Does your parent company’s location tell the whole story?

Most groups approach Pillar Two by asking one question: has our parent jurisdiction introduced the rules? That is a sensible place to begin. The Income Inclusion Rule is applied at parent level, so a parent in a jurisdiction that applies it can be charged on the low-taxed profits of entities further down the group.

On its own, though, it is an unreliable answer. A group whose parent jurisdiction has introduced nothing can still pay top-up tax. A group whose parent jurisdiction applies the full set of rules can find that most of the tax is collected somewhere else entirely.

Broadly, a qualified domestic minimum top-up tax gives the jurisdiction where low-taxed profits arise the first opportunity to collect. The Income Inclusion Rule then applies at parent level to what remains, and the Undertaxed Profits Rule acts as a backstop for anything still uncollected. The applicable coordination rules decide how they interact in a particular case.

The point that is easy to miss is that these rules belong to different jurisdictions. The domestic top-up tax belongs to the jurisdiction of the profits, the Income Inclusion Rule to a parent’s jurisdiction, and the Undertaxed Profits Rule to other jurisdictions where the group has entities. The useful question is therefore not whether the parent jurisdiction applies Pillar Two, but which of the jurisdictions the group touches applies which rule, for which fiscal period.

Many groups hold their operating businesses through one or more intermediate holding companies. Where an intermediate parent sits in a jurisdiction that applies an Income Inclusion Rule, that company may be required to apply the rule to the entities beneath it, whatever the ultimate parent’s jurisdiction does or does not do.

Partial ownership complicates this again. A partially owned parent entity can be required to apply the rule ahead of a parent above it, and joint ventures, minority holdings and investment entities are dealt with under separate provisions. None of this is visible from the parent company’s address.

Before any rule is applied, the group itself has to be defined. That means the entities consolidated by the ultimate parent, entities that would be consolidated under the deemed consolidation rules, and entities left out of the consolidated accounts only because of size, materiality or because they are held for sale.

Entity classification then shapes the result: excluded entities such as certain investment funds and governmental entities, investment entities with rules of their own, permanent establishments treated separately from their main entity, and transparent entities whose income is allocated elsewhere. Two groups with a parent company at the same address can have very different positions.

Pillar Two generally covers multinational groups with consolidated revenue of at least EUR 750 million in at least two of the four preceding fiscal years, subject to special rules. That test is applied to the ultimate parent’s consolidated financial statements, which is one more reason to identify the right parent entity before anything else.

A group close to the threshold, or one that has recently restructured, acquired or divested, should expect the answer to move between periods. The test is applied for each fiscal year, not once.