Like previous years, the days before Christmas saw an abundance of updates on Pillar 2. The Pillar 2 legislative proposal passed through the Dutch Senate on December 19, 2023, and entered into force as of January 1, 2024. In addition, the EU published a FAQ addressing questions raised by various stakeholders and the OECD published a new set of administrative guidance, with amongst others further clarification on application of the safe harbors. These updates are quite relevant as they provide detailed guidance for accurately assessing the impact of the Pillar 2 legislation.

This article is written by Juan Dosal ([email protected]) and Tim Hartong ([email protected]). Juan and Tim are both senior consultants and part of RSM Netherlands International Tax Services with a specific focus on Global Tax Policy and International Tax Advisory. 

With 2024 kicking off, Pillar 2 came into effect in numerous countries, as Pillar 2 entered into force as from January 1, 2024. As such, for FY 2024, multinationals surpassing annual revenues of EUR 750 million will be subjected to additional tax insofar as their effective tax rate is below 15% in any jurisdiction where they operate. Not only can this have a material impact on an MNE’s tax position, but it also creates a significant additional compliance burden. 

For the first years though, transitional safe harbor rules apply, which should reduce the compliance burden and provide more certainty on the tax impact of Pillar 2. Since the publication of these transitional safe harbor rules in December 2022, many MNE’s have taken action to ensure the safe harbor tests are passed in as many jurisdictions as possible. In this respect we have experienced that taxpayers are already conducting an impact assessment of the new legislation. Conducting such an assessment enables them to identify the possible impact of the new legislation and determine what the next steps are for ensuring compliance. 

New anti-abuse rules 

The OECD has now, amongst others, introduced anti-abuse legislation that should be considered when planning around application of the safe harbor rules. These new anti-abuse rules relate to the application of the simplified ETR safe harbor. Under the simplified ETR test, a jurisdiction is assumed not to be undertaxed, when the amount of covered tax expenses included in the financial statements divided by the profit before tax included in the CbCr, is higher than the transition rate (15% in 2024). As opposed to the detailed ETR calculation, the simplified ETR rules do not contain a provision to combat financial arbitrage, whereby differences in accounting methods, as well as book to tax differences are used to artificially pump up the ETR. 

Without such an anti-arbitrage provision in the simplified ETR test, the OECD has noticed that some multinationals are implementing hybrid arrangements whereby the CbCr profit before tax is artificially reduced through expenses that are considered in multiple jurisdictions (duplicate loss arrangements). Another method is making use of deduction non-inclusion arrangements whereby a CbCr profit before tax of one country is reduced through an intercompany arrangement, but no corresponding increase in the PBT of another country takes place. 

To combat this form of tax planning, the OECD introduced an additional set of rules through which the profit before tax and in the CbCr must be adjusted for deductions that are a result of hybrid arbitrage arrangements that are entered into after 15 December 2022.  

Though it makes sense that the OECD also includes anti-arbitrage rules in the simplified ETR calculation test, instead of only in the detailed ETR test, it does impact the simplicity of the simplified ETR test. Especially for hybrid structures, such as US check the box structures, could mean that the updated guidance results in not meeting the simplified ETR test, due to the adjustments that must be made for hybrid arbitrage arrangements.

On the upside, the administrative guidance also provided a much-needed confirmation for the routine profits test. Under the routine profits test, top up tax is deemed zero if the profit before tax in the CbCr is lower than the substance based carve-out. The substance based carve-out is equal to 5% of payroll costs plus 5% of eligible tangible assets. For the first 10 years, these percentages are higher though, with the carve-out for payroll costs starting at 10% and the carve-out for tangible assets at 8% before gradually declining to 5%. Confirmation has now been provided that these higher carve-out percentages may also be relied upon for purposes of the routine profit test, making it easier to pass this safe-harbor test.

Forward thinking

For multinationals with financial years following the calendar year, the first financial numbers should be completed shortly, based on which the tax provision will be prepared. Internationally active companies could consider using the 2023 draft numbers and tax provision as a proxy for the 2024 simplified ETR test. These numbers can be used for a proxy routine profit test as well. When conducting these proxy safe harbor calculations using 2023 numbers, the updated administrative guidance should be considered. Especially due to the new anti-hybrid arbitrage rules, the proxy results for safe harbor tests might not turn out as previously expected. By conducting these tests early in 2024 though, a revised strategy may still be adopted to make the most of the Pillar 2 safe harbor rules. 

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