OECD’s Pillar Two and managing tax dispute risks

Pillar Two is an OECD-led initiative which results in a global minimum tax regime applicable to groups with revenues of over EUR 750 million. For the UK, and many other jurisdictions, it went into effect in 2024.

Now is therefore the time to consider tax dispute risk vis-à-vis Pillar Two. For many groups, this will be relevant from an audit perspective, and technical issues may be emerging either from auditor engagement, or more generally as groups are affected by the details of Pillar Two.

Even where material Pillar Two tax exposures are not anticipated, the compliance and information-gathering processes required are often significant. Data may be required which have never been previously for tax purposes.

Registration processes and timeframes differ between jurisdictions. Registration deadlines in some key jurisdictions have already passed and in others they are about to fall due. In any case, the technical complexity of the rules means that filing positions must be considered well in advance of the deadline for submitting returns.

The details of the rules and their application in particular contexts remain the subject of much lobbying, including by industry bodies across various sectors, and discussions with tax authorities. In the UK, HMRC’s draft guidance on Pillar Two was recently the subject of a consultation process, with further changes anticipated. Meanwhile, individual taxpayers are discussing their own positions with tax authorities in an attempt to arrive at filing positions which are both technically compliant and feasible to comply with from a data perspective. Certain context-specific areas of uncertainty (e.g. relating to opaque consolidated entities of insurers) are emerging and are currently the subject of significant lobbying. Groups will need to consider in detail an extensive regime of elections, with complex points of interaction between elections. In many cases, hastily enacted rules are only now being tested against real-life fact patterns.

This technical complexity and compliance burden arise against a backdrop of what might have been argued to be an existential challenge. President Trump decided to remove the US from the OECD global tax deal in response to how an element of Pillar Two (specifically, the under-taxed profit rule) would affect the US and as a result of the difficult interaction between Pillar Two and the US Global Intangible Low-Taxed Income (“GILTI”) regime.  Further, draft legislation in section 899 of the One Big Beautiful Bill Act raised the spectre of retaliatory US tax measures against taxpayers in jurisdictions which impose the under-taxed profit rule (and certain other taxes which are regarded as “unfair foreign taxes”).

At the time of writing, it seems that discussions between the US and G7 may have reached a solution on these issues, subject to formal adoption by the OECD. If so, it seems that section 899 may be withdrawn. However developments in this area are fast paced and the legislative detail of any solution reached in respect of the US will merit close analysis for affected groups.

Tax is increasingly a global issue. Tax collection is important where inflation and debt rises, alongside the economic challenges represented by the cost-of-living crisis. Similarly, allocation of taxing rights, including transfer pricing, remains a hot topic for tax authorities across the globe. The number of transfer pricing enquiries illustrates this, as does an increase in international issues in dispute. As of 31 March 2024, GBP 14 billion of the tax under consideration in enquiries by HMRC’s Large Business Directorate related to international matters. UK transfer pricing yield stood at GBP 1.8 billion in 2023 and 2024 with 128 transfer pricing enquiries settled during the period.

It is crucial that multinationals take appropriate action to protect against double taxation where there is competition between tax authorities for collection. This is likely to include taking advice to ensure that appropriate transfer pricing measures are applied, retaining advice and documentation in case of audit, and considered implementation and regular review of policies, particularly where factual circumstances have changed.

In the context of Pillar Two, careful consideration may be needed to determine the relevant taxing jurisdiction. Furthermore, many of the technical complexities of the internal operation of the Pillar Two rules give rise to potential areas of double taxation. Pillar Two legislation has been enacted in haste and there are contexts in which it does not appear to operate as a cohesive whole. For example, areas of potential double taxation arise for insurers holding opaque consolidated investment entities. Even where no Pillar Two exposure is ultimately anticipated, it may be necessary to consider making one or more elections to arrive at that result, with the potential interaction of several of the available elections being another area of uncertainty giving rise to concerns of double taxation.

Pillar Two has resulted in technical complexity and a significantly increased compliance burden. New rules, guidance and processes are likely to lead to an increase in tax authority audit activity. This is likely to involve tax authorities looking into consistency of approach and accuracy in implementation, arising from the need for each jurisdiction to enact its own Pillar Two implementing legislation. A number of potential areas of uncertainty are being resolved through the issuing of guidance from the OECD and  jurisdictions where there is significant potential for implementation differences to arise. As a rule, where there is uncertainty, there is risk of challenge.

Although tax authorities may consider matters unilaterally, in a global setting a joint audit may be used to allocate taxing rights (see CMS article from an Italian and Swedish focus).

