As anticipated, the UK will implement the income inclusion rule for accounting periods beginning on or after Dec. 31. The relevant legislation was included in Part 3 of the Finance (No 2) Act 2023 and was passed with broad—though not unanimous—cross-party support. It received Royal Assent and thus became law on July 11.
Unlike some other jurisdictions, the UK has enacted the IIR by way of detailed charging provisions, rather than simply incorporating the OECD model rules by reference. Because the government had started consulting on the draft legislation before many of the technical details had been finalized at Organization for Economic Cooperation and Development level, it was already outdated by the time it was enacted.
Accordingly, a mere seven days after enactment, the government released proposed amendments to the legislation to ensure that it accurately reflects the agreed approach as set out in the OECD Administrative Guidance. The proposed amendments will be included in the 2023–24 Finance Bill and, when enacted, will be backdated to take effect from the introduction of the principal legislation.
At the same time, the government also released draft legislation to introduce the undertaxed profits rule—the UTPR, referred to as the undertaxed payments rule by the OECD—which will also be included in the 2023–24 Finance Bill. The commencement date for the UTPR will be specified by treasury regulations, but the government has previously indicated that it won’t be introduced before Dec. 31, 2024. In the meantime, it seems likely that further amendments to these provisions will be needed—to include, for example, the UTPR transitional safe harbor that was included in the July 2023 OECD Administrative Guidance, but doesn’t yet feature in the UK legislation.
The Pillar Two charge will be known as multinational top-up tax (MTT) in the UK and will operate as a free-standing tax charge separate from regular corporation tax. As a result, the UTPR will be implemented as a distinct tax charge, rather than by denying corporation tax deductions to UK companies.
Part 4 of the Finance (No 2) Act 2023 also introduces domestic top-up tax (DTT), which is a qualifying domestic minimum top-up tax in line with OECD principles. DTT, like MTT, takes effect for accounting periods beginning on or after Dec. 31. The DTT charging provisions operate largely by reference to the MTT.
The Impact
The UK will thus be one of the early adopters of Pillar Two. The precise impact of the new rules will necessarily depend on how many other countries are also early adopters, which at the time of writing remains unclear. For example, the UK has close economic links with Ireland, where corporation tax is charged at 12.5% on trading income—but it currently seems likely that Ireland, like other EU member states, will implement the IIR and QDMTT from Dec. 31, meaning that the UK IIR shouldn’t bite with respect to Irish subsidiaries of UK parents.
There may, however, be a material impact in 2024 at least on UK groups with Singapore and Hong Kong subsidiaries, given both territories have indicated that they won’t implement an IIR until Jan. 1, 2025—and both territories have corporate tax regimes that can result in low effective tax rates in certain circumstances.
It’s also possible to anticipate the effect the new rules will have on certain structuring techniques commonly used by UK groups. For example, the IIR seems likely to have an impact on larger multinational enterprises that have relied on the partial exemption from the UK’s controlled foreign company rules for companies engaged in group financing activities.
Reforms to the CFC rules in 2013 have enabled financing subsidiaries of UK companies to enjoy an effective rate of tax of around 5% on interest arising from loans made to other group companies, provided the corresponding deductions don’t erode the UK tax base.
Although the rules were amended to limit the exemption in 2019 in line with the EU’s Anti Tax Avoidance Directive 1 (which introduced various anti-tax avoidance measures), the benefits remain where significant people functions with respect to the CFC’s activities are outside the UK. The introduction of the IIR will limit, though not necessarily remove entirely, the benefit of such planning for companies within its ambit.
In the short term, the DTT seems likely to have a negligible impact (other than compliance costs), because it’s being introduced a mere eight months after the main corporation tax rate in the UK was increased from 19% to 25%. Corporation tax in the UK is in the main relatively closely aligned to accounting profit, and the principal allowances that may reduce the effective tax rate of a company—such as capital allowances on plant and machinery expenditure, and research and development expenditure credits (which are qualifying refundable tax credits for Pillar Two purposes)—shouldn’t result in a DTT charge.
Further down the line, the UTPR will limit the benefit for foreign groups of financing and intellectual property licensing strategies undertaken by foreign-parented groups that achieve a substantial rate arbitrage relative to the UK corporation tax rate. And UK subsidiaries of companies headquartered in the US (which seems unlikely to adopt Pillar Two for the foreseeable future) will need to consider the interaction of the UTPR with the US global intangible low-taxed income, or GILTI, rules and the new corporate additional minimum tax.
This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
Author Information
James Ross is a partner with Taylor Wessing and advises on a broad range of tax matters, with a particular focus on cross-border work.
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