Episode Transcript
[00:00:00] Speaker A: Foreign.
[00:00:06] Speaker B: And welcome to our the latest in our podcast series A and M Tax Talks, Tax Policy Updates where we bring you insights into the latest developments in global tax policy and controversy matters. My name is Tom Lopp. I'm a Managing Director in the International Corporate Tax team at A and M and I'm based in London. I've been working in tax for 25 years now. I joined A&M two years ago at the start of 2024, having previously worked at EY and KFMG here in the hey.
I'm joined today by David Smith from our Irish tax practice. David, would you like to introduce yourself?
[00:00:37] Speaker A: Hi, I'm David Smith. I'm also a Managing Director in A&M's international corporate tax team and I'm based in Dublin in Ireland.
I've been with A and M since November last year and I have about 40 years experience as a tax advisor, having worked previously at ey.
[00:00:55] Speaker B: Thanks David.
So without further ado, we'll launch into the podcast so today's podcast is focused on the new ultimate parent entity, or UPE Safe Harbor. This was announced by the OECD in January of this year as part of the side by side package of new measures for Pillar two.
So perhaps before we get too into the detail, we should think about why does the UPE safe harbour exist? So what is the issue that, you know the OECD and the inclusive framework we're trying to solve for here.
So if you just think about the Pillar 2 model rules, it's the parent jurisdiction, the UPE jurisdiction hasn't implemented an income exclusion rule, then there's a risk of taxation via the undertax profits rule, the utpr.
So that's led to a lot of concerns for jurisdictions in that situation around double taxation risk and also the compliance obligations, particularly if the UPE jurisdiction has a limited risk of low tax. And just to touch on what those compliance obligations are, if your UPE jurisdiction hasn't implemented an income inclusion rule, but many of the subsidiary jurisdictions have, then if they've implemented the UTPR as well, then each of those jurisdictions would have to consider whether the UTPR applies, potentially file some, you know, tax returns, do some calculations. So there's a risk of audit risk there. So you can see what is the concern of some of these jurisdictions, particularly if they're low taxed.
So the UPE safe harbor is, I guess, the inclusive framework's response from that to that. Sorry, it does differ from the full side by side package or side by side safe Harbor. We'll touch a bit on that today.
But David, do you want to just talk through a bit about what actually is the UPE safe harbor?
[00:02:44] Speaker A: Sure. Thanks Tom. So the UPE safe harbour, it's much narrower than the full side by side system. Full side by side safe harbour and it does only one thing. It switches off the undertaxed profits rule or the UTPR in respect to profits located in the ultimate parent entity jurisdiction.
So if or where the UPE safe harbor applies, other countries should not be able to collect top up tax under the UTPR on income earned in the UPE jurisdiction. So it's very much focused on the headquarters country and the entities, the the company subsidiaries and the parent located there. It does not switch off the qualified domestic minimum top up taxes, they still apply and it does not remove the globe filing obligations. So as you can see, it's much more limited than the side by side safe harbour.
So who is eligible or who might be eligible for the UPE safe harbour? Well, the first thing to note is that M and E groups must elect into the UPE safe harbour for it to apply.
And to do that the UPE must be in a jurisdiction that has what's called an eligible domestic tax system. And that eligible domestic tax system must have been enacted and be in effect on the 1st of January this year.
There are three key criteria that must be satisfied for a jurisdiction to have an eligible domestic tax system.
The first is that there must be at least a 20% statutory nominal corporate income tax rate.
The next is that there must be a qualified domestic minimum top up tax or a corporate alternative minimum tax accountee based on financial statement income that's consistent with the policy objectives of the global minimum tax at a nominal rate of at least 15%.
And finally, there must be no material risk that in scope M and E groups headquartered in that jurisdiction will be subject to an effective tax rate on their overall profits of their domestic operations below 15%.
So 20% minimum corporate income tax rate in the country, a QDMDT or a CAMT similar to the, you know, the pillar 2 minimum tax and no material risk that the group in groups in that country applied on a jurisdiction basis, not on a group by group basis, will fall below 15% in their effective tax rate.
Now, assessment of UPE tax regimes will be undertaken by the inclusive framework during the first half of 2026 and those that qualify will be added to the OECD's Global Minimum Tax central record.
Unlike side by side regimes, qualified status for UPE regimes is limited to pre existing regimes. It will not be possible for a jurisdiction to obtain qualified status for something that will qualify or that might qualify in the future for the UPE safe harbour eligibility criteria, but that were not in place on the 1st of January. So it's even more limited in terms of it must have existed after these rules were published. In fact, it must have existed before these rules were published.
That's the system in a nutshell, Tom.
You might pick it up now and kind of just explore what countries might meet these criteria.
[00:05:58] Speaker B: Yeah, because as you say, David, the criteria have to be met at 1st January 2026. So which think about which countries might be able to meet those criteria already do and I think start perhaps by thinking about why, why were the criteria sort of why, why do they have to be pre existing regimes? And our understanding is that there was quite a lot of pushback from some of the members of the inclusive framework who were concerned that this really should only be available for a small number of countries.
And so they want it to be the case that the country's rules already had to be in place.
So that does contrast to the side by side safe harbour, where there is an opportunity for countries to potentially change their rules to fit within that particular safe harbour.
