In our newsletter in July 2021, we summarised and commented on the potential changes to the taxation of profits for multinational groups published by the OECD/G20.  That newsletter can be found here https://cwenergy.co.uk/potential-changes-to-taxation-of-profits-for-multinational-groups

The OECD issued a report at the end of December 2021 that sets out details on how Pillar Two rules are to be implemented (“Model Rules”).  Pillar Two deals with the Global Anti-Base Erosion (“GloBE”) rules which provides for the introduction of a minimum corporate tax rate of 15%.

On 11 January 2022 HM Treasury and HMRC issued a consultation document to seek input on the UK application of the Model Rules and wider implementation questions.

In early 2022, OECD is expected to issue further guidance on these rules and also will engage further with stakeholders to refine the Pillar One rules.

In this newsletter, we summarise and briefly comment on some of the key components of the Pillar Two Model Rules and relevant parts of the UK consultation.

Background

Changes to the international tax rules had already been made through other BEPS (Base erosion and profit shifting) initiatives; however, it has been perceived that there remains a need for a broader change to address the possibility that companies could still shift profits to low tax jurisdictions.  Pillar Two seeks to ensure that large multi-jurisdictional businesses pay a minimum level of tax regardless of where they are headquartered, the jurisdictions they operate in, or where their profits are booked.

Where an “in scope” entity suffers a rate of tax lower than 15% in any jurisdiction the rules seek to identify this and levy a charge, normally in the group parent company, for the difference, thereby removing the advantage of shifting profits to low tax jurisdictions. The rules also allow a country that has implemented the rules to charge additional tax to bring their rate up to 15%, thereby preserving that jurisdiction’s primary right to levy taxes on income generated in its own jurisdiction.

Scope of the rules

The rules are to apply to multinational groups with annual global revenues greater than EUR 750m.  The value is taken from the consolidated financial statements of the parent entity.  For the rules to apply the EUR 750m revenue threshold needs to be met in at least two of the last four years preceding the year under consideration.  Therefore while the rules, at first sight, seem to replicate the scope of the Country-by Country Reporting rules they are slightly different.

If the multinational group is in scope, each entity in that group is subject to the rules.  There are some exclusions, e.g. not for profit organisations, pension funds and governmental organisations, but all multinational oil and gas and energy groups will be potentially affected if they meet the revenue threshold.

Pillar Two, however, applies only to multinational groups which means a group that includes solely UK tax resident companies with no foreign permanent establishments will not be subject to the rules.

Determining the rate of tax

The tax rate is determined by finding each entity’s “GloBE Income or Loss”, i.e. broadly profits, and its “Adjusted Covered Taxes”, i.e. the related tax liability for the period.  The values for each entity in the same jurisdiction are aggregated with an overall tax rate determined for each jurisdiction.

GloBE Income or Loss

Globe Income or Loss is found by taking the amount of income or loss that was included in the consolidated financial statements for each entity.  This amount is then subject to numerous adjustments.  For example, the following are to be adjusted:

• Any accrued illegal payments;
• Fines or penalties of EUR 50,000 or more;
• Pension costs accrued and not paid;
• Property, plant or equipment that has been revalued for accounting purposes but not sold;
• Certain foreign currency gains or losses of an entity whose accounting and tax functional currencies are different;
• Prior period errors and changes in accounting principles.

The starting point is therefore book profit and loss amounts and notably, the adjustments required to determine Globe Income or Loss do not include the items we would typically see being adjusted in a UK upstream oil company tax computation, such as add-back for depreciation, deduction for capital allowances and use of brought forward tax losses.  However, there are separate adjustments to be made to the calculation of Adjusted Covered Taxes in respect of temporary differences, i.e. profits and losses recognised in different periods for tax and accounting purposes (see below).

Gains and losses arising from the sale of greater than 10 per cent shareholdings and gains and losses in relation to a reorganisation where the gain or loss is deferred for local tax purposes are to be excluded.

However, a gain or loss on the disposal of an interest in an oil field would not seemingly be covered by the exclusions and potentially any gain arising would constitute GloBE income even though any gain may be exempt from tax where reinvestment relief applies.

