What is the Pillar 2 Undertaxed Profits Rule (UTPR)?

The Undertaxed Profits Rule, or UTPR, is a component of an international tax reform effort by the Organisation for Economic Co-operation and Development (OECD). This initiative, known as Pillar Two, aims to ensure large multinational enterprises (MNEs) pay a minimum effective tax rate of 15% on profits in every country where they operate. The framework establishes a sequence of rules to achieve this, starting with the Income Inclusion Rule (IIR).

The UTPR functions as a backstop to the IIR. While the IIR is the primary mechanism, allowing a parent company’s home country to collect a “top-up tax” on the low-taxed income of its foreign subsidiaries, it may not always apply. The UTPR is designed to step in when the IIR is not fully effective, ensuring the minimum tax is still collected.

Scope and Applicability of the UTPR

The Pillar Two rules apply to MNE groups with annual consolidated revenues of €750 million or more in at least two of the four preceding fiscal years. The UTPR is triggered when the Ultimate Parent Entity (UPE) of an MNE group is in a jurisdiction that has not implemented a qualified IIR. This allows other countries where the group operates to collect the tax shortfall.

A secondary trigger occurs if a parent company’s IIR does not apply to certain low-taxed entities within the group. For instance, complex ownership structures involving partially-owned parent entities might result in some profits not being fully subject to an IIR charge. The UTPR is intended to come into effect one year after the IIR, giving jurisdictions time to adopt the primary IIR rule first.

Calculating the UTPR Top-Up Tax

The calculation of the UTPR Top-Up Tax is a multi-step process. The first step is to identify all constituent entities of the MNE group located in low-tax jurisdictions. A low-tax jurisdiction is any country where the group’s Effective Tax Rate (ETR), calculated by aggregating the income and taxes of all entities within that country, is below the 15% minimum.

Once low-tax jurisdictions are identified, the “GloBE Income” is determined for the entities in each location. GloBE Income starts with the financial accounting net income of each entity and is then adjusted for a series of specific items. This standardized income base ensures a consistent calculation across different countries.

With the GloBE Income established, the MNE calculates the “Top-up Tax Percentage” for each low-tax jurisdiction, which is the 15% minimum rate minus the jurisdiction’s ETR. This rate is then applied to the jurisdiction’s “Excess Profit,” which is the GloBE Income less a “Substance-Based Income Exclusion.” This exclusion allows for a deduction based on a percentage of the MNE’s payroll costs and tangible assets. During a transitional period, these rates start at 8% for tangible assets and 10% for payroll costs, gradually decreasing to a permanent 5% rate for both by 2033.

The final step is to aggregate the jurisdictional Top-Up Tax amounts that were not collected under a qualified IIR. For example, if an intermediate parent company in the ownership chain applied an IIR and collected a portion of the tax, that amount is subtracted. The remaining sum from all low-taxed jurisdictions represents the total UTPR Top-Up Tax amount for the entire MNE group.

To illustrate, imagine an MNE has a subsidiary in Jurisdiction A with a 5% ETR and another in Jurisdiction B with a 10% ETR, and the UPE’s country has no IIR. The Top-up Tax Percentage for Jurisdiction A is 10% (15% – 5%) and for Jurisdiction B is 5% (15% – 10%). If the excess profit in Jurisdiction A is €200 million and in Jurisdiction B is €100 million, the jurisdictional Top-Up Tax would be €20 million and €5 million, respectively. The total UTPR Top-Up Tax to be allocated would be €25 million.

Allocating and Applying the UTPR

Once the total UTPR Top-Up Tax is calculated, it is distributed among the jurisdictions that have implemented the UTPR and where the MNE group has an economic presence. The allocation is based on a formula using two equally weighted factors: 50% on the MNE’s relative share of employees in each UTPR jurisdiction and 50% on its relative share of tangible assets. For example, if a country hosts 30% of the MNE’s employees and 20% of its tangible assets across all UTPR jurisdictions, its allocation key would be 25%, entitling it to collect 25% of the total UTPR tax.

After a jurisdiction determines its share, it can collect the revenue through two primary methods. The first is to deny a deduction for payments that would otherwise be deductible for domestic corporate income tax purposes. For instance, if a local entity must pay €1 million in UTPR tax and the local corporate tax rate is 25%, the tax authority could deny €4 million in deductions to generate the required tax.

The second method is for the jurisdiction to make an “equivalent adjustment,” such as a direct charge or a separate tax levied on the local entity equal to its share of the UTPR liability.

UTPR Safe Harbors and Exclusions

The Pillar Two framework includes several safe harbors and exclusions to simplify compliance. The Transitional Country-by-Country Reporting (CbCR) Safe Harbour provides a temporary reprieve from GloBE rules for an MNE’s operations in a jurisdiction. To qualify for this safe harbor, which applies to fiscal years beginning on or before December 31, 2026, the jurisdiction must meet one of three tests based on the MNE’s CbCR report.

• A de minimis test is met if the MNE group has average revenue of less than €10 million and average income of less than €1 million in that jurisdiction.
• A simplified ETR test is met if the jurisdiction’s effective tax rate, calculated using simplified data, is at least 16% for 2025 or 17% for 2026.
• A routine profits test is met if the jurisdiction’s profit before income tax is equal to or less than the substance-based income exclusion amount.

A separate permanent de minimis exclusion deems the Top-Up Tax for a jurisdiction to be zero if the MNE’s average GloBE revenue there is less than €10 million and its average GloBE income is less than €1 million. This calculation is based on the current and two preceding fiscal years.

Another provision, the Transitional UTPR Safe Harbour, deems the UTPR Top-up Tax for a UPE’s home jurisdiction to be zero if that jurisdiction has a corporate income tax rate of at least 20%. This relief applies for fiscal years ending before December 31, 2026, and provides relief for MNEs headquartered in high-tax jurisdictions that have not implemented a qualified IIR.

Compliance and Reporting Requirements

Compliance with the UTPR centers on a standardized form, the GloBE Information Return (GIR). The GIR is a detailed document designed to provide tax administrations with the data needed to assess Top-Up Tax liability. To complete the GIR, an MNE must report the number of its employees and the net book value of its tangible assets on a jurisdiction-by-jurisdiction basis.

The return also requires the MNE to report its calculated Top-Up Tax amounts and a summary of its ETR and tax exposure across all jurisdictions. The filing process is centralized, with a single entity in the MNE group filing the GIR with its local tax authority. This authority then exchanges the GIR with other relevant tax administrations.

The filing deadline for the GIR is 15 months after the end of the fiscal year, extended to 18 months for the first year an MNE is subject to the rules. The GIR is an information return and is separate from the actual tax return where the UTPR liability is ultimately declared and paid. The process for payment is determined by the domestic laws of the jurisdiction collecting the tax.