So for the UPE safe harbour, what we understand is that currently there's kind of three main countries that meet these criteria already, and that's Colombia, India and Nigeria. And there might be one or two more that could qualify, but we're really not expecting it to be very many more than that.
And so when I've discussed this with colleagues and clients, you know, one of the questions that comes up is, you know, would a pillar two country implement it? So might the UK implement this system?
And I think the UK would argue meet those criteria, right, because it's got the 25% tax rate, we've inflated the QDMCT and probably meet the third criteria around risk of top UP tax. But.
But actually if you step back and say, well, if you've implemented a pillar 2 qdmct that switches off all the other pillar 2 rules, so you've already got the protection from the utpr, which is really the main benefit of this safe harbour, and then if the UK, in the UK's case, you've also got no UTPR risk on your subsidiaries because we've implemented the income inclusion rule, so there might be a little bit of reduction in theory in what goes into your globe information return in respect to the UP jurisdiction.
But if you've implemented a pillar 2 QDMT, that information has probably been collected for those purposes anyway. So in summary, I don't think anyone who's actually implemented pillar 2 is very likely to benefit from this or to want to benefit from this safe harbour.
So I mean, one thing we talked about, David, is actually when you look at the criteria, you've already got a 20% tax rate, you've got a carry or a QDMTT and then potentially you've got little or no material risk of a top up tax charge really. So it feels like the rule switches off the UTPR in scenarios where it was probably quite unlikely to apply.
So I think that what is the benefit then? But, and I think it comes back to that compliance obligation. So I know, I appreciate a lot of you listening, may not have looked at this as much as some of us have, but the U.T.P.R, if you've got a situation where the parent jurisdiction has multiple subsidiary jurisdictions that have implemented that rule, that's a lot of extra filings for U.T.P.R, potentially a lot of extra risk. And you know, the UPE safe harbor applies, it switches that risk off and takes it off the table.
So, you know, you could imagine a large Indian multinational group could see that as quite advantageous. So I think that's the main benefit of it really doesn't really remove, doesn't touch the subsidiary jurisdictions. It just gives you reassurance that you won't have any compliance to do in respect of a UP jurisdiction and you're going to minimize the amount of, you know, risk of tax authority audits or indeed financial statement audit questions on how you're managing this risk. And I think, David, perhaps you'd come in there around the type of questions we've seen on UTPR from financial statement auditors.
[00:09:42] Speaker A: Sure. Well, you know, it's a really good point, Tom, because the thing to really, you know, bear in mind in relation to this is UPE safe harbor only affects the UTPR in the UPE jurisdiction.
So if there happen to be undertaxed subsidiaries elsewhere outside of the UPE jurisdiction, UTPR could still apply to that and indeed the IIR could apply at an intermediate parent entity level. So it really is focused only on the UP jurisdiction and as you say, it is a very limited practical impact where I've seen, and of course coming from a low tax jurisdiction where, you know, QDMDT is likely to be, you know, a feature and you know, in talking to clients about their audit exposures or how do they, how do they deal with their auditors in terms of this, you know, theoretically, you know, say for Irish subsidiaries or other companies. In fact it applies applies across the board but certainly in low tax jurisdictions.
How do clients convince their auditors that the tax provision is, you know, there's no material risk of understatement of the tax provision. When looking up through the group you say well what about the profits in the parent company jurisdiction or in the other low tax entities around the world.
So while this does nothing for the others, it certainly reduces the risk or eliminates the risk of the local subsidiary, let's say the Irish subsidiary, having to consider whether they are on the hook for a top up tax for the undertax profits of their parent in the ultimate in the parent location.
[00:11:18] Speaker B: That's what I've seen as well. We've worked with some clients to whether they have got a UTPR or top up tax that will be paid by the U.T.P.R. we've, we've inserted a pillar 2 holdco into the group literally just to mean that tax is paid in one place with one filing rather than having to deal with this issue of multiple filings across multiple jurisdictions and all the additional hassle that comes with that. So that is a. We can see the benefit of switching off the utpr I guess with this safe harbor it's just it only helps the parent jurisdiction and if you had a low tax subsidiary somewhere you still have that risk. So yeah, so I think that's interesting. The other point just quickly to finish with, I suppose that I looking at these rules and the criteria, you know we get a lot of clients generally, especially in the UK and other higher tax jurisdictions saying well I've got to do an awful lot of work calculations etc to prove out that I don't have to pay top up tax in the UK or Germany or elsewhere. And actually if you look at those criteria in this situation this UPE jurisdiction is able to satisfy that risk relatively straightforwardly. But actually one of the crude mct. But in future could we have something where if you can prove there's no material risk of top up tax under your local rules you can get. Maybe there's a quicker way to prove it out rather than doing the full globe calculation. But that's perhaps being a bit too optimistic and we'll have to wait and see.
[00:12:40] Speaker A: But yeah, maybe one to watch Tom.
So that's probably everything we wanted to cover in this short and sharp podcast. Thank you everyone for joining us today. Stay with us as we continue this journey in our upcoming podcasts. Please also check out our monthly newsletter which will bring you the latest key updates around selected editorial pieces from our Global Tax Network. And don't forget to follow this channel. There will be regular insights and updates through podcasts coming your way. And if you haven't done so already, please subscribe to receive the newsletter directly into your inbox. Thank you.
