Policy paper

Explanatory note — 27 September 2023 (accessible version)

Updated 27 September 2023

Schedule 1: Pillar Two

Summary

1. This measure amends the Parts and Schedules of Finance (No.2) Act 2023 that implement multinational top-up tax and domestic top-up tax, the UK version of the Organisation for Economic Co-operation and Development’s Pillar 2 rules. These amendments are made in a Schedule (Schedule 1) with two operative Parts, Parts 2 and 3.

2. Part 2 of the Schedule introduces the “undertaxed profits rule” (UTPR) into UK legislation.

3. Part 3 of the Schedule makes amendments to multinational top-up tax and domestic top-up tax provisions in the Finance (No.2) Act 2023.

Details of the Clause

4. Clause 1 introduces Schedule 1.

Details of the Schedule

Schedule 1: Part 1: Introduction

5. Paragraph 1 introduces Parts 2 and 3 of Schedule 1.

Schedule 1: Part 2: Undertaxed profits rule

6. Paragraph 2 includes UTPR within Part 2 of the Finance (No.2) Act 2023.

7. Paragraph 3 provides that section 122 will cease to refer specifically to the “responsible” members of the group so that any UK member can be a chargeable person for the purposes of the UTPR.

8. Paragraph 4, subparagraph 1 replaces section 123. The new section 123 provides that, where a group contains members that have a top-up amount, a member is chargeable if (a) it is a responsible member under the income inclusion rule (IIR) provisions, or (b) there is an “untaxed amount” allocated to it under the UTPR provisions. The amount charged is to be determined according to those provisions and converted into sterling (where necessary) using the average exchange rate for the accounting period.

9. Paragraph 4, subparagraph 2 retitles section 124 and inserts new subsection (8A) which introduces Chapter 9A.

10. Paragraph 5 inserts new Chapter 9A into Part 2 of the Act.

Chapter 9A

11. New section 229A defines “potentially undertaxed” for the purposes of multinational top-up tax. A top-up amount will be potentially undertaxed if it is not collected by the IIR mechanism. This ensures that IIR takes precedence over UTPR.

12. Subsection (1) provides that the top-up amount (including additional top-up amounts) of a member is potentially undertaxed if that member is located in the territory of the ultimate parent. This is necessary because the IIR will not apply to members located in the ultimate parent territory.

13. Subsections (2) and (3) provide that where the top-up amount of a member is collectible under an IIR, the “taxed condition” will be met, and the amount will not be collected through the UTPR.

14. Subsection (4) provides that particular rules will apply for joint venture groups.

15. New section 229B specifies when there is an “untaxed amount” for the purposes of multinational top-up tax and also provides rules for determining the amount that is untaxed.

16. Subsection (1) provides that both conditions A and B must be met for there to be an untaxed amount.

17. Subsection (2) gives condition A. This condition provides that a member will only have an untaxed amount where its top-up amount (including any additional top-up amount) is potentially undertaxed.

18. Subsection (3) gives condition B. This condition provides that a member will only have an untaxed amount if it still has a residual top-up amount (including additional top-up amounts) after allocation of its top-up amount to responsible members under Chapter 7.

19. Subsection (4) provides that the untaxed amount is the residual top-up amount, as determined under the previous subsection.

20. New section 229C provides the methodology for allocating an untaxed amount to UK members of the group.

21. Subsection (1) provides that one first determines the proportion of the untaxed amount that should be allocated to the UK (according to the UTPR allocation key, see new section 229D), and then allocates that UK proportion between the UK members.

22. Subsection (2) provides that amounts will not be allocated to investment entities.

23. New section 229D provides the rules for determining the proportion of an untaxed amount that should be allocated to the UK. This is the UTPR allocation key.

24. Subsection (1) provides the 8-step method for determining the allocation. The untaxed amount is allocated between territories according to the number of employees and the value of tangible fixed assets that the group has in each territory which applies a UTPR:

• steps 1-3: Find the number of employees of group members located in the UK, expressed as a proportion of the number of employees of group members located in all UTPR-applying territories
• steps 4-6: Find the value of tangible fixed assets held by group members located in the UK, expressed as a proportion of the value of tangible fixed assets held by members located in all UTPR-applying territories
• steps 7-8: Find the average of the two proportions

For example, if 15% of the group’s employees in UTPR-applying territories are employees of UK members, and 5% of the value of tangible fixed assets held by members located in UTPR territories are held by UK members, then ((15% + 5%) / 2) = 10% of the untaxed amount will be allocated to the UK.

