Key takeaways

Building on draft legislation published in July last year, and following a period of consultation, the publication of the Finance (No. 2) Bill 2023 (the "Finance Bill") moves the UK further forward in its process of implementing Pillar Two. The Finance Bill includes revised draft legislation introducing a Multinational Top-up Tax ("MTT") (adopting the Income Inclusion Rule) and new draft legislation implementing a domestic minimum top-up tax ("DMTT"). As anticipated, the MTT and DMTT will apply from accounting periods beginning on or after 31 December 2023. The UK government has previously announced that the undertaxed profits rule will not apply in the UK earlier than 2025 (accounting periods beginning on or after 31 December 2024), with draft legislation to be released at a later, as yet unspecified, date.

The UK draft legislation is broadly aligned with the OECD Pillar Two Model Rules (although it uses UK-specific legislative terms), and reflects some key developments in line with the OECD implementation package published by the Inclusive Framework in December 2022 (see our alert here) and the OECD Administrative Guidance published on 2 February 2023 (see our alert here). It will also likely inform other jurisdictions currently drafting domestic implementing legislation, with the expected date of implementation for many jurisdictions, including EU Member States, moving ever closer. Multinational groups now have little time to ensure the potential impacts of Pillar Two are adequately assessed and communicated to stakeholders.

The UK draft legislation provides greater certainty as multinational groups continue to navigate the complexity of the Pillar Two GloBE Rules. The Finance Bill includes the following:

• Amended draft legislation introducing the MTT which reflects the latest OECD Administrative Guidance, including a time-limited (31 December 2025 to 30 June 2026) mechanical approach to allocating tax paid under a Blended CFC Regime to low-tax jurisdictions. The US GILTI regime is the primary intended beneficiary of this agreement.
• The introduction of a UK DMTT which is intended to be a qualifying domestic minimum top-up tax based on the OECD’s Model Rules. The UK DMTT legislation resolves some of the ambiguity on certain aspects of the Model Rules. For instance, the local entity DMTT calculation broadly follows the same process as for the MTT, and optionality is provided for groups to rely on accounting standards used in the consolidated financial statements or UK GAAP. 
• Detailed legislative provisions implementing the transitional measures, which align with the OECD Model Rules and Administrative Guidance, including: (i) a transitional relief for substance-based income exclusion; (ii) transitional provisions for intra-group transfers of assets after 30 November 2021 (amended to incorporate the latest Administrative Guidance on Article 9.1.3 of the Model Rules); and (iii) a transitional safe harbour. The transitional safe harbour is in line with the OECD implementation package and is intended to apply to both the MTT and the DMTT on the same terms. 
• A clear description of the reporting process including: (i) a one-time requirement to register with HMRC for in-scope groups; and (ii) annual self-assessment returns. A single member of the group will report the MTT to HMRC, with the ultimate parent assumed as the default reporting member, although another company can be nominated. The DMTT is chargeable on qualifying entities tax resident in the UK. A GloBE Return will be filed by the group and both the MTT and the DMTT is payable and reportable annually.

These represent the key takeaways but we continue to work through the detail of the legislation. Whilst the intention behind the draft legislation seems to be to follow the OECD Pillar Two Model Rules, implementation package and Administrative Guidance, there are some areas where differences appear, or the position under the draft legislation in the Finance Bill is different to the draft MTT legislation published in July 2022. It will be important for taxpayers to understand whether these divergences are intentional on the part of the UK government or not. We are working to clarify these issues and will provide further updates.

Please get in touch with your regular Baker & McKenzie contact, or the contacts listed, with any questions on the scope and application of the new Pillar Two rules and their impact on your business.