Pillar Two: Deeper dive into updated draft Finance Bill legislation

Deeper dive into Finance Bill draft legislation on UK UTPR and other amendments to the UK Pillar Two rules

Deeper dive into updated draft legislation

Following the publication of updated draft amendments to the UK Pillar Two legislation on 27 September 2023, this article sets out further details on the expected Undertaxed Profits Rule (UTPR) safe harbour and other proposed amendments that reflect the latest Administrative Guidance issued by the G20 – Organisation for Economic Co-operation and Development (OECD) inclusive framework in July (hereafter referred as the July AG) and stakeholder observations on the Finance Act and L-Day publications.

As mentioned in the last edition of Tax Matters Digest, updated draft legislation for the next Finance Bill was issued on 27 September 2023 and is open for a further period of consultation until 25 October 2023.


The charging of the UK Multinational top-up tax (MTT) includes the UTPR in addition to the Income Inclusion Rule. Relevant changes are also made such that any UK members can be a chargeable person for the purposes of the UTPR should there be an ‘untaxed amount’.

The UTPR transitional safe harbour election mirrors one of the updates as seen in the July AG, where a jurisdiction’s combined nominal corporate tax rate (i.e. nominal national rate plus any state tax if applicable) is at least 20 percent, the ‘untaxed amount’ is treated as zero for the accounting period that begins on or before 31 December 2025 and ends before 31 December 2026 where this is not longer than 12 months. Note that the UTPR transitional safe harbour election will not apply for domestic Top-Up Tax (DTT) purposes.

Observation: The UTPR transitional safe harbour is beneficial in circumstances where: (i) the Ultimate Parent Entity (UPE) jurisdiction profits are subject to a low Effective Tax Rate (ETR), as determined for GloBE purposes; (ii) the Multinational entity (MNE) Group’s UPE is located in a jurisdiction that does not implement a qualifying domestic minimum top-up tax (QDMTT); and (iii) the MNE group has a Constituent Entity (CE) in a jurisdiction that will implement a UTPR effective in 2025 or earlier. However, it should be noted that the application of the UTPR transitional safe harbour will cause the UPE to lose eligibility for the Transitional CbCR Safe Harbour. Therefore, a MNE that is eligible for both safe harbours in the UPE jurisdiction in 2025 should carefully consider whether it may be beneficial to elect for the Transitional CbCR Safe Harbour due to the ‘once out, always out’ approach.


Section 259 is now amended to specify that a partnership does not include any entity that is a body corporate. 

New section 232A provides rules for the identification of a partnership regardless of whether there is a change in its membership, covering the following:

  •  A partner that remains a member of the partnership following a change to the partnership will continue to be treated as the same partnership;
  • Even if the ownership interests in the partnership change and none of the original partners remain, there is a treatment of continuity in the identity of a partnership; and
  • The administrative obligations of a partnership in relation to the accounting periods in which the partnership did exist may continue to be enforced where the partnership has ceased to exist.

Note that section 268A has the effect of applying the aforementioned new section 232A for DTT purposes. 

The other new provisions added have the effect of: (i) widening the MTT obligation and potential penalties to other partners of a partnership (that is not a limited liability partnership) if that obligation not be already fulfilled by the (actual) filing member; (ii) enabling partners to be made liable for MTT and DTT (if applicable), aligning with the definition of a chargeable person; and (iii) allowing a partner that has paid a liability in respect of the partnership to recover the amount from the other partners. 