Parallels with the policy objectives of Pillar Two may be drawn with those of the UK’s diverted profits tax (DPT) regime, which seeks to counteract contrived arrangements used by large groups (typically multinationals) that erode the UK’s tax base. This was a unilateral measure brought into effect on 1 April 2015. It seeks to tax companies from a UK perspective and does not allocate profits between jurisdictions. Reform of the DPT is expected following consultation.

In a UK context, there have been arguments about whether DPT falls outside of the provisions of double tax treaties (DTT), which could risk double taxation. The uncertainty over whether DTT protection would be provided in a DPT context is illustrated by Glencore Energy Ltd and another v HMRC [2019] UKFTT 438 (TC) (“Glencore”), which was followed by the introduction of legislation to allow relief against diverted profits tax as a result of the mutual agreement procedure (s114A Finance Act 2015). The legislation was intended to provide certainty. This matter, however, illustrates the challenge of managing double taxation globally alongside unilateral measures intended to impact the domestic tax system. 

As Glencore demonstrates, it is important that provisions are explicit to protect against double taxation in circumstances beyond the norm, or, where the usual taxes are not applicable, to ensure that all parties have clarity and certainty about dispute-resolution mechanisms.

Given the likelihood of multi-jurisdictional disputes arising from Pillar Two, dispute resolution in this context has long been on the OECD’s agenda. On 20 December 2022, the OECD issued its Public Consultation Document on Pillar Two – Tax Certainty for the GloBE Rules.

The OECD’s Public Consultation Document concludes that the following mechanisms might be employed by multinationals involved in Pillar Two disputes: (i) reliance on the Convention on Mutual Administrative Assistance in Tax Matters (MAAC) to facilitate the exchange of information between states’ respective competent authorities regarding interpretation of the rules; and (ii) initiation of the mutual agreement procedure (MAP) in the applicable double tax treaty with the aim of removing any double taxation by agreement.

Additionally, the OECD proposes incorporating new alternative dispute resolution provisions into domestic law and potentially adopting a multilateral convention to address Pillar Two disputes. 

On its most recent Tax Certainty Day (15 November 2024), the OECD referred to ongoing work on a multilateral convention, with discussion focussing on a common legal basis and scope. The possibility of expanding the OECD’s International Compliance Assurance Programme was also discussed.

Of these mechanisms, the MAP, which is in place in many double tax treaties, provides access to dispute resolution to allocate taxing rights between states. However, this mechanism is poorly equipped to deal with Pillar Two disputes. Article 25(1) of the OECD Model Convention does not provide a route to bringing Pillar Two disputes, principally because the requirement that there is “taxation not in accordance with a tax treaty” would typically not be met. The consultation procedure under Article 25(3) is an alternative route: “The competent authorities of the Contracting States […] may also consult together for the elimination of double taxation in cases not provided for in the Convention.” However, this does not give the taxpayer the right to initiate the process and would not assist in any matter outside of double taxation. Furthermore, any interaction with domestic laws would require consideration in this context.  

The process offers limited opportunities for taxpayers to be involved, relying instead on competent authorities agreeing between themselves. Similarly, not all taxes may be covered. Even where cases are within MAP not all result in resolution. Some authorities are unable to reach agreement. BEPS action 14 seeks to make dispute resolution measures more effective by addressing obstacles to MAP and the absence of arbitration procedures in treaties.

Importantly, domestic remedies must work alongside MAP (or arbitration or other dispute resolution methods). Similarly, any bilateral process should provide an effective resolution mechanism. This includes accessibility, timely resolution and a clear understanding of domestic tax authorities on the interaction of bilateral measures with their domestic resolution procedures. Transparency between tax authorities and taxpayers, plus a commitment to engagement, will be essential.

Where there is uncertainty, risk management is key. Consideration should be given to technical analysis to assess the position and apply new provisions accurately across the globe. It is important to identify potential issues at an early stage, allowing for proactive discussions with tax authorities.

Similarly, ensuring appropriate implementation of policies and maintaining robust documentary records may be helpful. Records should be retained both for tax technical positions taken and underlying data and compliance. A clear internal audit trail will foster clear discussions with tax authorities and provide the ability to respond swiftly and concisely to tax audits. (Note that disclosure should be considered carefully to ensure accuracy and that the appropriate information is provided). Retention of records for the time period covering the risk of audits or assessments may be critical.

As part of the CMS global network, with tax capability in over 70 offices, the CMS UK Tax Disputes & Investigations team is well-placed to advise on all forms of contentious tax matters. We advise taxpayers on technical issues in relation to Pillar Two as part of our tax advisory services, and we can assist with all aspects of tax dispute prevention, management and resolution.