UK passes Finance (No.2) Act 2023 introducing OECD Pillar Two measures

• The UK Finance (No.2) Act 2023 was enacted on 11 July 2023. It had previously been substantively enacted (for UK GAAP and IFRS purposes) on 20 June 2023.
  
  
• The Act contains the UK's provisions addressing the implementation of BEPS Pillar Two
  
  
• The Act also contains a number of other measures, including a new full-expensing regime for "main" rate plant and machinery, changes to the R&D tax relief regimes and the implementation of changes to the transfer pricing documentation requirements applicable to large multinational businesses operating in the UK.

UK implementation of Pillar Two

Finance (No.2) Act 2023 (the Act) includes the legislation to implement the Organisation for Economic Co-operation and Development (OECD) Base Erosion and Profit Shifting (BEPS) Pillar Two income inclusion rule (IIR) in the United Kingdom (UK). There are two elements to the legislation — the multinational top-up tax (MTUT) and the domestic top-up tax (DTT) — and both will apply to large multinational enterprises for accounting periods beginning on or after 31 December 2023.

The MTUT will apply to a "responsible member" of a qualifying multinational group. A qualifying multinational group will be a consolidated group if at least one of the members is not in the same territory as the others and the group has global annual revenues exceeding €750 million in at least two of the previous four accounting periods.

The UK is also introducing a "qualifying domestic minimum top-up tax" (QDMTT) in line with the OECD-agreed approach. In the UK, the QDMTT will be known as the DTT. This tax will apply to UK members of multinational enterprises, members of UK enterprises, and stand-alone UK enterprises, for accounting periods beginning on or after 31 December 2023. The DTT will apply to a "qualifying entity," defined as an entity located in the UK that either has revenues or is part of a group that has revenues exceeding €750 million in at least two of the previous four accounting periods.

We have highlighted some of the key points arising from the legislation below.

Charge to tax

Members of a qualifying multinational group will be chargeable to MTUT if they are responsible members who are responsible for other members of the group. Various conditions determine whether a member is responsible depending on its position within the group structure.

The amount of MTUT that is attributed to a responsible member will be calculated with reference to the member's inclusion ratio. The inclusion ratio will be determined based on the proportion of the profits that would be allocated to the responsible member if it were to prepare consolidated financial statements.

The DTT is charged on the UK member directly.

Safe harbors

The Act includes an election to apply a transitional safe harbor based on the country-by-country reporting (CbCR) rules for accounting periods commencing on or before 31 December 2026 and ending on or before 30 June 2028.

Filing and reporting

A single member of the group will report the MTUT and DTT liabilities to His Majesty's Revenue & Customs (HMRC). The ultimate parent of the group will be the default member, but groups will be able to nominate an alternative member to fulfil these responsibilities. The group will also need to file a Model Global Anti-Base Erosion (GloBE) Information Return.

Draft guidance

The UK Government has published, for consultation, partial draft guidance for the new MTUT and DTT. The draft guidance, which will eventually form three chapters of HMRC's guidance manual on multinational and domestic top-up tax, introduces the rules and provides details on their scope and administration. In particular, it discusses excluded entities, the revenue threshold test, the transitional CbCR safe harbor and how ownership is determined for the purpose of the rules. It also includes a section that maps the UK legislation to the corresponding sections of the OECD Model Rules. The consultation on the draft guidance is open until 12 September 2023.

Future revisions

As the Act progressed through Parliament, several Members of Parliament raised concerns over the need to allow flexibility regarding the timing of the introduction of Pillar Two (multinational and domestic top-up taxes) in the UK to match international implementation. Though this flexibility was not taken forward, the UK Government did commit to providing an update on the implementation on Pillar Two at the next UK fiscal statement in Autumn 2023 and, if necessary, in a fiscal statement in Spring 2024.

To that end, where the UK Government considers it necessary for the purpose of ensuring consistency with the wider Pillar Two rules, it can introduce regulations (as opposed to passing legislation in a new Finance Act) amending the provisions in this Act — though this regulatory power given by the Act may not be exercised after 31 December 2026.

Other measures

In addition to introducing the MTUT and DTT, the Act includes the following business tax measures.