25. Subsection (2) provides that a territory is considered to be applying the UTPR if it has implemented a qualifying UTPR, and a proportion of the untaxed amount will be allocated to it. The purpose of the latter part of the provision is to exclude a territory from the UTPR allocation key if it has not been able to collect amounts of UTPR previously allocated to it. This can happen where a territory collects the UTPR amounts via denial of tax deductions, and it has not collected the full amount of its UTPR allocation after all relevant deductions have been denied. In this circumstance, the provisions of that territory’s UTPR will set the amount to be allocated to that territory to nil. (This scenario will not arise for the UK, as the UK’s rules collect UTPR by a direct charge.)

26. New section 229E provides the rules for allocating the UK portion of the untaxed amount between UK qualifying members.

27. Subsection (1) provides the 8-step method for the allocation, which is similar to the UTPR allocation key (see new section 229D). The UK portion is allocated between UK qualifying members in proportion to the employees and tangible fixed assets of each member.

28. New section 229F introduces an election that allows a group to simplify the UTPR charge by making a single member liable for the entire UK portion of the untaxed amount.

29. Subsection (1) provides that if the election is made, there will be no allocation between members under the prior section. A single member will be liable for the entire UK portion of the untaxed amount.

30. Subsection (2) provides that the member that is being made liable under the election must be located in the UK and must consent to being made so liable.

31. Subsection (3) provides that the election is made annually. Because it is specific to UK chargeability, the election is to be made in the self-assessment return rather than the information return.

32. New section 229G provides rules for determining the number of employees of a member, for the purposes of the UTPR allocation.

33. Subsections (1) and (2) provide that the number of employees is to be the full-time equivalent and set out how to calculate this. Adjustments are made where the member was not a member of the group for the entire period.

34. Subsection (3) sets out the conditions under which a person is an employee of a member of a multinational group.

35. Subsection (4) provides that employees of a flow-through entity are treated as employees of members of the group that are both (a) located in the same territory as the flow-through entity and (b) not flow-through entities themselves. If there is no such member, such employees are disregarded for UTPR allocation purposes.

36. Subsection (5) provides that subsection (4) will not apply to employees of a permanent establishment of a flow-through entity.

37. Subsection (6) ensures that the first condition of subsection (3) will be met if the employment costs of a person are paid by a permanent establishment that does not prepare financial statements, and those costs would have been recorded in the notional statements of the permanent establishment.

38. New section 229H provides rules for determining the value of tangible fixed assets of a member, for the purposes of UTPR allocation.

39. Subsections (1) and (2) provide that the value of tangible fixed assets for a member is the average of that value at the beginning and end of the period. The value used is to be net of depreciation, depletion, and impairment.

40. Subsections (3) and (4) provide that where a member joins or leaves the group during the period, the value of its tangible fixed assets used for the purposes of subsection (1) at the start or end of the period will be nil if it is not a member at that time.

41. Subsection (5) provides that where a permanent establishment does not prepare separate financial statements, notional values are to be used, and those values are to be excluded from the accounts of the main entity for the purposes of this section.

42. Subsection (6) provides that tangible fixed assets held by flow-through entities are to be treated as being held by members of the group that (a) are located in the same territory as the flow-through entity and (b) are not flow-through entities themselves. If there is no such member, the assets are ignored for UTPR allocation purposes.

43. Subsection (7) provides that subsection (4) will not apply to assets which are held by a permanent establishment of a flow-through entity.

44. Subsection (8) defines “tangible fixed assets” for the purposes of new Chapter 9A.

45. New section 229I provides special rules for joint venture groups, which consist of a joint venture and its subsidiaries. Under the Pillar 2 rules, joint venture groups are ring-fenced from the other members of the group; their effective tax rate and top-up amounts are determined separately.

46. Subsections (1) to (3) provide that the untaxed amount of a joint venture group is calculated in a similar way as for ordinary members under new sections 229A and 229B, with the following exceptions:

• the “potentially undertaxed” condition does not need to be met
• for the joint venture group to have an untaxed amount, the ultimate parent of the multinational group of which it is a part must not be subject to an IIR tax. This is the case where the ultimate parent (a) is an excluded entity or (b) is located in a territory that does not apply a qualifying IIR
• the value of the untaxed amount is determined for all the members of the group in aggregate, rather than separately for each member as under 229B(4)

Where there is a joint venture group which is owned in equal parts by two different qualifying multinational groups, the process of determining the untaxed amount will be undertaken twice, once in respect of each group.

