Pillar 2 update – Permanent safe harbours, tax credits and side by side

After robust negotiations among OECD members, on 5 January, the OECD has published a document outlining significant changes to the future shape of Pillar 2.

All groups within the scope of Pillar 2 should be aware of the updates, particularly those headquartered in non-Pillar 2 jurisdictions with regimes similar but not identical to Pillar 2 (e.g. the US).

What changes have been made to Pillar 2?

The document outlines:

1. That temporary safe harbours will be extended by a year to cover 2027.
2. A new permanent Effective Tax Rate (ETR) safe harbour has been introduced. Although it is described as a more simplified approach, it is more complex than the current safe harbour and is calculated by accounts package data, rather than Country by Country Return (CbCR).
3. Confirmation of continuing work to establish permanent substance-based (routine profits) and de minimis safe harbours.
4. Pillar 2 benefits now include a broader array of tax incentives classified as Qualifying Tax Incentives (QTIs).
5. Some details of the side-by-side regime for multi-national (MNE) groups headquartered in jurisdictions with OECD-approved tax regimes could mean disapplication of the main Pillar 2 taxing provisions and substantially streamlined reporting.

US and similar regime headquartered groups

• Sub-groups headquartered in Pillar 2 jurisdictions with income inclusion rule (IR) legislation, which ensures 15% tax in all countries of that sub-group and under-taxed profits rule (UTPR) legislation, and looks at the whole group, are required to fully report and pay tax under that legislation in 2024 and 2025.
• From 2026 onwards, neither UTPR nor IIR will apply to groups headquartered in jurisdictions with tax regimes classed as having a qualifying domestic regime (the US regime has already been identified by the OECD as qualifying), where an election to apply the side-by-side safe harbour has been made.  This will also apply to the group’s constituent entities located in other jurisdictions, though they will be required to comply with any domestic QDMTT.
• Group information return filings showing the group structure and other local data are still required for all group entities located in jurisdictions with a local Pillar 2 QDMTT.

Groups that are likely to be impacted should organise their 2024 and 2025 responsibilities while also planning for cost-effective filing options starting in 2026.

Permanent Simplified ETR safe harbour

• Implemented in 2026 through Administrative Guidance.
• Effective for 2027 calendar years or 2026 if one of three tests applies:
  • The QDMTT safe harbour applies to the tested jurisdiction;
  • Only one jurisdiction has taxing rights under GLoBE rules for the tested jurisdiction;
  • All jurisdictions that have taxing rights for the tested jurisdiction have a simplified ETR safe harbour for 2026 and the MNE group has elected to apply the simplified ETR safe harbour.
• Uses data from the financial accounts consolidation package, not the CbCR.
• This rate is calculated in line with local legislation, with defined minimum adjustments to accounts income and accounts tax to form a ratio of Simplified Tax divided by Simplified Income.
• Groups may apply for first election and re-entry election eligibility for the Simplified ETR regime, if no top-up tax has arisen in the previous 2 years, which is beneficial and removes the ‘once out always out’ rule of the temporary safe-harbour.

Simplified income

• Excludes dividends and equity gains and losses.
• Contains adjustments for shipping, regulatory capital and insurance adjustments.
• OCI adjustments are not required if deferred tax on these is in OCI and at a rate greater than the minimum rate.
• A range of other, more complex elections are available and will be covered by more detailed articles.

Simplified taxes

• Based on the accounts and includes deferred tax amounts.
• Significant complexity remains in the deferred tax adjustments, which is likely to require some effort to integrate into the accounts package or to maintain separately for Pillar 2.
• DTL movements on deferred tax liabilities subject to the 5 year recapture are generally ignored; valuation allowances are ignored, recast of deferred tax to 15% is required.
• Simplified position for allocation of taxes to permanent establishments is welcome but will require consideration.
• Transfer pricing adjustments occurring within 12 months of the transaction year can be elected to be recorded in the year of the transaction rather than in the year when the transfer pricing adjustments are made.

Additional considerations

There are several elections proposed that will require some further consideration, in particular:

• Tax-neutral entities
• GloBE elections are all available in calculating Simplified Income and Simplified Taxes
• Simplifications for loss years.
• Election for adjustments to tax or income arising within 12 months to be in that year

Tax incentives

A new category of qualifying tax incentives (QTI) allows expense-based or production-based tax incentives, by election, to be added to Covered Taxes.

An incentive must be:

• An expenditure-based giving tax benefit in addition to the deduction for the expenditure (whether by increased deduction, exemption of income or tax credit), but the tax benefit must not exceed the expenditure incurred.
• Calculated by reference to expenditure incurred or production (based on volume produced) as of the date of determination.
• Generally available (i.e., not limited to Pillar 2 groups).

Incentives are subject to a cap of either 5.5% of the eligible payroll costs in a jurisdiction or, by 5-year election, 1% of the tangible fixed assets.

As the QTI is not included in GloBE income, it may be more beneficial to elect for tax credits to be QTIs rather than other Pillar 2 approved tax credits (QRTCs or MTTCs).

Groups will need to consider the cap and the benefit or otherwise of this exemption where they currently obtain benefits from QRTCs or MTTCs.

Groups within the scope of Pillar 2 will need to assess the impact of the newly released information and determine how best to proceed with their Pillar 2 implementation.

For US-headquartered groups, focus is likely to be on cost-effective reporting for 2024 and 2025 and identifying low-cost reporting solutions thereafter.

Groups headquartered in other jurisdictions should take time to assess whether the current Pillar 2 implementation plans have enough focus on ensuring the accounts consolidation package can contain the data required for the new Simplified ETR calculations or how best to implement a ‘Pillar 2 system add-on’ to deal with managing the data required and assessment of any elections.

Where there are tax incentives, consideration needs to be given to whether they meet the definition for being QTIs and then, if current benefit is obtained, whether electing into the new regime is beneficial.