Substance-based Income Exclusion Carve Out

In order to seek to include only “excess profits” of a company in the rules, GloBE Income is to be reduced by two further amounts:

• A payroll carve out at 5 per cent of the payroll costs of employees of the entity; and
• A tangible asset carve out at 5 per cent of the book value of relevant assets. Such assets are stated to include property, plant and equipment and also natural resources.

There are transitional rules which allow higher rates to apply for the first ten years.

Adjusted Covered Taxes

Adjusted Covered Taxes is found by taking the amount of current tax expense accrued in the financial accounts for taxes levied, broadly, on the entity’s income or profits.

We would expect in scope taxes to include both PRT and SCT and also other oil tax regimes such as Norway’s special tax, Netherlands’ state profit share and Denmark’s hydrocarbon tax.

In addition, taxes imposed in lieu of a generally applicable corporate income tax are also included.  This is expected to cover petroleum sharing contracts where tax is often paid by the host state on behalf of the oil company out of the state’s share of oil.

In quantifying the amount of current tax expense in any year it appears this will be the amount of tax that has or will be included in a submitted tax computation as the amount of current tax expense that relates to an uncertain tax position is to be excluded until that tax has been paid.

Deferred tax expense is to be included in the calculation of Adjusted Covered Taxes.  Where there is a deferred tax expense the tax rate used to calculate deferred tax is to be recast, in most cases, downwards so that deferred tax cannot be recognised at a rate above 15%. Deferred tax credits will also be recognised at a rate restricted to 15%.

There are multiple further adjustments that should be made, with perhaps the most significant being an adjustment to the deferred tax being removed from the calculation of Adjusted Covered Taxes if a deferred tax liability is not “recaptured pursuant to this article” within five years.  This appears to mean the deferred tax liability must have “reversed” within five years or the Adjusted Covered Taxes amount is reassessed for the year the deferred tax expense was included. This five-year rule does not apply where the deferred tax meets the definition of “Recapture Exception Accrual” which means tax expense is attributable to certain items including:

• Cost recovery allowances on tangible assets;
• The cost of a licence or similar arrangement from the government for the use of immovable property or exploitation of natural resources that entails significant investment in tangible assets; and
• De-commissioning and remediation expenses.

These items are not further defined in the report.  On the face of it, this may mean that deferred tax charges made for items such as accelerated capital allowances on-field development costs may not be subject to the five-year rule.

De minimis exception

A group may elect on an annual basis for the rules not to apply to certain jurisdictions where the entities in that jurisdiction have both:

• average GloBE revenue (broadly, the revenue included in the consolidated accounts for that jurisdiction) of less than EUR 10 million; and
• average GloBE income (calculated as set out above) is a loss or is less than EUR 1 million.

The average is calculated by taking the current and preceding two years of GloBE revenue and GloBE income.

There is also reference to a “GloBE Safe Harbour”.  It appears that details of this exclusion are to be included in the GloBE Implementation Framework which has yet to be published.

From the UK consultation document, it appears the GloBE Safe Harbour may use the country by country (CBCR) filings (with some adjustments) to identify if there is a lower risk of a particular jurisdiction being subject to tax below the minimum rate.  This safe harbour approach may remove the need to undergo a full set of calculations for a safe harbour jurisdiction.

Transitional rules

In the first year that an entity comes within the scope of the GloBE rules, the entity is to take account of all deferred tax assets and liabilities reflected or disclosed in the financial accounts in arriving at the Adjusted Covered Tax.  The impact of any valuation adjustment (where the full deferred tax asset is not recognised) is disregarded so that the utilisation of losses that were unrecognised for deferred tax purposes are taken into account in determining the tax charge.

Charging provisions

Where a tax rate has been found that is below the 15% minimum tax rate then a top-up tax is to be charged (called Income Inclusion Rule).  This is usually levied by the tax jurisdiction of the parent company of the group.  Where the tax jurisdiction of the parent company of the group has not implemented the GloBE rules then a jurisdiction further down the ownership chain may levy the top-up tax.  The rules use a top-down approach so that, for example, if the jurisdiction of the parent company of the group does not operate the GloBE rules but an immediate subsidiary is in a jurisdiction that has implemented the rules then it is that jurisdiction that charges the top-up tax.