47. Subsection (4) provides that the untaxed amount of a joint venture group, once identified and valued, is not differentiated from the untaxed amount of the multinational group and is allocated in the same way.

48. Paragraph 6 subparagraph 1 to 3 amends headings within Schedule 16 to provide for the UTPR transitional safe harbour election.

49. Subparagraph 4 inserts a new Chapter 3 to Schedule 16 to provide the election for the UTPR transitional safe harbour, where the ‘untaxed amounts’ of all group members in the territory of the ultimate parent are treated as zero for an accounting period. The election can only be made for accounting periods that end before 31 December 2026 and where the members of the group in the territory have a combined nominal tax rate of at least 20%.

50. Subparagraph 5 amends new Schedule 16A to provide for an exclusion from the UTPR for groups with a presence in six or fewer territories, and where the total value of tangible fixed assets is €50 million or less, after excluding the tangible fixed assets held by members in the reference territory. The “reference territory” is the territory with the greatest total value of tangible fixed assets for the group. The group can only benefit from this exclusion in the first five years in which it is in scope of the UTPR. This exclusion is intended to provide a grace period for large domestic groups that are beginning to expand into multinational groups.

51. Paragraph 7 limits the meaning of “multinational top-up tax” in section 128(7)(b)(i) to the IIR provisions of the multinational top-up tax. This is necessary because some territories may implement a UTPR but not an IIR. It also amends section 257 to specify that the UK’s multinational top-up tax is a qualifying UTPR.

52. Paragraph 8 adds a term to the index of defined expressions and an election to the list of elections in Schedule 15. It also amends sections 272 and 273 to specify that Chapter 9A will not apply for domestic top-up tax purposes.

53. Paragraph 9 provides that the Treasury may determine the implementation date of UTPR in regulations made by statutory instrument. It also provides that the Treasury may make other regulations regarding the implementation of UTPR.

Schedule 1: Part 3: Other amendments

54. Paragraph 10 subparagraph 1 makes an amendment as a consequence of the change to the definition of “partnership” in paragraph 10(3) of this Schedule.

55. Subparagraph 2 inserts New section 232A to provide rules for the identification of a partnership where there is a change in its membership. It also ensures that obligations of a partnership may continue to be enforced where the partnership has ceased to exist.

56. Subsection (1) replicates the existing section 122(6) which provides that where a partner remains a member of the partnership following a change to the partnership, it will continue to be treated as the same partnership.

57. Subsection (2) provides that there is a treatment of continuity in the identity of a partnership even if the ownership interests in the partnership change hands and none of the original partners remain.

58. Subsection (3) provides that, when a partnership no longer exists, its administrative obligations and rights persist in relation to the accounting periods in which the partnership did exist. Any person who is a partner in the final accounting period continues to be treated as a partner.

59. Subsection (4) defines a “transfer of ownership interests” in a partnership.

60. Paragraph 10(3) amends section 259 to specify that a partnership does not include anything that is a body corporate.

61. Paragraph 10(4) inserts new section 268A, which applies new section 232A for domestic top-up tax purposes.

62. Paragraph 10(5) aligns the definition of a chargeable person for the purposes of domestic top-up tax and multinational top-up tax and omits subsections from section 269 that are superseded by the application of new section 232A.

63. Paragraph 10(6) amends Schedule 14 to provide that an obligation of a partnership (that is not a limited liability partnership) that has not been met may, by issue of a notice, be made an obligation of the partners, who may then receive penalties for failure to meet that obligation. A partner who is the subject of such a notice will be treated as the filing member for that obligation, in addition to the actual filing member and any other partners who are also being treated as a filing member in respect of that obligation as a result of a notice.

64. New paragraph 37A provides for a partnership payment notice (an adaptation of the group payment notice, see paragraphs 34 to 37). The partnership payment notice enables partners to be made liable for Pillar 2 charges, which is not possible under the group payment notice.

65. New paragraph 37B provides that where a partner has paid a liability arising in respect of the partnership, they may recover the amount from the other partners. The payment or recovery of tax by a partner is disregarded for their own tax purposes. The payment of a liability is to be taken into consideration for both the liability of the partnership and any liability of the partners resulting from a partnership payment notice.

