What Is the Pillar Two Global Minimum Tax?
A guide to the Pillar Two global minimum tax, explaining its core enforcement mechanisms, computational framework, and new compliance obligations for MNEs.
An international tax initiative, known as Pillar Two, is being led by the Organisation for Economic Co-operation and Development (OECD) and the G20. The framework aims to ensure large multinational enterprises (MNEs) pay a minimum level of tax on their income, regardless of where they operate. This coordinated effort by over 140 jurisdictions establishes a global minimum corporate tax rate to address tax competition and corporate practices that erode the tax base of various countries.
Scope of the Global Minimum Tax
The Pillar Two rules target large multinational enterprise (MNE) groups with a consolidated revenue of €750 million or more. An MNE group is subject to the rules if its total revenue meets this threshold in at least two of the four preceding fiscal years, based on its ultimate parent entity’s consolidated financial statements. A group is considered multinational if it includes at least one entity or permanent establishment operating in a different jurisdiction from its parent entity.
Even when a group meets the revenue threshold, certain entities are excluded from the application of the rules. These Excluded Entities include:
- Government entities
- International organizations
- Non-profit organizations
- Pension funds
- Certain investment funds and real estate investment vehicles that are ultimate parent entities
While these entities are not subject to the tax calculations, their revenue is included when determining if the MNE group meets the €750 million threshold.
The GloBE Rules Framework
The enforcement of the Pillar Two minimum tax is achieved through the Global Anti-Base Erosion (GloBE) rules. This framework ensures that in-scope MNEs pay at least a 15% effective tax rate in every jurisdiction where they operate. The rules identify low-taxed income and impose a “top-up tax” to bring the total tax on that income up to the 15% minimum.
Income Inclusion Rule
The primary mechanism is the Income Inclusion Rule (IIR), which is applied by the country where the MNE group’s parent entity is located. If a subsidiary operates in a foreign jurisdiction and its profits are taxed below the 15% minimum, the IIR allows the parent’s home country to collect the top-up tax. The calculation is specific to each jurisdiction, and many countries began implementing the IIR for fiscal years starting on or after December 31, 2023.
Undertaxed Profits Rule
The Undertaxed Profits Rule (UTPR) is a backstop measure that applies when the Income Inclusion Rule cannot be used, such as when the parent entity’s home country has not implemented the IIR. In these cases, the responsibility for collecting the top-up tax shifts to other countries where the MNE group has operations. The UTPR is often enforced by denying tax deductions, and it generally takes effect one year after the IIR, with many countries applying it for fiscal years starting on or after December 31, 2024.
Qualified Domestic Minimum Top-up Tax
A Qualified Domestic Minimum Top-up Tax (QDMTT) allows a country to retain primary taxing rights over low-taxed profits generated within its own borders. By enacting a QDMTT that meets OECD standards, a country can collect the top-up tax from entities within its jurisdiction before another country can apply the IIR or UTPR. This ensures that any additional tax revenue from the 15% minimum tax on domestic profits flows to its own treasury.
Calculating the Effective Tax Rate and Top-Up Tax
The core of Pillar Two compliance is a multi-step calculation performed for each jurisdiction to determine if profits are taxed below the 15% minimum and to calculate the required “top-up tax.” The process starts with an MNE’s financial accounting information but requires specific adjustments to arrive at a standardized base for the global minimum tax.
Determining GloBE Income
The starting point is the net income or loss of each entity as reported in the MNE’s consolidated financial statements. This figure is then adjusted to create a standardized tax base called “GloBE Income.” Required adjustments include adding back certain disallowed expenses like fines and penalties, while excluding items like specific dividends and equity gains to prevent double taxation.
Identifying Covered Taxes
The next step is to identify the “Covered Taxes” paid or accrued on the GloBE Income. This includes current and deferred tax expenses recorded in the financial statements. This amount is also adjusted, for instance, by removing taxes related to income that was excluded from the GloBE Income base.
The Substance-Based Income Exclusion
The framework includes a Substance-Based Income Exclusion (SBIE) to avoid penalizing companies for genuine business activities. The SBIE carves out a portion of income that represents a routine return on substantive operations. This exclusion reduces the amount of GloBE Income subject to the top-up tax.
The SBIE is calculated as a percentage of the value of tangible assets and payroll costs within a jurisdiction. For the initial years, the exclusion is 8% for tangible assets and 10% for payroll. These rates will gradually decrease over a ten-year period to a permanent level of 5% for both.
The Final Calculation
The jurisdictional Effective Tax Rate (ETR) is calculated by dividing the adjusted Covered Taxes by the GloBE Income after the SBIE has been subtracted. If the ETR for a jurisdiction is below 15%, a top-up tax is due. The top-up tax percentage is the difference between 15% and the ETR. This percentage is then multiplied by the income base (GloBE Income minus SBIE) to determine the final tax liability.
The GloBE Information Return
Compliance with Pillar Two requires filing a standardized report known as the GloBE Information Return (GIR). This return provides tax authorities with the information needed to assess an MNE’s Pillar Two tax liability. The GIR must contain details on the MNE’s corporate structure and the financial data used to compute the effective tax rate and top-up tax for every jurisdiction.
A designated filing entity within the MNE group, usually the ultimate parent entity, is responsible for filing the GIR. The return is filed with the tax administration in the parent entity’s jurisdiction and the information is then exchanged with other relevant tax authorities. The filing deadline is 15 months after the end of the reporting fiscal year, though this is extended to 18 months for the first year an MNE is subject to the rules.