Tax credits  

The treatment of tax credits can materially impact the relevant jurisdictional ETR calculation and result in a top-up tax for a multinational group. For the purposes of the ETR calculation, a tax credit is either an increase to the adjusted profits (the denominator) or a reduction to the covered tax balance (the numerator). Although both adjustments reduce the jurisdictional ETR, a reduction to the covered tax balance has a greater downward impact on the ETR. Some of the key amendments proposed by the draft legislation include:

  • The draft legislation defines a new category of tax credit, the ‘marketable transferable tax credit’ (MTTC), as a tax credit that: (i) can be used by the holder of the tax credit to reduce its covered tax balance in the issuing jurisdiction; and (ii) meets the legal transferability and marketability standards in the hands of the holder (section 148A). The transferability and marketability conditions are consistent with those laid down in the July AG that were introduced to cover certain tax credits such as those included in the US Inflation Reduction Act;
  • In the hands of the originator, the MTTCs are treated (favourably) as an increase to the GloBE tax base (denominator). If the originator uses the credit, it includes the face value of the tax credit in the GloBE income. If the originator transfers the MTTC, the originator includes the transfer price (rather than face value) in income. A purchaser of a MTTC includes the difference between the purchase price and the face value of the MTTC in its GloBE income when – and in proportion to the amount of the tax credit – the purchaser uses the credit to satisfy its covered tax liability. If a transferable tax credit is not sufficiently marketable, it may be treated as a reduction to Covered Taxes (the numerator); and
  • The draft legislation also provides for the allocation of tax credits arising from tax equity partnerships (section 176C). It confirms that where a member is an investor in a tax equity partnership arrangement and an election is made for including qualifying excluded equity gains or losses (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), whereas any non-qualifying flow-through tax benefits are reflected as a reduction to the covered tax balance. The provisions set out when such flow-through tax benefits are qualifying or not, along with provisions on applicability of the proportional amortisation method or the subtraction method.

Observation: The draft legislation is largely consistent with the guidance on tax credits contained in the July AG, which should provide some comfort to multinational groups regarding the UK’s common approach to implementation of the Pillar Two rules into its domestic legislation. The clarifications regarding the MTTC would be relevant for ETR computations in respect of overseas subsidiaries (e.g. US) for UK-based groups that benefit from such marketable and transferable tax credits.

Permanent Establishment (PE) income and expense attribution

Section 159 has been amended 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 PEs of that main entity. 

A new subsection has been added to section 159 to provide for amounts to be reflected (or not reflected) in the underlying profits of the PE regardless of whether it is subject to tax (should it be income) or deductible (should it be an expense).

Controlled foreign companies (CFC)

A new term ‘CFC entity’ is defined to enable 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. 

Substance-based Income Exclusion (SBIE) 

Changes to the SBIE in the updated draft legislation address issues related to location, simplification and impairments raised in the July AG. However, there are no changes providing updates in relation to the treatment and valuation of operating leases for the SBIE purposes - instead a placeholder is added for now in one of the new provisions. 

  • Location – If an Eligible Employee spends more than 50 percent of their time in the CE jurisdiction, the whole of their eligible costs are allocated to that jurisdiction. If it is less than 50 percent, then the portion of their time relatable to that jurisdiction will be available for the payroll carve-out. Similarly for tangible assets, if more than 50 percent of the use of tangible assets is referable to the jurisdiction, all of the carrying value of the tangible asset is available for the carve-out. If it is less than 50 percent, then the actual proportionate use is available. Note that these changes may still not produce appropriate answers for the shipping and airline industries, given the amount of time ‘in port’ for ships or ‘on the ground’ for aircraft. The updated draft legislation introduces the power to further update the rules by way of regulation concerning the treatment of payroll costs and assets for the purposes of the SBIE. 
  • Simplification – Section 196 is amended to clarify that the inclusion of payroll costs and assets when calculating the substance-based income exclusion is voluntary, i.e. the MNE is not obligated to calculate the maximum allowable claim if they are to claim under the SBIE, balancing the costs and benefits of the compliance obligations involved in capturing in-scope independent contractor costs for instance.
  • Impairment – For the purpose of determining the carrying value of Eligible Tangible Assets required for the SBIE, both impairment losses and the reversal of impairment losses will be included provided the reversal does not mean that the carrying value would be exceeded if there was no impairment loss.  