66. Paragraph 10(7) adds new terms to the index of defined expressions in Schedule 17.

67. Paragraph 11 amends section 127(5) to clarify the definition of a qualifying non-profit subsidiary.

68. Paragraph 12 amends section 128 so that a main entity may be a responsible member in respect of its permanent establishment. The additional wording is necessary because a main entity has a controlling interest but not an ownership interest in its permanent establishment.

69. Paragraph 13 inserts a new subsection that provides a definition of “revenue”.

70. Paragraph 14 amends section 147 to ensure that the adjustment for pension fund expense provides for scenarios where groups have received amounts from funds, which can occur where the fund is in surplus. The addition of “directly” in subsection (2) is intended to clarify that the amounts of income and expense referred to are limited to those recognised in the accounts of a sponsoring employer solely due to the funding requirements or overfunding of its pension fund. These amounts do not include other amounts, including those received from or paid to fellow group members of the sponsoring employer whose employees may be beneficiaries of the fund. Similarly, the contributions made to the fund and the amount received from the fund, as referred to in paragraphs (a) and (b), must also be direct.

71. Paragraph 15(1) inserts new section 147A to provide for the treatment of tax credits.

72. Subsection (1) adjusts the profits so that qualified refundable tax credits and marketable transferable tax credits are accounted for as income and any other tax credits are accounted for as a tax expense.

73. Subsections (2) and (3) confirm the definitions of qualifying refundable tax credits and marketable transferable tax credits for the purposes of this section are the same as section 148 and section 148A respectively.

74. Subsection (4) introduces section 148B and section 148C which provide for the rules for valuing marketable transferable tax credits.

75. Subsection (5) introduces section 176A and section 176B which provide for the rules for valuing transferable tax credits that are not marketable transferable tax credits.

76. Subsection (6) introduces section 176C and section 176D which provide for the rules for tax credits received by a tax equity partnership.

77. Paragraph 15(2) amends the heading of section 148 to make clear that the section provides for the meaning of qualifying refundable tax credits.

78. Paragraph 15(3) inserts new section 148A to provide for the treatment of transferable tax credits.

79. Subsection (1) provides that a transferable tax credit is a tax credit where the group member is an originator, or a purchaser and the transferability condition is met.

80. Subsection (2) provides that a marketable transferable tax credit is a transferable tax credit where the marketable condition is met.

81. Subsection (3) provides that these conditions depend on whether the member is the originator or a purchaser.

82. Subsection (4) provides that the transferability condition is met for an originator if the tax credit can be transferred to an unconnected person within 15 months of the end of the accounting period in which the credit was granted. For a purchaser, the condition is met if the credit is transferred before the end of the accounting period that the credit was purchased in.

83. Subsection (5) provides that the marketable condition is met for an originator where the transferability condition is met or where similar credits are traded between unrelated persons within 15 months of the end of the accounting period in which the credit was granted, and the trade price is 80% or more of the credits net present value. For a purchaser, the condition is met where the credit was acquired from an unconnected person at a price of 80% or more of the credits net present value.

84. Subsection (6) sets out how to determine the net present value of a tax credit. This is calculated by assuming that the holder can use the full amount of the credit it is entitled to in each period and should use government debt instruments with a similar maturity to determine the discount rate.

85. Subsection (7) clarifies which accounting period should be used for the purposes of section 148A and 148B.

86. Subsection (8) confirms that where a transferable tax credit also meets the definition of a qualifying refundable tax credit, it is not treated as a transferable tax credit.

87. New section 148B provides for the profit adjustments required by the originator of a marketable transferable tax credit. The profits are adjusted to reflect the value of the marketable transferable tax credits held by the originator. The full value is recognised as income when the credit is not transferred within 15 months of the accounting period in which the credit was granted. Where the credit is transferred within 15 months, the consideration of the transfer is recognised. The section also includes the treatment to be applied when a credit is transferred for consideration that is less than the value of the tax credit.

88. New section 148C provides for the profit adjustments required for the purchaser of a marketable transferable tax credit. The profits are adjusted to include the value of the marketable transferable tax credits held as a purchaser. Where a tax credit is used in an accounting period, the amount of the credit used is to be recognised as income. The section also provides for how the value of the tax credit used in an accounting period is calculated.

89. Paragraph 15(4) and (5) amend section 175 and section 176 respectively to include marketable transferable tax credits when making adjustments to the covered tax balance.

