What Is the UTPR Tax and How Does It Work?

The Undertaxed Profits Rule, or UTPR, is a tax rule developed as part of a broad international agreement led by the Organisation for Economic Co-operation and Development (OECD). This agreement aims to address tax avoidance by large multinational companies by ensuring they pay a minimum level of tax on their profits, regardless of where they are earned. The UTPR functions as a secondary enforcement tool, allowing a country to collect additional tax from a subsidiary of a foreign-based multinational corporation if that corporation’s profits in another country are taxed below an agreed-upon minimum rate.

This rule is intended to prevent companies from shifting profits to jurisdictions with very low or zero corporate tax rates to minimize their global tax liability.

The Pillar Two Framework and UTPR’s Role

The UTPR is an integral part of a global initiative known as Pillar Two, developed by the OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting (BEPS). The objective of Pillar Two is to ensure that large multinational enterprises (MNEs) are subject to a minimum effective tax rate of 15% on their profits in every jurisdiction where they operate. The rules are collectively referred to as the Global Anti-Base Erosion (GloBE) rules.

To achieve this 15% minimum tax, the Pillar Two framework introduced a set of interlocking rules. The principal mechanism is the Income Inclusion Rule (IIR), which requires the ultimate parent entity (UPE) of an MNE group to pay a “top-up tax” in its home country. This tax covers the difference between the 15% minimum rate and the lower effective tax rate paid by its subsidiaries in other jurisdictions.

The Undertaxed Profits Rule serves as a secondary or “backstop” mechanism to the IIR. The UTPR is designed to apply in situations where the IIR has not been fully effective in collecting the top-up tax. For instance, if the country where the MNE’s ultimate parent entity is located has not implemented a qualifying IIR, the UTPR allows other countries where the MNE group has operations to collect the remaining portion of the top-up tax. This hierarchical application creates an incentive for all countries to adopt the Pillar Two rules.

Determining Applicability to a Business

The Pillar Two rules, including the UTPR, apply to multinational enterprise (MNE) groups that meet a specific size requirement. The primary scope rule is a revenue threshold: the rules cover MNE groups with annual consolidated revenues of €750 million or more in at least two of the four preceding fiscal years. An MNE group is defined as a collection of entities bound by a common ownership structure that requires them to prepare consolidated financial statements.

Certain types of entities are excluded from the scope of these rules. These “Excluded Entities” include governmental entities, international organizations, non-profit organizations, and pension funds. Investment funds and real estate investment vehicles that are the ultimate parent entities of a group may also be excluded.

The UTPR mechanism itself is not automatically applied to all in-scope MNEs; its activation depends on specific circumstances. The UTPR is triggered when the low-taxed income of a constituent entity within the MNE group is not fully subjected to a top-up tax under a qualified Income Inclusion Rule (IIR). A primary trigger is when the ultimate parent entity of the group is located in a jurisdiction that has not implemented a qualifying IIR.

Another trigger occurs even if the parent’s jurisdiction has an IIR, but that rule does not cover certain low-taxed entities within the ownership chain. In these cases, the UTPR addresses these gaps to ensure the 15% minimum tax is collected from the MNE group.

Calculating the UTPR Top-Up Tax

The calculation of the UTPR top-up tax begins with determining the total top-up tax amount for the entire MNE group on a jurisdictional basis. The process involves identifying jurisdictions where the group’s Effective Tax Rate (ETR) is below the 15% minimum rate. The top-up tax is the amount needed to bring the tax on profits in that jurisdiction up to the 15% level.

The formula to determine the top-up tax for a specific jurisdiction is: (15% Minimum Rate – ETR) x Excess Profit. To use this formula, “GloBE Income” is first calculated, which starts with the financial accounting net income or loss of the entities in a jurisdiction, subject to specific adjustments. The second component is “Adjusted Covered Taxes,” which are the income taxes recorded in the financial accounts, also with several adjustments.

Once GloBE Income and Adjusted Covered Taxes are determined, the ETR can be calculated by dividing the Adjusted Covered Taxes by the GloBE Income. If this ETR is below 15%, a top-up tax is due. The tax is not applied to all GloBE Income, but rather to “Excess Profit,” which is determined after applying the substance-based income exclusion. This exclusion is a carve-out designed to protect a routine return on substantive business activities.

The substance-based income exclusion is calculated as a percentage of the value of tangible assets and payroll costs in that jurisdiction. These percentage rates are higher in the initial years of the framework and will gradually decrease over a ten-year transitional period. The carve-out starts at 8% for tangible assets and 10% for payroll costs, eventually declining to a permanent rate of 5% for both. This carve-out amount is subtracted from the GloBE Income to arrive at the Excess Profit figure.

Allocation and Imposition of the UTPR

Once the total top-up tax amount for the MNE group has been calculated, the next step is to allocate this liability among the jurisdictions that have implemented a UTPR. This allocation does not depend on transactions between the low-taxed entity and the entities in the UTPR jurisdictions. Instead, the OECD Model Rules prescribe a specific formulaic approach to distribute the tax liability.

The allocation key is based on the relative substance of the MNE group’s presence in each country that has a UTPR in effect. The formula uses two factors, weighted equally: the number of employees and the net book value of tangible assets. A jurisdiction’s share of the total UTPR tax is determined by taking 50% of its proportion of the group’s total employees in all UTPR countries and adding that to 50% of its proportion of the group’s total tangible assets in all UTPR countries.

After a jurisdiction receives its allocated share of the UTPR tax, it must then impose this tax on the MNE’s constituent entities located within its borders. The most common method is to deny a tax deduction to the local subsidiary for otherwise deductible payments, such as interest or royalties paid to other group members. The amount of the denied deduction is calculated to generate an additional tax liability equal to the allocated UTPR amount.

The alternative method is to require an equivalent adjustment that results in an additional cash tax expense for the subsidiary, such as a direct charge or a supplementary levy. The choice of mechanism is left to the individual jurisdictions implementing the UTPR.

GloBE Information Return Requirements

To facilitate the administration of the Pillar Two rules, a standardized reporting framework has been established, centered on the GloBE Information Return (GIR). The GIR is a standardized form that MNE groups within the scope of the rules must file. Its purpose is to provide tax administrations with the information necessary to assess an MNE’s GloBE tax liability and to ensure the correct application of the IIR and UTPR.

The GIR requires the disclosure of a significant amount of data. A primary section requires general information about the MNE group, including the identification of every constituent entity, its location, and its classification for GloBE purposes. This section also includes details on the group’s overall corporate structure, such as ownership interests between entities.

Another part of the GIR is dedicated to the data needed for the jurisdictional ETR and top-up tax calculations. MNEs must report the financial data used to determine the GloBE Income or Loss and the Adjusted Covered Taxes for each jurisdiction in which they operate. The return also requires information on the calculation of the substance-based income exclusion and the resulting top-up tax liability for any low-tax jurisdictions.

Finally, the GIR must contain information regarding the allocation of any top-up tax under the IIR and, if applicable, how the total UTPR tax amount is allocated among jurisdictions. The ultimate parent entity or a designated filing entity within the MNE group is responsible for filing the GIR. The return is due within 15 months after the end of the fiscal year, though this is extended to 18 months for the first year a group is subject to the rules.