Where there is still tax to pay then another mechanism may apply (called the Undertaxed Profits Rule) which would arise if the parent company of the group is not subject to the Income Inclusion Rule and the top-up tax has not been collected by other jurisdictions (e.g. where none of the companies in the ownership chain is in jurisdictions that have implemented the GloBE rules), the remaining top-up tax is charged by jurisdictions that have group entities and have adopted the GloBE rules. The amount of tax charged by each jurisdiction is based on the relative size of the group’s entities measured by tangible assets and the number of employees.

UK domestic minimum tax

The UK consultation document includes a section on the possibility that the UK will implement a domestic taxation rule that would apply to charge income to UK taxation under domestic law if the Pillar 2 rules would otherwise apply in respect of UK activities.  The consultation states that absent a domestic minimum tax, these rules will mean low tax profits in the UK will likely be topped up in foreign jurisdictions.  This domestic minimum taxation would be designed to ensure tax flows to the UK rather than a foreign jurisdiction.

UK implementation timing

The UK consultation is open until 4 April 2022 with the draft legislation to be published in summer 2022.  It is expected the legislation will be included in Finance Bill 2022-2023 and have effect from 1 April 2023.  The Undertaxed Profits Rule and domestic minimum tax rule (if implemented) would be introduced from 1 April 2024 at the earliest.

Comments

The Model Rules include many concepts which were not set out in earlier papers and reports.  The OECD guidance, when published, should hopefully set out in more detail how some of these concepts and calculations are expected to work.  In addition, the UK consultation and legislative process will provide more clarity.  However, we do now know that these rules will be complex and for the proposals to work effectively, will need to be implemented cohesively across all relevant jurisdictions that have signed up.

For upstream oil and gas operations in the UK, one would expect that the rules should not be relevant due to the high rate of tax applicable to UK upstream companies.  However, there are some instances where there is a possibility that the rules could apply.  For example, on the refund of PRT, the repayment interest is not taxable which may result in a reduced effective tax rate.  Where decommissioning losses are carried back the credit to current tax may be greater than the associated capped deferred tax charge thereby also reducing the effective tax rate unduly.  Where reinvestment relief applies to field disposals this may also give rise to a tax charge below the minimum rate.  The utilisation of losses that have arisen on claims to ring-fence expenditure supplement may also cause issues. Other anomalies may emerge as the rules are analysed further.

For UK based oil and gas groups with activities overseas it may be that the rules could be in point, but with the potential for countries to change their domestic rules in the style that the UK has suggested may mean that these rules, in most cases, become one of domestic law compliance and group reporting.

We shall provide further updates as more details are published.

CW Energy LLP

February 2022

In our newsletter last year we summarised and commented on the proposed rules for the notification of uncertain tax treatments.  That newsletter can be found here https://cwenergy.co.uk/notification-of-uncertain-tax-treatments-draft-legislation-published/

Since then the relevant statutory provisions have been included in Finance (No.2) Bill 2021-2022, and last week revised draft HMRC guidance was published, subject to a short period of consultation.  The consultation will run to 1 February 2022.

The big change in the Finance Bill was the omission of the notification requirement where it is reasonable to conclude that, if a tribunal or court were to consider the tax treatment, there is a “substantial possibility” that the treatment would be found to be incorrect. The notes accompanying the legislation indicate that this trigger may yet, however, be adopted.

In this newsletter, we summarise and comment on some of the key parts of the Finance Bill clauses and accompanying notes and the recently published revised draft guidance.

Threshold for notification

As a reminder, for the uncertain tax treatment to be notifiable there must be more than £5m of tax at stake (which includes SCT) in the year ended on the last day of the period covered by the return.