90. Paragraph 15(6) inserts new section 176A which provides for the adjustments to the covered tax balance of a member that holds a non-marketable transferable tax credit as an originator.

91. New section 176B provides for the adjustments to the covered tax balance of a member that holds a non-marketable transferable tax credit as a purchaser.

92. Paragraph 16(1) inserts new section 176C which provides for the allocation of tax credits under tax equity partnerships. It confirms that where a member is an investor in a tax equity partnership arrangement and an election is made under section 165, any qualifying flow-through tax benefits provided to the member under the arrangements are excluded from its covered tax balance (and accordingly will increase the combined covered tax balance, to the extent that these have been accounted for within the current tax expense). Non-qualifying flow-through tax benefits are reflected as a credit in the covered tax balance. The section confirms that section 176D determines the extent to which any flow-through tax benefits are ‘qualifying’ for arrangements where the profits of the investor are accounted for using the proportional amortisation method, or where the filing member has made an election to use the proportional amortisation method for that member. It also confirms that section 176E applies in all other circumstances. It also includes the conditions for determining whether a member is and isn’t an investor in a tax equity partnership arrangement. The section also provides the meaning of the proportional amortisation method for the purposes of applying the section.

93. New section 176D provides for the steps required to determine the extent to which flow-through tax benefits provided to an investor under the proportional amortisation method are qualifying.

94. New section 176E provides for the steps required to determine the extent to which flow-through benefits provided to an investor under the subtraction method are qualifying.

95. Paragraph 16(2) adds the election in section 176C to the list of elections in schedule 15.

96. Paragraph 17 clarifies the wording of section 151(7), which deals with adjustments for companies in distress.

97. Paragraph 18 clarifies the wording of section 152 which deals with adjustments where life assurance business is carried on.

98. Paragraph 19 provides that the reference to “excluded dividends” in section 153(1) only refers to the second type of excluded dividends set out in section 141(2)(b).

99. Paragraph 20 clarifies the definition of qualifying intra-group financing arrangements to prevent circularity.

100. Paragraph 21 amends section 159 to clarify that where an amount is properly attributable to a main entity, it is not to be reflected in the underlying profits of any permanent establishments of that main entity. In addition, such amounts are reflected (or not reflected) in the underlying profits of the permanent establishment irrespective of whether they are considered for tax purposes.

101. Paragraph 22 makes an amendment to section 168 that allows the profits of transparent entities and reverse hybrid entities to be allocated to an individual as well as to an entity. It also adds a provision that ensures that such profits are properly allocated when the ultimate parent of a group is a flow-through entity. Separately, the definition of “tax transparent” in section 238 is amended so that an entity may be tax transparent to a certain extent (for instance, if it is transparent for the purposes of taxes on income but not taxes on capital gains).

102. Paragraph 23 amends section 173 to ensure that, where a member of a group is made liable to a tax that is a substitute for a tax on profits, it will be a covered tax regardless of which territory is imposing the tax.

103. Paragraph 24 amends section 177, section 178 and section 179 by inserting a number of new subsections that make provision regarding the reallocation of tax expense.

104. New section 178(1A) provides that, where an amount of qualifying current tax expense relates to profits that are not included in the member’s underlying profits, the amount will still be reallocated to another member of the group if the amount would have been so allocated under section 167 or 168 if, hypothetically, the profits had been included in the member’s underlying profits. This ensures that, where the profits of a hybrid entity are taxed at the level of its parent, the tax can be allocated to that hybrid entity.

105. New section 178(1B) clarifies when an amount of tax expense that has been reallocated from one member to another is to be excluded from the covered tax balance.

106. New section 178(5) and (6) clarify that, where an amount of qualifying current tax expense is not reallocated due to the limit relating to mobile income, it remains with the original member. If the income or gains to which the tax expense relates are not included in the adjusted profits of the member to which it would have been allocated, the tax expense is excluded from the covered tax balance of both members.

107. New section 179(1A) provides that a qualifying current tax expense amount allocated to a Controlled Foreign Company (CFC) is to be regarded as a qualifying current tax expense of that CFC for the purposes of section 175(2)(a).

108. New section 179(3A) and (3B) make equivalent provision to sections 178(5) and (6) for amounts not reallocated from an owner to a CFC.

