L-Day: Implementation of the OECD Pillar Two Side-by-Side package

• Two elective safe harbours, the first of which excludes US-parented groups from having any liability to the UK’s multinational top-up tax (MTT) by providing that none of the members of such a group have any (additional) ‘top-up amounts’ that would trigger MTT (‘Side-by-Side Safe Harbour’). A second, more limited, safe harbour allows groups to elect for their parent and (only) members of the group in that parent’s territory not to have any ‘untaxed amount’ that would trigger MTT under its undertaxed profits rule (‘UPE Safe Harbour’). Neither safe harbour prevents the UK from imposing its domestic minimum top-up tax (DMTT) on companies or permanent establishments that are located in the UK. The legislation for the Side-by-Side Safe Harbour is sufficiently flexible to cater for other territories to be added. That raises the possibility of other countries applying to the OECD to have their domestic tax regimes recognised for the purposes of that safe harbour; for those other regimes to qualify under the UK’s Side-by-Side Safe Harbour they must also be specified as qualifying in UK regulations or an HMRC notice. The UPE Safe Harbour also only applies to countries that are both specified on an OECD list and in UK regulations (or an HMRC notice), but (unlike the Side-by-Side Safe Harbour) the draft legislation does not specify any country as automatically qualifying for the UPE safe harbour;
• A new ‘Simplified ETR Safe Harbour’ (SESH), which allows groups to use simplified calculations to demonstrate that their Effective Tax Rate (ETR) at least equals the 15 percent needed to avoid liability to MTT. The draft legislation sets out the conditions for the SESH to apply (including a look-back condition, to limit the circumstances in which a group that is subject to full MTT calculations can then qualify for this safe harbour, being that no top-up tax was due with respect to that jurisdiction in the previous two years), how it applies to some non-standard group members, and sets out that the calculation is the normal ETR calculation for the full MTT rules but with specific ‘simplifications’, along with the SESH’s interaction with some other MTT provisions. This safe harbour is to be a permanent feature of the rules, ultimately replacing the existing transitional safe harbour; and
• An election for a territory’s qualifying tax incentives (QTIs) to be excluded from the covered taxes and adjusted profits of any of the group’s standard members in that territory, so increasing those covered taxes (and, if applicable, removing any of those QTIs that would otherwise be included in their adjusted profits). This reduces the risk of that territory having an ETR below 15 percent that may potentially trigger MTT. This treatment is available for any mechanism (for example, tax credits, allowances, deductions or reduced tax rates) that is generally available to all taxpayers and reduces covered taxes by an amount that is proportional to either expenditure in the territory or production of goods in the territory. There are some exceptions (for example, grants or direct subsidies cannot be a QTI) and the amount that can be excluded is capped at 5.5 percent of the group’s eligible payroll costs in the territory (or, if higher, 5.5 percent of its depreciation that is used to determine the group’s eligible tangible net asset amounts in the territory). There is a facility for the group to instead elect for the cap to be 1 percent of its eligible tangible asset amounts excluding the value of its land and other assets that have not been depreciated etc.

The Side-by-Side Safe Harbour, the UPE Safe Harbour and the preferential treatment of QTIs apply for accounting periods beginning on or after 1 January 2026, with the SESH applying for accounting periods beginning on or after 31 December 2026 (but with an election to apply it for accounting periods beginning on or after 31 December 2025).

In addition, the Transitional Safe Harbour’s expiry is postponed by the legislation by a further 12 months, so that it will, broadly, be available for accounting periods ending on 31 December 2027 and for non-December year ends up to and including those ending on or before 30 June 2029.

Which businesses will this impact?

The changes are only relevant to multinationals that are large enough to be subject to the UK’s Pillar Two rules (MTT and DMTT); in broad terms, those whose annual turnover exceeds €750 million. Among this group, the first safe harbour is of most interest to all members of any group with a US parent (including any UK subsidiaries), while the SESH is of wider application – specifically, to the many groups who currently rely on the transitional safe harbour to minimise the cost of complying with MTT’s required calculations. It remains to be seen which countries will qualify for the UPE Safe Harbour.

The preferential treatment of QTIs will be relevant to any of these large groups with overseas operations in territories that provide non-refundable tax incentives (such as tax credits) for producing goods, or incurring expenditure, in that territory. Although not as preferential as the treatment already afforded to some refundable tax credits (which are, generally, treated as income rather than reducing taxes), preventing these QTIs from being treated as a tax reduction affords some protection from them triggering an MTT liability in respect of the territory that grants them.

Other updates to MTT and DMTT rules

In addition to correcting errors in the MTT and DMTT legislation, other changes that the draft legislation proposes include some welcome extensions of:

• The rules for held for sale entities, to discontinued operations which, as a result, will no longer automatically be considered as not being a member of the group;
• The relieving provisions for debt releases by companies in distress, which is now to include releases as part of a compromise or arrangement under Part 26A of the Companies Act 2006 (or corresponding provision under overseas law);
• The international expansion safe harbour (from the MTT’s undertaxed payments rule), by excluding some assets held by stateless entities when determining whether the group has breached the €50 million cap for this safe harbour; and
• The ability to elect that a group’s non-material members have no top-up amounts from MTT to also apply for DMTT purposes.

Comment

Despite the proposed simplification measures, Pillar Two remains a complex area and there will be substantial work required for affected businesses in evolving their Pillar Two compliance approach and monitoring implementation developments across all relevant jurisdictions.

Please reach out to your usual KPMG in the UK contacts or the authors if you have any questions on the implications of these developments for your business.

For further information please contact:

• Damon Lambert
• Qasim Javid