Minimum taxation Pillar 2: exclusions, safe harbours, and pitfalls

The new Pillar Two regulations are designed to ensure that large multinationals pay a minimum of 15% profit tax on their group profits, irrespective of where the group companies are established. If an entity’s profit is charged at an effective rate lower than 15%, there is a risk of an additional charge in one jurisdiction, or even multiple jurisdictions. Although the legislation appears simple on the face of it, the underlying calculations are complex, the provisions and terminology are new, and the potential implications are far-reaching. In this article, we will discuss a number of exceptions to the principal rules, the proposed safe harbours, and the potential pitfalls in determining the effective tax rate.

Scope of Pillar Two

The Dutch transposition of these international Pillar Two rules and the implementation of the corresponding European Directive is provided for in the Minimum Tax Act 2024. This legislative proposal is expected to be further developed in the course of 2023 and will be enacted on 1 January 2024, after being approved by the House of Representatives and the Senate. The legislation, including the top-up tax and information and reporting requirements, essentially applies to all companies forming part of a group, multinational or domestic, with a consolidated annual group revenue of a minimum of € 750 million.

Exceptions: excluded entities

Pillar Two provides for a number of exceptions. Excluded from the scope of the legislation are, for example, specific governmental entities, non-profit organisations, pension funds and, subject to certain conditions, investment funds and investment vehicles.

Exclusions: modified calculations

The data included in the financial statements is used as a basis for calculating whether, and, if so, where, any additional tax charge might be required. Certain tax corrections are subsequently applied to this net profit (or loss) in order to calculate what is known as the ‘qualifying income’. In short, the effective tax rate (ETR) depends on the qualifying income and the covered taxes.

Specific exceptions may apply, including if an entity falls under the scope of the legislation. The three main exclusions are the reduction in excluded income based on actual substance, what is known as the ‘de minimis’ exclusion, and an exclusion during the start-up stage of a group.

1. Substance based income exclusion (lower top-up tax)
   If the average ETR for all group entities established in a single state is lower than 15%, there is a risk of a top-up tax being imposed. The top-up tax is calculated for the qualifying income, after adjusting for actual substance. This adjustment is equal to the sum of a percentage of the employee charges and of the tangible fixed assets. Note that this allowance is subject to a number of terms and conditions.

2. De minimis exclusion (i.e. no top-up tax)
   The de minimis exclusion means that no top-up tax is imposed if the average qualifying revenue in a particular state is less than €10 million and the average qualifying income in that state is less than €1 million. In order to determine the average qualifying revenue and the average qualifying income, it is important to take into account the two preceding years and a number of tax adjustments.

3. Exclusion for initial phase (i.e. no top-up tax)
   Pillar Two also provides an exclusion for companies in the initial phase of their international activity; they are not required to calculate their ETR and top-up tax at this stage. Simply put, no top-up tax is imposed during the initial phase if the group entities are established in no more than six different states and the sum of the net book value of the tangible assets is no more than €50 million. Compliance with these requirements will need to be assessed on an annual basis. Note that this exclusion may also apply to large domestic corporate groups.

Safe harbours?

The OECD proposed three ‘safe harbours’ in early February 2023. A simplified calculation is performed for these safe harbours, including of the ETR. Further details are not yet known at this stage, and the OECD must further develop these simplifications. We are, of course, monitoring these developments closely.

Pitfalls: is 15% really 15%?

For this and other reasons, it is important to focus on the complexity of the regulations. The alternative terminology, in conjunction with the prescribed tax corrections, means that a thorough, in-depth analysis is indispensable in determining the implications of Pillar Two for companies. In order to determine the impact on your company, it is simply not sufficient to merely determine that a local statutory tax rate is above the minimum: a 15% tax rate does not always mean an effective tax rate of 15%. The same applies to the de minimis exclusion: a commercial income of less than €1 million does not necessarily mean a qualifying income of less than €1 million. In addition, Pillar Two contains a number of specific terms which vary from the meaning generally used under Dutch tax law. Under Dutch tax law, for example, a participation is defined as a capital interest of 5% or more; in the context of Pillar Two, this is 10% or more.

Other points of attention

In addition to conditions that reduce the top-up tax, there are also provisions that result in an additional top-up tax. This is the case, for example, if the ETR calculated in a previous year later turns out to be too low as a result of changes in the qualifying income in a previous financial year, or if the domestic top-up tax calculated has not actually been paid.

We also note that the Dutch legislative proposal is based on the OECD’s Pillar Two regulations and the European Directive based on these regulations. Although many countries will adhere to the OECD regulations when transposing Pillar Two into their national legislation, and European countries will also take the European Directive into account, there is a likelihood of differences (including differences in interpretation) arising between the legislations in different countries.

Final remarks

Since the new Pillar Two legislation could have a major impact on both the tax positions and the business models of large multinational companies, a timely, in-depth and holistic analysis of the consequences is essential. Our specialised advisors would be happy to assist you. If you have any questions about the Pillar Two legislation, the exceptions and points of attention, or the practical implications for your business, please contact our experts . We look forward to discussing how we can be of service!

The legislation and regulations in this area may be subject to change. We recommend that you discuss the potential impact of this with your Baker Tilly consultant.