109. Paragraph 25 makes various amendments to sections 179 and 180, which deal with controlled foreign companies (CFCs). Subparagraphs (2), (3) and (5) define a new term, “CFC entity”. The change enables tax that is allocated to a CFC from its parent to also be allocated to permanent establishments of, or disregarded entities owned by, that CFC. It supplants the term “blended CFC entity” that was defined in section 180(10). Subparagraph (4) omits that subsection and makes other consequential changes.

110. Paragraph 26 amends section 180 to ensure that the effective tax rate of an entity in a blended CFC regime is calculated correctly.

111. Paragraph 27 amends section 183(3)(b), ensuring that the domestic tax rate of the member is used where it relates to the utilisation of a domestic loss. It also inserts new section 183A.

112. New section 183A provides that, where a member has set a domestic loss against foreign income, and its territory consequently raises the limit on foreign tax credits that may be applied against tax on the foreign income, a special foreign tax asset will be created. This asset can be used to increase the covered tax balance of the member. It provides that the value of that asset is the amount of the domestic loss used, multiplied by the nominal rate of tax in the member’s territory but restricted to the minimum rate of 15%. It limits the amount of the asset that can be used in the period to the additional amount of foreign tax credits that may be credited as a result of the utilisation of the domestic loss. Any remainder may be carried forward.

113. Paragraph 28(1) amends section 196 to clarify the calculation of eligible payroll costs for the purposes of the substance based income exclusion where an employee carried out work in two or more territories.

114. Paragraph 28(2) amends section 197 to clarify the calculation of eligible tangible assets amounts for the purposes of the substance based income exclusion where an asset is located in more than one territory during the period.

115. Paragraph 29 amends section 196 and 197 to clarify that the inclusion of payroll costs and assets when calculating the substance based income exclusion is voluntary.

116. Paragraph 30 amends section 197 to include impairment losses and the reversal of a previous impairment loss in the calculation of the substance based income exclusion.

117. Paragraph 31 inserts new subsection (7A) in section 197 to clarify the calculation of eligible tangible asset amounts for the purposes of the substance based income exclusion where part of an asset is held for lease but another part of the asset is retained for use by the member holding the asset.

118. Paragraph 32(1) inserts new subsection (7A) in section 195 to provide for new section 197A.

119. New section 197A is a placeholder for the treatment and valuation of operating leases for the purposes of the substance based income exclusion.

120. Paragraph 33 inserts new section 198A to introduce a power to make further provisions by way of regulations concerning the treatment of payroll costs and assets for the purposes of the substance based income exclusion.

121. Paragraph 34 amends section 211 to provide that, where:

• assets are transferred intra-group between two parties in a tax consolidation group
• the parties are located in the same territory
• an election to exclude intra-group transactions has been made

the value of the assets used in determining the adjusted profits of each member is the carrying value of the assets in the hands of the transferor.

122. Paragraph 35 amends section 213 to specify what happens if profits or qualifying tax expense are allocated to an investment entity that is being treated as tax transparent by election.

123. Paragraph 36(1) inserts new section 219A which introduces an election for simplified calculations for non-material members.

124. New section 219A provides for a simplified version of the rules to be applied to non-material members. It uses figures from the country-by-country report so that the adjusted profits and covered tax balance of non-material members do not need to be calculated.

125. Subsections (1) and (2) provide that, where an election is made in respect of a non-material member:

• the adjusted profits of that member do not need to be calculated and the figure for revenue for that member is to be used instead
• the covered tax balance of that member does not need to be calculated, and the figure for income tax accrued may be used instead

126. Subsection (3) provides that a member will be non-material if its financial results are not consolidated by the ultimate parent because of an exclusion on size or materiality grounds, or if it is a permanent establishment of such a member.

127. Subsection (4) provides that revenue and income tax accrued are to be derived from qualified financial statements.

128. Subsection (5) provides that financial statements will be qualified if they are (a) prepared in accordance with country-by-country reporting guidance of the relevant territory, and (b) externally audited and confirmed to be non-material. If the revenue exceeds €50 million, they must be prepared in accordance with an acceptable or authorised financial accounting standard.

129. Subsection (6) provides that the “relevant territory” is the one where the country-by-country report is filed.

130. Subsection (7) defines “income tax accrued” by reference to the relevant legislation implementing Organisation for Economic Co-operation and Development (OECD) country-by-country reporting guidance, or that guidance itself.

131. Subsections (8) to (10) provide that the election must be made in the first accounting period in which the member is subject to Pillar 2 rules. The election may be revoked at any time but cannot be made again once revoked.

