CW Energy LLP

Proposed changes to taxation of profits for multinational groups – Pillar Two

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

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.


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.


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