Currency conversion rules 

The draft legislation (section 254) seeks to mirror the guidance provided in the July AG – in summary, the draft legislation provides the below guidance:

  • The presentation currency used in the consolidated financial statements (CFS) of the ultimate parent is to be used for the purposes of undertaking the MTT calculations. Further, for converting any other adjustment amount into the CFS currency, the conversion should be made in accordance with the authorised accounting standards used for the purposes of preparing the CFS, or the standards that would have been used had such statements been prepared – this provides some flexibility in the rates used for currency translation where the amounts relevant to the MTT calculations are not already in the CFS currency;
  • For the purposes of comparing an amount to a figure expressed in Euros in the MTT legislation (e.g. revenue thresholds), the average exchange rate for the month of December that preceded the end of the accounting period to which the amount relates should be used. The draft legislation also clarifies the sources to be used for such exchange rates i.e., the rates prescribed by the European Central Bank or the Bank of England or the average rate on a just and reasonable basis (in order of priority); and
  • To the extent the CFS currency is not Sterling, the top-up tax liability needs to be converted into sterling using the average exchange rate for the accounting period.

Observation: Relying on the common approach, the draft legislation prescribes the currency conversion rules that are largely in line with the relevant AG issued by the OECD – this consistency provides more certainty for MNE groups as they assess the availability of data required for the GloBE ETR calculations and plan for future systems changes needed.


For the purposes of computing the UK MTT liability, the current legislation allows for a credit for any qualifying domestic top-up tax (QDTT) payable in an overseas jurisdiction that goes on to reduce the top-up tax liability under the IIR/UTPR. The draft legislation inserts a new provision to provide for instances where an amount of QDTT is to be treated as not accruing to the member where the enforceability of the amount is in question, which means that either the member disputes its enforceability or the tax authority that imposed the QDTT considers the amount unenforceable (section 256A). In case the enforceability of a QDTT ceases to be in question, either because the amount is paid or dispute is settled, any QDTT amounts will then accrue. 

The draft legislation also provides for a few clarificatory amendments concerning investment entities, non-applicability of UTPR for DTT purposes and also guidance on transition year where a member is subject to DTT before it is subject to Pillar Two rules (i.e. before it is in scope of another jurisdiction’s IIR or UTPR). 

Observation: The clarificatory amendments surrounding DTT are largely in line with the July AG and are welcome given the rules come into force from 2024 onwards (financial years ending on or after 31 December 2023).

QDTT safe harbour

The draft legislation introduces the concept of QDTT safe harbour election through insertion of new Schedule 16A. 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 MTT. The election can only be made if a QDTT applies. The election cannot be made where the enforceability of an amount of QDTT is in question (see above). There are additional ‘switch-off rules’ that can apply, such as:

  • If the ultimate parent or another responsible member is a flow-through entity and the territory it is located in cannot impose a QDTT 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; and 
  • If the QDTT imposed in the territory does not apply to a group within scope of Pillar Two in the initial phase of international expansion, the election cannot be made for that territory.

A QDTT is accredited for the purposes of the above safe harbour election if that tax is specified as such in regulations made by HM Treasury (not yet released).

Lastly, there are additional provisions regarding availability of the QDTT safe harbour in relation to non-standard members of a multinational group (such as joint ventures, investment entities and minority owned members).

Observation: The application of the QDTT safe harbour means multinational groups will only need to compute their potential top-up tax liability once under the relevant QDTT rules and should likely reduce the compliance burden for multinational groups. The regulations to be released by HM Treasury setting out which QDTT are accredited will be keenly awaited. 

Other key amendments

A transitional reporting election has been prescribed by HMRC that provides for alternative requirements for the information that must be contained in an information return in respect of certain members of a multinational group (Schedule 16, Part 3). Further information on such a reporting election and the relevant alternative requirements is awaited.

Should you wish to discuss this draft legislation and what it may mean for your business, please contact the authors or your usual KPMG in the UK contact.