132. Paragraph 36(2) inserts new section 251A, which provides a definition of “country-by-country report” and “the OECD’s guidance on country-by-country reporting”, with consequential changes to the definition of “qualifying country-by-country report” in Schedule 16, which is relevant to the transitional safe harbour rules.

133. Paragraph 36(3) to (5) make consequential amendments to section 276 and Schedules 15 and 16.

134. Paragraph 37 amends section 227(2) to cover the possibility of a joint venture in which two multinational groups each hold 50% ownership interests.

135. Paragraph 38 amends section 236(2) by combining paragraphs (b) and (c) and simplifying the language. It also clarifies the language of section 236(2)(e) by creating a new subsection (2A) and amends the test in section 236(2)(e) so that it applies to all ownership interests, including indirect interests.

136. Paragraph 39 amends section 240(1) so that the test is applied after having assumed that the flow-through entity is located in the territory in which it was created. This assumption is necessary because whether the flow-through entity is a responsible member or not will depend on its location.

137. Paragraph 40(1) replaces section 254 with updated rules on currency conversions.

138. Subsection (1) provides that calculations are to be carried out in the currency of the consolidated financial statements of the ultimate parent.

139. Subsection (2) provides that where an amount is required to be converted into the currency of the consolidated financial statements, the conversion is done to accord with the authorised accounting standards or the appropriate accounting standard if consolidated financial statements are not prepared.

140. Subsection (3) provides that where a provision requires an amount to be converted into euros for the purpose of comparison with a threshold in the legislation, the average exchange rate for the December of the preceding period should be used.

141. Subsection (4) and subsection (5) specify the source of rates for the purposes of subsection (3).

142. Paragraph 40(2) provides the rule for the conversion of top-up amounts into sterling for the purpose of calculating the amount charged.

143. Paragraph 41(1) amends the subsections of section 255 which determine whether the OECD’s Pillar 2 rules are considered to apply to a member of a group. It is clarified that the test applies period-by-period and for a particular member of the group (the “relevant member”), rather than the group as a whole. Two new conditions are introduced, both of which must be met in addition to that in the current provision. Condition B ensures that at least one member that is located in the territory of the relevant member is subject to a qualifying IIR tax or undertaxed profits tax. Condition C is that the transitional safe harbour does not apply to the territory for that period. Consequential changes ensure that, in effect, Condition C does not need to be met for the purposes of paragraphs 2 and 3 of Schedule 16.

144. Paragraph 41(2) amends paragraph 2 in Schedule 16 which deals with intra-group transfers before entry into the regime.

145. Paragraph 42(1) inserts new section 256A to provide for instances where a qualifying domestic top-up tax (QDT) credit is not taken into account to reduce any top-up tax amounts or additional top-up amounts due under the IIR or UTPR. An amount of QDT is treated as not accruing where its enforceability is in question, which means that either the member disputes its enforceability or the tax authority that imposed the QDT considers the amount unenforceable. Once the enforceability is addressed, either because the amount is paid or the dispute is settled, any QDT amounts will accrue.

146. Paragraph 42(2) and (3) are consequential amendments.

147. Paragraph 43 inserts new subsections (9) and (10) to section 272. These subsections provide that where an investment entity has not made a profit in the accounting period, for the purpose of domestic top-up tax the total top-up tax amount is divided by the number of qualifying entities in the group to arrive at each members top-up amount.

148. Paragraph 44 inserts new section 273A to provide that for the purposes of domestic top up tax, references to the first accounting period for the Pillar 2 rules within section 185, section 197 and paragraph 2 of Schedule 16 are to the first accounting period that an entity is a qualifying entity.

149. New section 273B provides for instances where a member is subject to domestic top up tax before it is subject to the Pillar Two rules (for example, before it is in scope of another jurisdiction’s IIR or UTPR). The transition year for domestic top up tax will reset when the Pillar Two rules subsequently apply to the member and the provision sets out how deferred tax liabilities, collective additional amounts and special loss deferred tax assets arising in the interim shall be treated.

150. Paragraph 45 amends Schedule 14 to provide that HMRC is not liable to repay any amount of overpaid tax unless a claim has been made. This paragraph also amends paragraph 33 in Schedule 14 to clarify that any amount paid that was not due incurs interest at the rate provided for in regulations.

