Finance Bill: Amendments to the UK’s existing Pillar Two rules

Finance Bill 2024-25 introduces various amendments to the UK’s existing Pillar Two rules, as contained in Finance (No.2) Act 2023. In particular, Schedule 4 of the Finance Bill seeks to introduce the Undertaxed Profits Rule (UTPR) legislation into UK domestic law, introduces the anti-arbitrage rules in respect of the transitional country-by-country reporting (CbCR) safe harbours, and makes other proposed amendments to ensure that the UK legislation is consistent with the OECD’s Administrative Guidance in respect of Pillar Two. Below we have set out further details on the most significant points to note:

• UTPR - the previous Government had issued draft legislation back in July 2023 (subsequently updated in September 2023). The Finance Bill is largely in line with the draft legislation previously issued, setting out an eight-step process to establish the proportion of the untaxed amount allocated to UK group companies, which is driven by the proportion of employees and tangible fixed assets in the UK compared to the overall group. The Finance Bill also includes the UTPR safe harbour which will apply for one year (i.e. the accounting period commences on or before 31 December 2025) where the minimum tax rate in the potentially undertaxed ultimate parent entity jurisdiction is at least 20 percent. The Finance Bill confirms the UK’s UTPR rules will apply for accounting periods beginning on or after 31 December 2024;

• Anti-arbitrage rules - the Government has proposed some changes to the draft legislation previously issued. These rules seek to target deduction/non-inclusion, duplicate loss, and duplicate tax recognition arrangements and, where applicable, will result in an adjustment to the CbCR profit before tax and/or the corresponding income tax expense used for the purposes of determining if a jurisdiction qualifies for one of the Transitional CbCR safe harbour tests. Of particular note, the provision which switches-off the deduction/non-inclusion where the counterparty does recognise taxable income has been modified. Previously this referenced a ‘devalued tax loss’ (i.e. a tax loss against which a valuation allowance or accounting recognition adjustment was in place) whereas this has been modified to ‘devalued tax attribute’ which is consistent with the OECD Administrative Guidance.It is worth noting that these rules relate to ‘arrangements’ entered into or modified on or after 16 December 2022, but only to the amounts accruing on or after 14 March 2024. Taxpayers are encouraged to reassess their intragroup financing and other related arrangements to determine whether they are potentially in scope of these rules and the impact this could have on any Transitional CbCR safe harbours which were expected to apply;
  
  
• Flow-through entities - the Finance Bill seeks to introduce into UK domestic law modifications to the rules around flow-through entities. Flow-through entities are those which are regarded as tax transparent in the territory in which they were created. The changes introduce the concept of ‘reference entity’ in determining whether the profits of any flow-through entities need to be reallocated to other entities and, if so, to which entities. This follows on from the Administrative Guidance issued by the OECD in June 2024. These rules are particularly relevant to entities which are not directly subject to tax on their own profits, such as single-member disregarded US LLCs where the tax is generally paid by a US owner/member. Taxpayers which have these types of entities in their group are encouraged to review these changes and assess the impact, if any, this could have. The proposed changes need to be considered in line with the rules around reallocations of covered taxes; and
  
  
• Domestic top-up tax - for UK domestic top-up tax purposes only, new subsection 272(3A) substitutes section 193 with a new section 193 and section 193A for the purposes of determining domestic top-up tax. The new method introduces an allocation key which is based on effective tax rate and adjusted profits is used, so top-up amounts are effectively allocated to profit-making members in proportion to each member’s contribution to the total top-up amount due under the UK domestic top-up tax.

The Finance Bill sets out the commencement of the various changes at section 63 and taxpayers are recommended to consider this as a number of the changes are relevant to accounting periods commencing on or after 31 December 2023 and others to accounting periods commencing on or after 31 December 2024. In addition, some of the proposed changes have a retrospective election, so taxpayers should also consider whether making such an election would be beneficial.

Finally, the Finance Bill introduces legislation that repeals the Offshore Receipts in respect of Intangible Property (ORIP) rules in Chapter 2A of Part 5 Income Tax (Trading and Other Income) Act (ITTOIA) 2005.

For further information please contact:

• Kashif Javed
• Michael Smith