New full-expensing regime for main-rate plant and machinery: This regime replaces the 130% super-deduction that ended on 31 March 2023. The main-rate pool of allowances covers all "plant and machinery" unless the items are of a class that need to go into a special rate pool or a single asset pool (for example, because they have been treated as "short life" assets). The Act also provides for the extension of 50% first-year allowances for special rate expenditure, which had also been scheduled to end on 31 March 2023.

Research and development (R&D) tax relief changes: The Act introduces changes to the R&D tax relief rules that (i) require claimants to submit a prenotification of their claim, (ii) expand the categories of qualifying expenditure to include data licences and cloud computing costs, and (iii) require additional information be provided to support claims. The changes generally have effect for accounting periods beginning on or after 1 April 2023, but the requirement to provide additional information with a claim has effect for claims made on or after 1 August 2023. The previously announced proposed restriction of overseas expenditure on externally provided workers, which was due to come into effect from 1 April 2023, has been delayed to 1 April 2024. The Act does not include legislation for the additional relief for qualifying "R&D intensive" small and medium-sized enterprises (SMEs) applicable from 1 April 2023. This will be legislated for in a future Finance Bill.

New electricity generator levy (EGL): The levy, which will be in effect from 1 January 2023 to 31 March 2028, applies a temporary 45% charge on "exceptional receipts" realized from the sale of wholesale electricity by nuclear, renewable, biomass and energy from waste sources. The EGL is limited to companies or corporate groups with relevant electricity output exceeding 50 gigawatt hours across a year and apply only to exceptional receipts exceeding £10m per annum. The timing of enactment of the new EGL is important for large companies that are within the scope of the EGL and the quarterly instalment payment (QIP) rules. Those companies will need to take EGL liabilities into account (including those arising before formal enactment of the measure) in calculating the first QIP due after enactment, which could be as early as 14 July 2023.

Higher investment allowance rate: The Act introduces a higher investment allowance rate within the energy (oil and gas) profits levy (EPL) for expenditure incurred on or after 1 January 2023 on the decarbonization of oil and gas production. Qualifying expenditures will get allowance at 80%, compared to the main rate of 29%. Qualifying expenditures include capital expenditures on powering oil and gas production facilities from non-fossil fuel sources, and the reduction or elimination of flaring and venting of greenhouse gases.

Modified transfer pricing documentation requirements: The Act implements changes to the transfer pricing documentation requirements applicable to large multinational businesses operating in the UK, applicable for accounting periods commencing on or after 1 April 2023.

Technical changes: Certain technical changes are made to the corporate interest restriction (CIR), qualifying asset holding company (QAHC) and real estate investment trust (REIT) rules, and to the genuine diversity of ownership (GDO) condition.

The legislative cycle begins again

On 18 July 2023, the UK Government will publish draft legislation for inclusion in Finance Bill 2024. The draft clauses, which will largely cover preannounced policy changes, will be published alongside explanatory notes, tax information and impact notes, responses to consultations and other supporting documents.

For additional information with respect to this Alert, please contact the following:

Ernst & Young LLP (United Kingdom), London

• Fiona Thomson
  
  
• James Taylor
  
  
• Jack Gifford
  
  
• Mark Eaton
  
  
• Richard Milnes, Financial Services
  
  
• Jenny Coletta, Financial Services
  
  
• Chris Sanger, Tax Policy
  
  
• Mike Gibson, Corporation Tax

Ernst & Young LLP (United States), UK Tax Desk, New York

• Graham Shaw

Ernst & Young LLP (United States), FSO Tax Desk, New York

• Alex Magee

Ernst & Young LLP (United States), Transaction Tax Desk, New York

• Alex Prince

Ernst & Young LLP (United States), UK Tax Desk, Chicago

• Sarah Logan

Ernst & Young Tax Co. (Japan), UK Tax Desk (Asia-Pacific), Tokyo

• Richard Johnston
  
  
• Rebecca McKavanagh

Published by NTD's Tax Technical Knowledge Services group; Carolyn Wright, legal editor

For a full listing of contacts and email addresses, please click on the Tax News Update: Global Edition (GTNU) version of this Alert.