BEPS & Diverted Profits Tax (for SME owners)

What is Base Erosion and Profit Shifting? What is the Multilateral Instrument? When did it come into force? What are the Pillar 1 and 2 projects? What is the Undertaxed Profits Rule? What is the Income Inclusion Rule? What is the Domestic Minimum Tax? Will either of these affect me or my SME clients?

This is a freeview 'At a glance' guide to Base Erosion and Profit Shifting (BEPS).

At a glance

What is BEPS?

BEPS poses a universal challenge for tax authorities. BEPS arises from deliberate tax planning that exploits gaps and inconsistencies in tax rules of different countries and jurisdictions to shift profits and income to low-tax jurisdictions or make them disappear altogether.
The G20 countries and the Organisation for Economic Cooperation and Development (OECD) have been working on the BEPS project.
On 7 June 2017, 68 countries and jurisdictions signed a Multilateral Instrument (MLI) in order to implement the treaty-based recommendations of the BEPS process.
An additional eight countries are expected to sign in the future.
This will update some 1,100 bi-lateral treaties and includes measures to prevent treaty abuse, changes to the definition of Permanent Establishment (PE), changes to the residence tie-break for companies, mutual agreement procedures and mandatory binding arbitration.
The new measures will apply once participants adapt their treaties and ratify the MLI.

The MLI came into force in the UK on 1 October 2018. It began to have effect for UK tax treaties from:

1 January 2019 for taxes withheld at source.
1 April 2019 for Corporation Tax
6 April 2019 for Income Tax and Capital Gains Tax

The date on which individual UK tax treaties are modified by the MLI depends on the date our treaty partners deposit their own instruments of ratification, acceptance or approval.

The original BEPS Framework consisted of 15 Actions:

Address the tax challenges of the digital economy.
Neutralise the effects of hybrid mismatch arrangements.
Strengthen controlled foreign companies rules.
Limit base erosion via interest deductions and other financial payments.
Counter harmful tax practices more effectively, taking into account transparency and substance.
Prevent treaty abuse.
Prevent the artificial avoidance of permanent establishment status.
(8 through 10 are grouped together as the Transfer Pricing (TP) Actions)
TP relating to intangibles and Cost Contribution Arrangements
TP relating to returns on capital-rich group companies.
Recharacterisation of transactions and use of TP methods in tax-abusive situations.
Establish methodologies to collect and analyse data on BEPS and the actions to address it.
Require taxpayers to disclose their aggressive tax planning arrangements.
Re-examine transfer pricing documentation.
Make dispute resolution mechanisms more effective.
Develop a multilateral instrument.

The OECD's BEPS project has developed into the Pillar 1 and 2 projects:

Pillar 1 aims to redefine tax allocation rules ensuring an element of the residual profit of a multinational company (MNC) is taxed in the countries where the revenue is sourced.
Pillar 2 aims to ensure that there is a global minimum tax rate. Historically, in 2021, over 130 countries signed up to a minimum tax rate of 15%.

Pillar 2 is made up of two key measures:

The Undertaxed Profits Rule (UTPR) which allows for an additional tax charge where an MNC's effective global tax rate is less than 15%.
The Income Inclusion Rule (IIR) allows the jurisdiction of the MNC's ultimate parent company to use a top-up tax where foreign subsidiaries have not paid that minimum level of tax.

Countries could also adopt a Domestic Minimum Tax (DMT). This tax would operate instead of the other two measures, were they not to be implemented. It allows a top-up tax to be imposed in the country in which the undertaxed profits are generated.

Will it affect me or my clients?

It is unlikely to affect typical UK-based Small and Medium-Sized Enterprises (SMEs) or their owners as they are probably too small.

The measures are primarily aimed at large multinational companies with revenue in excess of €750 million and have been designed to minimise the impact on SMEs.
- Taxpayers categorised as Wealthy or Mid-sized by HMRC should also be aware of the changes even if it does not currently impact them.
- Broadly, to be in scope of UTPR or DMT a group must have annual revenue of €750 million in at least two of the four fiscal year immediately preceding the year in question.
Companies who considered themselves to be a SME, but are part of a larger multi-national group should check the group size as they may inadvertently be included in the rules.
Its important to be aware that the UK DTT can apply to standalone entities as well as MNE's and domestic groups, where the revenue threshold is exceeded.
There are a number of safe harbours and exemptions that have been introduced to simplify reporting.

