What Is the Global Top-Up Tax and How Does It Work?

A global minimum tax, often called a “top-up tax,” is changing how large multinational companies are taxed. This mechanism is part of the Organisation for Economic Co-operation and Development’s (OECD) Pillar Two framework, agreed to by over 140 jurisdictions. The goal is to ensure large multinational businesses pay a minimum effective tax rate of 15% on profits in every country where they operate.

This initiative targets strategies used by companies to shift profits to low-tax jurisdictions, a practice known as base erosion and profit shifting (BEPS). By establishing a global floor for corporate taxation, the top-up tax ensures profits are taxed where the economic activities that generate them occur.

Scope of the Top-Up Tax

The Global Anti-Base Erosion (GloBE) rules apply to large multinational enterprises (MNEs). An MNE group is subject to these rules if its annual consolidated revenues are €750 million or more in at least two of the four fiscal years before the one being tested. This threshold aligns with Country-by-Country Reporting (CbCR) requirements to simplify administration. The rules apply to each entity within the group, including the parent company, subsidiaries, and permanent establishments.

Certain “Excluded Entities” are carved out from the GloBE rules, even if their MNE group meets the revenue threshold. These entities are not seen as contributing to the tax avoidance issues the rules address.

Excluded Entities include:
Government entities
International organizations
Non-profit organizations
Pension funds
Investment funds and real estate investment vehicles that are the ultimate parent entity (UPE) of the group

While the income of these entities is not used to calculate the top-up tax, their revenue is included when determining if the MNE group meets the €750 million threshold.

Calculating the Top-Up Tax

Determining the top-up tax is a multi-step calculation performed for each country where an MNE operates. This jurisdictional approach means high taxes in one country cannot offset low taxes in another, as each is evaluated independently against the 15% minimum rate.

The Effective Tax Rate (ETR) Calculation

The first step is calculating the MNE’s Effective Tax Rate (ETR) for each jurisdiction using a specific formula from the GloBE rules. The ETR is determined by dividing the “Adjusted Covered Taxes” by the “GloBE Income” for that jurisdiction, providing a standardized measure of the actual taxes paid on local profits.

GloBE Income starts with the net income or loss of each entity in the jurisdiction from the MNE’s consolidated financial statements. This figure is then adjusted to exclude items like certain dividends, equity gains or losses, and disallowed expenses such as fines.

Adjusted Covered Taxes begin with the current tax expense accrued in the financial accounts. This amount is adjusted for deferred taxes to account for timing differences between when income is recognized financially versus when it is taxed. A key adjustment remeasures deferred tax expense to the 15% minimum rate if the local rate is higher, preventing the creation of excess deferred tax assets.

The Top-Up Tax Percentage

Once the ETR is calculated, it is compared to the 15% minimum rate. If a jurisdiction’s ETR is below 15%, a top-up tax is triggered. The top-up tax percentage is the difference between 15% and the ETR. For example, if a jurisdiction’s ETR is 10%, the top-up tax percentage is 5%.

The Substance-Based Income Exclusion (SBIE)

The GloBE rules include a Substance-Based Income Exclusion (SBIE) to protect a portion of income from substantive economic activities. This carve-out reduces the amount of profit subject to the top-up tax, focusing the tax on “excess profits” rather than returns on tangible investments and local employment.

The SBIE is a percentage of the value of eligible tangible assets (like property and equipment) and payroll costs in the jurisdiction. Initially, the carve-out is 8% for tangible assets and 10% for payroll costs. These percentages will gradually decline over a ten-year transition period to a permanent rate of 5% for both.

The Final Top-Up Tax Amount

The final step is calculating the top-up tax liability. This is done by determining the “excess profit,” which is the GloBE Income minus the SBIE amount. The top-up tax percentage is then applied to this excess profit. For example, with €100 million in GloBE Income, a €20 million SBIE, and a 5% top-up tax percentage, the final tax would be €4 million.

Collection and Enforcement Mechanisms

The Pillar Two framework establishes a coordinated order for collecting the top-up tax using a hierarchy of three interlocking rules. This structure prevents gaps in enforcement and ensures the minimum tax is paid, regardless of where the parent company is located or whether that country has adopted the rules.

Qualified Domestic Minimum Top-up Tax (QDMTT)

The first right to collect the top-up tax belongs to the jurisdiction where the low-taxed profits were generated. A country can implement a Qualified Domestic Minimum Top-up Tax (QDMTT), a domestic tax consistent with GloBE rules, to collect the tax directly from MNEs operating within its borders.

This mechanism allows the low-tax jurisdiction to retain the revenue. An MNE’s payment under a QDMTT is credited against its GloBE tax liability, reducing the amount other countries can collect to zero. This creates a strong incentive for low-tax jurisdictions to adopt a QDMTT.

Income Inclusion Rule (IIR)

If the low-tax jurisdiction has not implemented a QDMTT, the responsibility shifts to the parent entity under the Income Inclusion Rule (IIR). The ultimate parent entity (UPE) of the MNE group must pay the top-up tax for its low-taxed foreign subsidiaries to its home country’s tax authority.

The IIR operates on a top-down basis. If the UPE’s country has not implemented an IIR, the obligation moves to the next parent entity in the ownership chain that is in a jurisdiction with the rule. This ensures the tax is collected at the highest possible level.

Undertaxed Payments Rule (UTPR)

The Undertaxed Payments Rule (UTPR) is a backstop to the IIR, capturing any top-up tax not collected under a QDMTT or IIR. This can happen if the UPE is in a jurisdiction without an IIR. The UTPR can also apply to low-taxed income in the UPE’s home jurisdiction.

The UTPR allows other jurisdictions where the MNE operates to collect the tax, often by denying tax deductions for payments to other group entities. The tax collected is allocated among countries with the UTPR based on a formula that considers the MNE’s tangible assets and employees in those locations.

Key Exclusions and Simplifications

The Pillar Two framework includes provisions to simplify compliance for MNEs in certain situations. These measures, including a de minimis exclusion and transitional safe harbors, reduce administrative complexity for lower-risk jurisdictions without undermining the minimum tax’s objectives.

De Minimis Exclusion

An MNE can choose to treat the top-up tax for a jurisdiction as zero if its operations there are small. This exclusion applies if the MNE has both average GloBE Revenue under €10 million and average GloBE Income or Loss under €1 million in that jurisdiction, calculated over a three-year period. This rule avoids complex calculations for jurisdictions with an immaterial economic footprint.

Transitional Safe Harbours

Temporary safe harbors are available for fiscal years beginning on or before December 31, 2026, and ending on or before June 30, 2028. These allow an MNE to avoid detailed GloBE calculations for a jurisdiction if it meets one of three tests using data from its Country-by-Country Report (CbCR). If a jurisdiction qualifies, its top-up tax is zero for that year.

The three tests are:
A de minimis test based on CbCR data (under €10 million revenue and €1 million profit).
A simplified ETR test using CbCR data compared against a transition rate (15% for 2023-2024, 16% for 2025, and 17% for 2026).
A routine profits test where profit is less than or equal to the substance-based income exclusion amount.

A jurisdiction that fails to qualify for a safe harbor in one year cannot use the safe harbors in any subsequent year.