151. Paragraph 46 amends paragraph 2 in Schedule 16 which deals with intra-group transfers before entry into the regime. The amendment adjusts the value of deferred tax assets that can be taken into account in relation to such transfers.

152. Paragraph 47 amends Part 2 of Schedule 16 to clarify that the transitional safe harbour election is made by the filing member is respect of a territory and has the effect that all members located in the territory are treated as not having any top-up amounts for the purposes of multinational top-up tax.

153. Paragraph 48 inserts new Part 3 to Schedule 16 to provide for the transitional reporting election, which may change the reporting requirements for the information contained within the information return for all members in the territory for which the election is made. HMRC may specify in a notice what the alternative reporting requirements are for the accounting periods for which an election is made. The existing provisions for the submission of information returns in Schedule 14 apply to these alternative requirements. The part includes the conditions that are required to be met in order to make the election.

154. Paragraph 49 inserts a new Schedule 16A titled ‘Multinational top-up tax: safe harbours’.

155. New Part 1 Chapter 1 introduces the qualifying domestic minimum top-up tax (QDMTT) safe harbour election. The filing member may make an election under which all members of the group located in a territory are treated as not having top-up tax amounts for the purposes of calculating multinational top-up tax. The election can only be made if a QDMTT applies. The election cannot be made where the enforceability of an amount of QDMTT is in question. Additionally, the following “switch-off rules” apply:

• if the ultimate parent or another responsible member is a flow-through entity and the territory it is located in cannot impose a qualifying domestic top-up tax on an ultimate parent or responsible member that is a flow-through entity, the election cannot be made for the territory of that responsible member. (It is possible that a QDMTT ordinarily imposes the tax only on the standard members of the group in the territory but will impose the tax on a flow-through entity where there are no standard members. In this case, the condition at subsection 3(d) would not be met. For this condition to be met, it must be the case that the QDMTT will not be imposed on such members even when there is no other member to charge.)
• if the qualifying domestic top-up tax imposed in the territory does not apply to a group within scope of Pillar 2 in the initial phase of international expansion, the election cannot be made for that territory

156. New Chapter 2 provides for the application of the safe harbour to non-standard members of the group. A separate election can be made for joint venture groups, investment entities, and minority owned members. There are two further switch-off rules for joint venture groups and investment entities.

157. Paragraph 50 makes miscellaneous amendments that correct errata or improve clarity, with no changes to the purpose of the relevant provisions.

158. Paragraph 51 adds a number of terms to the index of defined expressions in Schedule 17.

159. Paragraph 52 provides that these amendments will commence on the same date as the Part being amended, and they will therefore come into effect for accounting periods commencing on or after 31 December 2023.

Background note

160. This measure makes amendments to the multinational top-up tax and domestic top-up tax, which was introduced in Finance (No.2) Act 2023 and will come into effect from 31 December 2023.

161. The provisions in that act implement the “Income Inclusion Rule” (IIR) and a “Qualifying Domestic Minimum Top-Up Tax” (QDMTT) in line with the approach agreed with international partners through the “Organisation for Economic Co-operation and Development” (OECD).

162. The OECD approach was published as the Pillar 2 model rules. The model rules were agreed by the “Inclusive Framework on Base Erosion and Profit Shifting”, a group of over 130 countries committed to cooperation in the field of international tax.

163. The model rules set out an approach that has been designed to ensure that large multinational enterprises pay a minimum level of tax in each territory in which they operate. The minimum level of tax that has been agreed under the rules is 15%. If necessary, a top-up charge is applied to bring the effective tax rate up to 15%.

164. The model rules include a secondary rule which allows the top-up charge to be collected in cases where neither the IIR nor a QDMTT applies. This rule is called the “Undertaxed Profits Rule” (UTPR) and is provided for under Part 2 of Schedule 1 in this measure. The effective date of the UTPR provisions will be set in regulations.

165. The UTPR works as a backstop to ensure that any amounts of top-up charge that are not collected under the IIR or a QDMTT will still be collected. These “untaxed” amounts are identified and then allocated between territories that enforce the UTPR. The allocation is made according to an allocation key that reflects the relative proportion of tangible fixed assets and number of employees in each of those territories.

166. A QDMTT is a top-up tax charged by a territory on the profits of entities located in that territory, to ensure that they pay the minimum level of tax, in accordance with the model rules. The effective tax rate of the entities is calculated in the same way as it is for the other Pillar 2 taxes, including multinational top-up tax.