Reporting under BEPS

The BEPS initiative introduced a requirement to submit annual country-by-country reports setting out information relating to global activities, transfer pricing strategies and the level of income and taxes paid in each location. It is limited to groups with consolidated revenue in excess of €750 million.

The UK has now introduced mandatory TP documentation requirements in line with these requirements as part of Finance (No 2) Act 2023.

What's new?

Guidance and legislation

In October 2023, the OECD published a new multilateral convention on reallocating taxing rights to market jurisdictions, improving tax certainty, and removing digital service taxes. It also brings a finalisation of Pillar 2 closer.
On 15 December 2023, the UK and over 135 members of the OECD/G20 Inclusive Framework reached an agreement on the third set of administrative guidance for Pillar Two, published on 18 December 2023.
The UK's adoption of the Multi-national Top-Up Tax (Income Inclusion Rule) and the Domestic Minimum Tax took effect for accounting periods beginning on or after 31 December 2023 and was enacted in the Finance (No 2) Act 2023.
HMRC published draft guidance in December 2023. See, Draft guidance on Multinational Top-up Tax and Domestic Top-up Tax. The Undertaxed profits rule is expected to apply to accounting periods beginning after 31 December 2024.
In June 2024 the OECD published Agreed Administrative Guidance and Consolidated Commentary to the Global Anti-Base Erosion Model Rules
As part of the UK's commitment to the OECD's Pillar 2, the Finance Bill 2023-24 will provide for the Undertaxed Profits Rule (UTPR) to have effect no earlier than for accounting periods beginning on 31 December 2024.
In July 2024, HMRC issued educational letters regarding the UK adoption of OECD Pillar 2. The letters are being sent to taxpayers who HMRC consider to be in scope of the new Multi-national Top-up (MTT) and Domestic Top-up (DTT) taxes, taxpayers who have asked to be on HMRC's mailing list and interested agents.
On 29 July 2024, HMRC have published a policy paper, 'Multinational top-up tax and domestic top-up tax — transitional country by country reporting safe harbour anti-arbitrage rule'.
- This amendment relates to a transitional ‘Country-by-Country Reporting’ safe harbour anti-arbitrage rule agreed by the OECD Inclusive Framework in December 2023.
- The aim of the additional provisions is to prevent Multinational Enterprises (MNEs) from benefiting from the safe harbour where they have entered certain hybrid arbitrage arrangements.
- It also ensures that UK legislation remains consistent with OECD administrative guidance on the GloBE rules agreed by the UK and other members of the Inclusive Framework. See, HMRC policy paper on Transitional CbCR Safe Harbour: anti-arbitrage rule
In August 2024 HMRC has updated its guidance to include details of how to register to report Pillar Two taxes, and added a new section on common misconceptions.
On 19 December 2024, the OECD/G20 Inclusive Framework on BEPS published a factsheet and a pricing automation tool on Amount B. See, Pillar One - Amount B.
In January 2025, the OECD Inclusive Framework on BEPS released a series of documents on the application of the Global Anti-Base Erosion (GloBE) Rules. These documents focus on the compliance and reporting obligations.
- Tax Challenges Arising from the Digitalisation of the Economy:
- GloBE Information Return (Pillar Two) XML Schema
In January 2025, HMRC on the Multinational Top-up Tax and Domestic Top-up Tax: Supplementary draft guidance. This consultation will close on 8 April 2025. See, Multinational Top-up Tax and Domestic Top-up Tax: Supplementary draft guidance

HMRC online service

Groups can now register for the Pillar 2 top-up taxes digital service, using their Government Gateway user ID.
Agent credentials will not work for group registration.
The deadline to register is 6 months from the end of the accounting period in which the group becomes a qualifying group.
HMRC expect to release the next stage of the online service in late 2024. Amongst other things this will allow customers to make payments and authorise agents to carry out future tasks on their behalf.
HMRC are working with third-party software providers to provide the ability to submit UK Pillar 2 returns using existing third-party software products.

Useful guides on this topic

Diverted Profits Tax
Large multinational enterprises (MNEs) that use arrangements between connected parties to divert profits away from the UK and avoid UK tax, will be subject to the Diverted Profits Tax (DPT). Who does it apply to? What are the rules?

Companies: Permanent establishment & residence
What are the rules for determining a company's country of residence? What is central management and control? When does a company create a permanent establishment in another country?

External Links

TP documentation requirements

Multilateral convention

BEPS & Diverted Profits Tax (for SME owners)

HMRC online service

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