Tax and Legal News – June 2024

Pillar 2 is one of the most frequently mentioned tax topics of late (and not only at EY).

Starting this year, the related set of rules ceased to exist in the realm of science fiction and took the form of a very real piece of legislation – the Top-up Taxes Act. The plural is quite appropriate here, because there are two new taxes: the allocated top-up tax (generally to be paid by the top entity in a group) and the Czech top-up tax (to be paid by Czech entities and Czech permanent establishments of the group).

The fact that this is not a simple issue is evidenced by the scope of the related legislation. The recently published OECD Consolidated Commentary is already over 330 pages long, and the Czech law, with its 152 sections, is not far behind. 

As expected (and quite logically), a large number of taxpayers took the path of least resistance, which in the terminology of Pillar 2 means the path of “safe harbours”.

Compared to the full calculation of the top-up tax, this is indeed a huge simplification. Ideally, the taxpayer should only need two figures from the CbCR report (i.e. total revenue and pre-tax profit for the jurisdiction), plus a total tax expense figure extracted from the financial statements. On the basis of this data alone, it should be possible to verify whether the de minimis condition or the minimum simplified effective tax rate has been met in a given country. If so, the top-up tax for that country is considered to be zero. 

If none of the above options works, the taxpayer can still try to calculate whether the profit shown in the CbCR report corresponds to the so-called “profit excluded on the basis of the economic substance of the group” for the country in question. It sounds a bit scary, but in principle it’s a question of whether there are adequate assets and personnel (relative to the profits made) in the country under consideration. The volume of required data is slowly increasing, though not beyond a tolerable limit.     

But as it happens in life, the devil is in the details.  So let’s take a closer look at one such calculation (or at least some parts of it).  

Before starting any calculations, you need to find out if you have the right CbCR report. A basic requirement is consistency of data. For example, do you know that all data for a country must generally be based on the same type of financial statements? Similarly, all data used for a single entity must come from the same source. Otherwise, you can't use the country's safe harbour rules at all. Relatively detailed guidance in this regard is provided by the OECD Administrative Guidance issued in December 2023, currently embodied in the draft first amendment of the Top-up Taxes Act.

Another issue is the accuracy of the data in the CbCR report. Some may be surprised to find that -based on the methodology for completing this report - the income does not include (mostly exempt) dividends received from subsidiaries. Previously rather uninteresting information becomes extremely important when calculating the simplified effective tax rate. On the other hand, capital gains (including exempt ones) should be included in the CbCR report, which may in practice somewhat affect the resulting effective tax rate.

Also note that for some companies you will need to carry out the calculation completely separately (for example, joint ventures).

Despite the possible pitfalls, it’s definitely worth taking this route. At the end of it, you can expect that most jurisdictions will drop out of the obligation to make a full calculation of the top-up tax (and, more importantly, to prove its correctness in future tax audits). And that’s well worth a bit of effort.

Moreover, according to unofficial Czech tax administration interpretations, the safe harbours should also apply equally to the Czech top-up tax (though a more specific regulation in the law wouldn’t hurt). 

In any case, we wish you smooth and safe passage through all harbours (pillar-related or otherwise) in the coming summer holidays.