2. Pillar Two
Pillar Two aims to create a fairer and more stable international tax system by protecting the tax base and curbing tax avoidance by multinational corporations. The publication of the Global Anti-Base Erosion Model Rules (Pillar Two) by the OECD in December 2021, outlined a global minimum taxation for international companies. It was implemented in Ireland in 2023 by way of Section 94 of the Finance (No.2) Act 2023’s insertion of (a new) Part 4A of the Taxes Consolidation Act (TCA) 1997.
The regulatory framework of Pillar Two stipulates that in certain cases, a top-up tax must be levied on large multinational companies. To determine this tax, the tax base ‘GloBE Income’ is set in relation to the predefined recorded taxes ‘Adjusted Covered Taxes’. This allows for the identification of the states in which a multinational group of companies (MNE Group) is subject to an effective tax rate of less than 15%. When a group of companies has an effective tax rate of less than 15% in a certain country, a top-up tax is generally levied at the level of the ultimate group company within the framework of the ‘Income Inclusion Rule’ (IIR) and ‘Qualified Domestic Top Up Tax’ (QDTT). In the event that the low taxation is not (or is not fully) compensated for by the IIR, the ‘Undertaxed Profits Rule’ (UTPR) applies, the aim being to raise the effective tax rate of multinational groups to a minimum of 15%. However, the top-up tax is only calculated after deduction of a substance-related discount, so that ultimately only the ‘excess’ profit is subject to taxation.
In the Irish context, Pillar Two’s target group and addressees are constituent entities located in Ireland that are part of an MNE Group. The prerequisite for designation as an MNE Group is that it achieves a turnover threshold of at least €750 million in the consolidated financial statements of the ‘Ultimate Parent Entity’ in at least two of the four previous financial years.
Though simple in theory, in practice, there is considerable scope for uncertainty as by implementing these rules into Irish tax law, new laws have been introduced (which require interpretation), and ordinary accounting is interrupted by the increased administrative burden of the minimum tax assessment. The starting point for the calculation of GloBE Income is the result of the included group entity according to the annual financial statements (before consolidations of intra-group transactions). The result of the included company is generally to be calculated in accordance with the accounting standard used in the preparation of the consolidated financial statements of the group parent company. In addition, there are various adjustments and voting rights which must be carefully exercised. For example, uncapitalized tax deferrals on loss carryforwards can lead to an effective tax rate of less than 15% in the year of loss offsetting. This would trigger the application of Pillar Two provisions, and so the delta between the actual tax rate and the 15% minimum rate would be subject to tax.
Some uncertainties can be preempted or clarified in Irish tax law by way of Revenue Opinions or Confirmations in accordance with Tax and Duty Manuals Part 37-00-40. However, the parameters for seeking a Revenue Opinion are relatively narrow. The question therefore arises as to whether Pillar Two risks can be insured.
Pillar Two coverage: W&I insurance or tax insurance
Two types of policies can be used to insure tax risks:
- Warranty and indemnity (W&I) insurance, which is used to insure unknown tax risks that emanate from events in the past. Placed in the context of a corporate transaction, the provisions of W&I insurance are linked to the warranties and indemnities provided by a seller to a buyer in a sale and purchase agreement. A significant part of the cover is protection in the event that a seller has not disclosed relevant information to a buyer, or for risks which have not been discovered in due diligence.
- Tax insurance is a form of standalone insurance that covers both known and unknown tax risks that have arisen in the past or may arise in the future. It has a much broader scope of application than W&I insurance and so can cover tax risks outside of an M&A transaction, e.g. those risks for which a resolution might otherwise be sought by seeking a Revenue Opinion or Confirmation.
Insurer appetite — W&I Insurance
Approximately a third of insurers are willing to provide insurance cover for tax risks related to Pillar Two under a W&I insurance policy. Another third have clear reservations about providing coverage under W&I insurance, while the final third have yet to take a position. A list of reasons for the reluctance to offer tax cover under a W&I insurance policy includes:
- Pillar Two being typically outside of the scope of tax due diligence
- Lack of experience or lack of market consensus
- The accounting standard may lead to risk allocation uncertainty (in the context of de-/first-time consolidation)
- Liability for a third-party tax is difficult to assess without considering the position of both sides of a transaction
- Certain issues are outside of the control of the parties (such as which countries have implemented the rules)
- Uncertainty regarding political decision-making on Pillar Two implementation
Insurer appetite — Tax insurance
The picture as relates to standalone tax insurance is clearer, and here there is a general willingness among insurers active in the Irish market to provide cover for Pillar Two risks. Insurers will consider areas such as:
- Risks around inconsistency in implementation and interpretation in national law or tax authority commentary.
- The Group’s use of Safe Harbor Rules.1
- Risks related to the question of whether the non-consolidation of MNE Groups/units of companies is correct (this is likely to be particularly relevant at the time of first filing Pillar Two returns).
The majority of insurers surveyed will consider covering known Pillar Two risks under a tax insurance policy.