Challenges To Pillar 2 And The Tax Control Framework

The idea stems from the belief that unfair tax competition and a “race to the bottom” must be prevented. For this reason, and as part of its broader “base erosion and profit shifting” project, the Organisation for Economic Cooperation and Development OECD proposed a scheme in 2021 to ensure that internationally operating groups paid an effective minimum tax rate of 15% on their profits. Following the OECD’s lead, the EU adopted this approach and embedded it in the EU Anti-Tax Avoidance Directive (ATAD), Directive 2022/2523, which EU member states are required to adopt into national law.

Framework

The core of Pillar 2 consists of three top-up tax rules:

1) The domestic minimum top-up tax;

2) The income inclusion rule (IIR); and

3) The undertaxed profits rule (UTPR).

The rules as jointly known as the Global Anti-Base Erosion (GloBE) rules. In brief, the system works as follows: If a (tax) jurisdiction’s effective tax rate is lower than 15%, that jurisdiction itself can add a top-up tax to reach the minimum level of 15%. If that jurisdiction does not add the top-up tax, other jurisdictions where members of the international group reside can add the top-up tax. This is first done at the level of the head of the group (IIR), followed by the level of the other jurisdictions in which the group is active (in the form of the UTPR).

Implementing Pillar 2 in the tax control framework

For multinational groups, Pillar 2 has substantial consequences for the tax control framework (TCF). Noting that the core of Pillar 2 is to ensure these groups pay an effective tax rate of at least 15% on their worldwide profits, it is of the utmost importance that there is continuous control over the group’s tax position. A TCF is an indispensable tool in this regard.

Key requirements for a Pillar 2 proof TCF

We have now outlined the key elements of Pillar 2 and noted that these must be reflected in the TCF. Below, I set out the six key requirements for the tax control framework that are necessary to comply with Pillar 2 legislation and regulations.

1) Increased requirement for tax governance and monitoring

The TCF must ensure the company has a clear understanding of the effective tax burden in each relevant jurisdiction, as required under the Pillar 2 rules. This calls for a robust system for identifying, monitoring, and managing tax risks, including the risks of underpaying corporation tax in low-tax jurisdictions.

2) Adjustment of internal processes and reporting

The calculation of the effective tax rate under Pillar 2 is based on adjusted income and tax burden per jurisdiction, with adjustments applied to commercial annual figures (e.g. substance carve-outs, carry-forwards, and adjustments for permanent and temporary differences between commercial and taxable profit). The TCF must be able to process these data flows and ensure that the correct data is collected and reported in a timely and accurate manner.

3) Management of compliance risks and assurance

The TCF must include procedures to ensure the company complies with the reporting and payment obligations arising from the Minimum Tax Act 2024 and the implementation of the EU Minimum Tax Directive 1. This includes obtaining assurance regarding the accuracy of tax disclosures, and reporting conduct that is unlawful or unethical.

4) Assessment of tax incentives

The TCF must provide insight into the tax incentives embedded in management controls, and into the treatment of tax incentives under Pillar 2. Certain tax schemes, such as Qualified Refundable Tax Credits (QRTCs) and Qualified Marketable Transferable Tax Credits (QMTTCs), are treated favourably under Pillar 2, and this affects the calculation of the effective tax rate and the level of additional tax.

5) Simplification measures and “safe harbours”

Pillar 2 provides for simplification measures, such as safe harbour rules, which allow for a simplified calculation of the effective tax rate under certain conditions. The TCF must be able to assess whether and when these simplifications apply and how they are correctly applied.

6) International coordination and reporting

As Pillar 2 is implemented globally, the TCF must take into account differences in implementation and interpretation across jurisdictions. This requires international coordination and monitoring of changes in local legislation and practice.

Conclusion

Pillar 2 imposes stricter requirements on the tax control framework of multinational enterprises, particularly in the areas of data collection, risk management, compliance, reporting, and international coordination. The aim is to ensure the enterprise meets the minimum effective tax rate globally, and is prepared for the complex and evolving requirements of the international tax landscape.