The Finance Bill contains a clarification of how to measure whether the threshold is met in cases where tax losses are created or increased using treatments that are ‘uncertain’. Where such losses are used, the rules will look to the actual reduction in the tax liability, but where the losses are unused a 10% reduction in liability is assumed unless there is no reasonable prospect of the loss being used to reduce tax liability. In the latter case, the value is zero.

In determining whether there is a reasonable prospect of the uncertain loss being used the same process as applies to the determination of potential lost revenue for penalties for inaccuracies is to be used.  This process considers both technical and practical reasons why the loss will not be used e.g. we would expect a lack of sufficient anticipated profits from current field interests would be a relevant factor.

While there are examples of how to calculate the amount of tax at stake in the draft guidance, we would expect complications will still remain.

Provision made in the accounts trigger

The first of the two remaining triggers is where the taxpayer has made a provision in their accounts to reflect the probability that a different tax treatment will be applied to the treatment reflected in a tax return.

In earlier draft legislation this trigger required the provision to be in accordance with GAAP.  This condition has now been removed so a provision whether rightly made or not may satisfy this trigger.

The draft guidance notes that there must be a link between that provision and at least one entry (which includes nil) on a relevant tax return.  The trigger may apply “irrespective of where the provision is presented in the accounts” which presumably references amounts provided as deferred tax as well as provisions included in current tax.

The draft guidance includes an example where a provision was not made in the accounts that included the transaction but a provision was raised subsequently in a later period.  The draft guidance makes clear that this would satisfy the trigger when the provision was raised (i.e. in the later period).

HMRC’s known interpretation of the law trigger

The second of the two triggers for notification is where the taxpayer files on a basis where it is known that HMRC’s interpretation of the law is different.  There are two ways that an interpretation may be taken as being “known”:

1. Where the position is generally known to all taxpayers from documents published by HMRC; and
2. Where the position is specifically known to a taxpayer through correspondence with HMRC.

Whether the taxpayer actually did or did not know of HMRC’s interpretation is not relevant as the rules say that “HMRC’s position on a matter is taken to be “known” by a company or partnership”.

Documents published by HMRC

The draft guidance includes some illustrative, but not exhaustive, examples of publications that could indicate HMRC’s known position, and include HMRC Manuals, Statements of Practice, Public Notices, Revenue & Customs Briefs and Explanatory and technical notes relating to legislation (with the latter newly added to the publications that indicate HMRC’s known position).

The draft guidance also sets out publications that should not be considered as containing HMRC’s known view, being advice provided in HMRC forums and submissions HMRC makes in litigation.

In earlier draft guidance it was stated that “advice provided via Online HMRC forums” were not to be considered so this later draft guidance appears to make it clearer that statements made at the Direct Tax Forum (for example) should not be taken to represent HMRC’s interpretation of the law.  In addition, although the minutes of each Direct Tax Forum are published there is potentially insufficient analysis for a company to understand the technical detail and intended application.

Furthermore, much of the correspondence between HMRC and the industry is in the form of letters and meetings between HMRC and UKOITC, Brindex and OTAC.  These letters and meeting notes are not published and are not in the public domain so presumably should not be considered in determining what is a “known” HMRC position.

Known to the taxpayer through correspondence with HMRC

In addition to published materials, a taxpayer may know HMRC’s interpretation from “dealings with HMRC by or in respect of the company or partnership (whether or not they concern the amount in question or the transaction to which the amount relates)”.

The draft guidance notes that dealings with HMRC may include not just a written view of the correct tax treatment from HMRC but also discussions with an HMRC CCM or Tax Specialist.  It seems reasonable where a taxpayer has a written view from HMRC of a legal interpretation that they are put on notice that a certain treatment is that favoured by HMRC, but it seems strange that a telephone discussion with an HMRC Inspector may be considered as giving a taxpayer sufficient notice of the known position of HMRC.

There is no group concept in this part of the rules so that if a similar discussion has happened with Company A and a year later the same technical question arises with regard to another group company, Company B, that latter company seemingly has no knowledge of HMRC’s known position as the first discussion was not in respect of its affairs. Similarly, if an adviser such as CWE is aware of a particular HMRC treatment from correspondence on one client other CWE clients would not be treated as having that knowledge.

