Pillar Two: CbCR safe harbour anti-arbitrage rule draft legislation

On 29 July 2024, the Government published draft legislation to implement the transitional Country-by-Country Reporting (CbCR) safe harbour anti-arbitrage rule, ensuring that the UK legislation remains consistent with the OECD G20 Inclusive Framework’s December 2023 Administrative Guidance. The draft legislation stops attempts by multinational enterprises (MNEs) to avoid Pillar Two top-up tax by exploiting a temporary simplification in the rules. The legislation will apply from 14 March 2024 (with some retroactivity in certain cases), and will prevent MNEs that enter into certain avoidance transactions from accessing the simplification.

Substantively, the UK legislation tracks the core of the OECD principles as set out in the December 2023 guidance. This will be a welcome confirmation for taxpayers, bearing in mind both the retroactive nature of some aspects of the rules, and the fact that calendar year taxpayers are already six months into their first year of the Pillar Two rules being in force. 

However, as always when internationally agreed concepts are brought down into local law by way of domestic implementation, there are both some linguistic differences, and some potential divergences of substance. As ever, this means that the devil will be in the detail, and affected taxpayers will need to review the rules carefully and think about their application to their particular fact pattern.

In summary:

• The anti-arbitrage rules seek to enact the part of the December 2023 Administrative Guidance relating to the Simplified Effective Tax Rate (ETR) Transitional Safe Harbour, aimed at specific arrangements that sought to engineer a Simplified ETR above the 15 percent to 17 percent threshold;
• The anti-avoidance applies to arrangements entered into on or after 16 December 2022 (or subsequently amended) – but to disqualified expense (e.g. interest expense) or duplicate tax expense accruing on or after 14 March 2024;
• The wording is deliberately wide and so covers not just interest-bearing loans but ‘provision of credit’ or the ‘making of an investment’, akin to the OECD guidance; There is no ‘purpose’ filter, meaning that the rules apply in a mechanical sense. This is likely to lead to hard cases both in favour of and against taxpayers / tax administrations, but seems to be the intended approach taken by the legislation (following closely that of the OECD equivalent);  
• The draft legislation specifically requires that the “credit or investment is neither reflected as an increase in the revenue, or a gain” for the expense to be disqualified for the Simplified ETR Safe Harbour – this wording is potentially too wide as it is the return on the credit or investment that should need to be reflected in profit, not the whole credit provided; and
• The rules are meant to apply where the taxable income is offset by tax losses for which no deferred tax asset is recognised, or would not be recognised, absent the instrument giving rise to the arbitrage. The UK rules set out the concept of a ‘devalued tax loss’ being a tax loss whose value is less than the tax loss multiplied by the tax rate that applies to the relevant Constituent Entity. This has a broader impact as it would cause the anti-arbitrage rules to apply to disallow the whole expense where only part of the tax loss is derecognised for accounting purposes, which taxpayers may consider is inequitable.

Businesses impacted should consider the timing and application of these rules and their impact on the draft Transitional CbCR Safe Harbour workings. Additionally, businesses should ensure that reasonable steps are taken to recognise full deferred tax assets for tax losses in lending and investing entities where permitted under accounting standards. As ever with Pillar Two, close integration between the tax and accounting position is absolutely critical, and affected taxpayers will need to engage in continual and dynamic assessment (and reassessment) of their overall Pillar Two position, as well as their ongoing eligibility for safe harbour access on a yearly basis. 

The draft legislation is open for consultation until 15 September 2024, so businesses should consider submitting representations on any points of concern.

In addition, to provide certainty for affected businesses, the Government has confirmed that the UK will introduce the Undertaxed Profits Rule (UTPR) of Pillar Two for accounting periods beginning on or after 31 December 2024, and will continue efforts to ensure the UK rules are effective and up to date.

For further information please contact:

• Kashif Javed
• Damon Lambert