2026.
There will be separate pay and file obligations and standalone returns for IIR, UTPR and QDTT.
For more specific changes included in the Finance Bill, read the following expert insights: