Policy paper

Explanatory note — 18 July 2023 (accessible version)

Updated 27 September 2023

Clause 1 and Schedule 1: Multinational top-up tax

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 Two 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. The UTPR is one of two charging mechanisms within the multinational top-up tax regime. The primary mechanism, which is known internationally as the “Income Inclusion Rule” (IIR), was introduced in the existing Act.

3. The UTPR works as a backstop to ensure that any amounts of multinational top-up tax that are not collected under an IIR 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.

4. 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

5. Clause 1 introduces Schedule 1.

Details of the Schedule

Schedule 1: Part 1: Introduction

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

Schedule 1: Part 2: Undertaxed profits rule

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

8. Paragraph 3 provides that section 122 will cease to refer specifically to the “responsible” members of the group.

9. 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) they are a responsible member under the 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.

10. Paragraph 4, subparagraph 2 retitles section 124 and inserts new subsection (8A) which introduces Chapter 9A. 11. Paragraph 5 inserts new Chapter 9A into Part 2 of the Act.

Chapter 9A

12. 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.

13. 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.

14. 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.

15. Subsection (4) provides that particular rules will apply for joint venture groups. 5. 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 provides 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.

49. 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.

50. Paragraph 8 adds two terms to the index of defined expressions.

51. Paragraph 9 includes the election made under section 229F in the list of elections in Schedule 15.

52. Paragraph 10 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

53. Paragraph 11 inserts new chargeability provisions which apply the rules to partnerships in the same way they apply to corporate entities to the greatest extent possible. It defines “partnership”, “limited partnership”, “limited liability partnership” and “trust”. It omits section 122(4) to section 122(6), which as a consequence of this amendment are no longer required. It also introduces partnership payment notices to the administration Schedule.

54. New section 232A provides 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.

54. Subsection (1) replicates the existing subsection 122(6), which is omitted by paragraph 11(1).

55. 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.

56. 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.

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

58. Subsection (5) specifies that this section applies only to partnerships that are not bodies corporate.

59. Paragraph 11(4) inserts new section 268A, which applies new section 232A for domestic top-up tax purposes.

60. Paragraph 11(5) omits subsections that are superseded by the application of new section 232A.

61. Paragraph 11(6) amends Schedule 14 to provide that an obligation of a 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.

62. 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.

63. 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.

64. Paragraph 11(7) adds new terms to the index of defined expressions in Schedule 17.

65. Paragraph 12 specifies 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.

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

67. Paragraph 14 clarifies the wording of section 151(7), which deals with adjustments for companies in distress.

68. Paragraph 15 provides that the reference to “excluded dividends” in subsection 153(1) only refers to the second type of excluded dividends set out in section 141(2)(b).

69. Paragraph 16 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.

70. Paragraph 17 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).

71. Paragraph 18 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.

72. Paragraph 19 amends section 177, section 178 and section 179 by inserting a number of new subsections that make provision regarding the reallocation of tax expense.

73. 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 appropriate under section 167 or 168. 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.

74. 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.

75. 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.

76. 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).

77. 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.

78. Paragraph 20 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.

79. Paragraph 21 amends section 180 to ensure that the effective tax rate of an entity in a blended CFC regime is calculated correctly.

80. Paragraph 22 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.

81. 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.

82. Paragraph 23 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, and
• 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.

83. Paragraph 24 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.

84. Paragraph 25 inserts new section 219A which introduces an election for simplified calculations for non-material members. It also defines “country-by-country report” within Part 3, with consequential changes to the definition of “qualifying country-by-country report” in Schedule 16, which is relevant to the transitional safe harbour rules.

85. 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.

86. 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, and
• the covered tax balance of that member does not need to be calculated, and the figure for income tax accrued may be used instead

87. 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.

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

89. 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.

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

91. Subsection (7) defines “income tax accrued” by reference to the relevant legislation implementing OECD country-by-country reporting guidance, or that guidance itself.

92. 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.

93. Paragraph 25(2) inserts new section 251A, which provides a definition of “country-by-country report”.

94. Paragraph 25(3) and (4) make consequential amendments to Schedules 15 and 16.

95. Paragraph 26 amends subsection 227(2) to cover the possibility of a joint venture in which two multinational groups each hold 50% ownership interests.

96. Paragraph 27 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.

97. Paragraph 28 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.

98. Paragraph 29 amends the subsections of section 255 which determine whether the OECD’s Pillar Two 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 Pillar 2 tax (including a domestic minimum top-up 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.

99. Paragraph 30 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.

100. Paragraph 31 amends paragraph 6 of Schedule 16 to correct a minor error.

101. Paragraph 32 makes miscellaneous amendments that correct errata or improve clarity, with no changes to the purpose of the relevant provisions.

102. Paragraph 33 adds three terms to the index of defined expressions in Schedule 17.

103. Paragraph 34 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

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

105. The provisions in that act implemented the “Income Inclusion Rule” (IIR) in line with the approach agreed with international partners through the “Organisation for Economic Co-operation and Development” (OECD).

106. 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.

107. 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%.

108. The model rules include a second rule which allows the top-up charge to be collected in cases where the IIR would not apply. 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.