It would appear that this test can only be triggered if the discussions with HMRC are in respect of the tax affairs of the company itself.  Therefore, if for example a company’s tax manager is engaged in general discussions with HMRC policy teams about how a law should be interpreted as part of an oil industry discussion, then that will not be sufficient for the company or partnership to be taken as knowing HMRC’s known position from “dealings with HMRC by or in respect of the company or partnership”. Also, if the tax manager is employed by a service company within the group it would seem that no other companies within the group can be deemed to be aware of any discussions the manager holds with HMRC.

Other HMRC comments

The draft guidance does make some further comments:

• There is recognition that there is a large volume of published material and the new rules are “not intended to act as a series of tripwires leading to penalties”. The draft guidance suggests that HMRC expects a “level of familiarity” with its published material but where guidance is hard to find there is more likely to be a reasonable excuse for not making a notification.  The guidance suggests a higher hurdle where a treatment is “novel, contentious, high-value or high-risk such that a careful examination of HMRC’s view would be warranted”;
• HMRC has confirmed that where the known position of HMRC cannot be determined or is unclear then this trigger cannot apply. This is potentially applicable to many situations in the oil industry as guidance often does not address particular circumstances;
• The trigger can still apply where there is legal uncertainty of whether HMRC’s known position is indeed correct. The example given in the draft guidance is where the Upper Tribunal has found against HMRC’s technical position but HMRC has not yet adopted the Upper Tribunal’s technical analysis as their “known” position.  In that scenario, the draft guidance provides that the trigger condition may be met even though the Upper Tribunal has not supported HMRC’s known position;
• HMRC acknowledges that their publications may be “out of date or contain conflicting advice”. The draft guidance states where HMRC’s position is contradictory the most recently published statement is to be taken as the known position.  This is different from earlier draft guidance that stated that where statements were contradictory the trigger would not be satisfied as there was no known position.

Exemption from notification

Even where a trigger test has been satisfied, a business is not required to notify HMRC if it is reasonable to conclude that HMRC already have available to them all, or substantially all, of the information relating to the amount, including the amount itself, that would have been included in a notification.

Perhaps unsurprisingly the draft guidance seeks to make clear that to rely on this exemption each individual taxpayer will need to make the uncertain treatment obvious to HMRC.  It will not be sufficient if this information “is hidden away or it is obscure”.

There is also no group concept for this aspect so even if other group companies have made HMRC aware of similar treatments in their own affairs this will not exempt the particular company.

Furthermore, the draft guidance indicates that in the course of any discussions with HMRC over uncertain treatments it would be recommended that taxpayers make clear that the discussion is to avoid the requirement to notify and the discussion is documented. We would expect most taxpayers will wish to expressly confirm that they will not make a formal notification of the uncertain tax treatment under these rules.

In a change from earlier guidance, HMRC has clarified that if a company treats a transaction in accordance with how it was outlined in a clearance request and the business undertakes and treats the transaction in the way included in the clearance, there will be no further need to notify the transaction.  In the earlier guidance, this exemption only applied where HMRC agreed with the treatment included in the clearance.

HMRC have encouraged businesses to seek exemption early and in real-time rather than reporting formally under these rules.

Form of the notification

The Finance Bill provides that the form of the notification shall be specified in a notice to be published by HMRC.  This notice has not yet been published.

Comments

The omission of the “substantial possibility” trigger is welcome as that element of the rules would have led to a lot of uncertainty as to its application.

The Finance Bill has now passed the Committee Stage and although both the draft guidance and related statutory provisions are not final, the potential for these rules to apply to transactions currently being undertaken means that companies should be considering their impact now.

The draft guidance does provide some assistance to companies seeking to understand how to meet their obligations.  We expect companies will need to look at relevant transactions carefully and prepare notifications or commence earlier discussions with HMRC where necessary. Consideration of these rules will also need to become part and parcel of any tax planning being undertaken for groups within the regime.

We at CW Energy will be working with clients who will be within the regime to ensure that the implications are understood and to assist them in complying with the new rules.

CW Energy LLP
January 2022