Pillar Two is a complex tax regime. International groups are often confused as to how it affects them. What questions should directors of their UK subsidiaries be asking?
Pillar Two has been designed to set a global minimum tax rate of 15% for large groups. In broad terms, if a group has an effective tax rate (ETR) of less than 15% in a given jurisdiction, the difference is chargeable as a top-up tax.
To date, over 140 countries have introduced Pillar Two or have committed to doing so. Many jurisdictions remain undecided. Others, such as the US where some of the largest insurers are headquartered, have voiced opposition to the rules.
What is the role of subsidiaries in Pillar Two?
Large groups headquartered in non-Pillar Two jurisdictions (like the US), or otherwise present in those countries, might believe they don’t need to carry out an ETR calculation for those jurisdictions. But this is usually a wrong assumption. There are mechanisms for group members in Pillar Two jurisdictions to collect top-up taxes that are due in relation to a non-Pillar Two jurisdiction. In the UK, two such mechanisms exist:
- An income inclusion rule (IIR). This charges a top-up tax to the ultimate parent company on the low-taxed income of a constituent entity that is not collected by a domestic top-up tax. The ultimate parent is primarily liable for this tax. But if that parent’s jurisdiction has not implemented Pillar Two, an intermediate parent entity is liable instead.
- An undertaxed profits rule (UTPR). This requires group members to collect top-up taxes relating to a parent or sister entity that aren’t already captured by a domestic top-up tax or an IIR.
Could head office get it wrong?
So what does this mean for UK subsidiaries of large insurance groups? For international, group-wide matters like Pillar Two, a top-down approach is usually taken. This means the group’s head office provides instructions to its subsidiaries on what they need to do to comply with local Pillar Two rules.
But a problem arises if the head office (or its advisers is not well-versed in the status of Pillar Two rollout across all its jurisdictions. Specifically, it may not be aware that UK subsidiaries could be liable for top-up taxes in respect of other group members. Read our previous article on how UK intermediate entities of US-parented insurance groups are affected by Pillar Two, linked below.
Directors of UK subsidiaries may instead need to adopt a bottom-up approach. They would initiate Pillar Two discussions with their head office, relay the precise UK requirements, and ask the right questions. That way the group is clear on how to help its UK subsidiaries comply with local Pillar Two requirements.
Clearing up misconceptions
Through these discussions UK company directors may discover misunderstandings from head office (or its advisers) about the application of the Pillar Two rules in the UK.
Here are some of the most common misconceptions, along with counter arguments.
Top-up tax can’t be applied in respect of non-Pillar Two jurisdictions…
Although those jurisdictions haven’t brought in Pillar Two rules, the UK (among other Pillar Two countries) has implemented the IIR, which can collect top-up taxes in respect of low-taxed subsidiaries of UK companies. It also has the UTPR, which can collect top-up taxes in respect of low-taxed parent and sister companies.
Our headline tax rate is at least 15% in each jurisdiction, so no top-up taxes will arise…
For Pillar Two, rather than comparing the headline tax rate to 15%, groups need to compute their ETR (based on specific rules) and compare this to the 15%.
Our ETR is at least 15% in each jurisdiction, so we don’t need to prepare any calculations…
Groups will still need to file yearly Pillar Two returns. They must also prepare calculations that show the ETR is at least 15% in each jurisdiction.
Pillar Two is a temporary problem. It will be abolished sooner or later given that countries such as the US are refusing to implement it…
The OECD (which has designed the rules) says it will keep working with the US on Pillar Two. And with over 140 countries signed up so far, Pillar Two won’t be going away any time soon.
As we have no top-up tax, is it possible to write to HMRC to be exempted from Pillar Two filings?…
HMRC makes no allowances for nil returns (or exempting anyone from the regime). Groups in scope will have to file returns even if they show no top-up taxes under the simplified or full ETR tests.
Groups with a UK presence that are in scope of Pillar Two are also in scope of country-by-country (CbC) reporting. Groups’ filed CbC reports will contain some financial information on the group’s activities in each jurisdiction (including revenues and taxes paid). HMRC will see the information in these reports, either because the group has filed them directly or because they have filed them in a jurisdiction that shares this information with HMRC. This means HMRC will use this knowledge as a database for expected Pillar Two returns.
What should UK directors do next?
UK company directors must consider whether Pillar Two applies to the group of which their UK subsidiaries form a part. After the upcoming 30 June 2025 registration deadline (where only limited information is required), directors should engage with the wider group to coordinate Pillar Two compliance that includes the UK subsidiaries.
For more information about issues raised in this article, please contact Mimi Chan, Jannat Moyeen or Rebecca Davies.
For an overview of the Pillar Two rules and which groups are in scope, read our previous article here.
