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Additional Top-Up Tax

Additional Top-Up Tax

Table of Contents

Additional top-up tax is added to the initial top-up tax under Article 5.2.3 of the OECD Model Rules.

Additional top-up tax can occur in two main ways.

Prior-Year Adjustment

A prior-year adjustment can arise under Article 5.4.1 of the OECD Model Rules where:

• A constituent entity makes an election to carry back a capital gain on local tangible assets

• A deferred tax liability is not released within five fiscal years

• There is a prior year increase in covered taxes (for example, as a result of a review of prior year tax returns)

• A current tax expense that is claimed as adjusted covered tax is not paid within four years

• An election is made for deemed distribution tax.

In these cases, the ETR and top-up tax calculation for the previous year needs to be recalculated. Any additional top-up tax is then levied in the year of the recalculation.

If there is no net Pillar Two GloBE income for the jurisdiction for the recalculation year, the net Pillar Two GloBE income is increased by:

Additional top-up tax/15%

Domestic Tax Loss Exceeds Pillar Two GloBE Loss

The other occasion that additional top-up tax could arise is under Article 4.1.5 of the OECD Model Rules, where a domestic tax loss is greater than the Pillar Two GloBE loss. The Pillar Two GloBE loss derives from the financial accounts of the constituent entity (with GloBE adjustments), and therefore a difference in the tax treatment locally could give rise to a different domestic tax loss.

This could occur for instance if for domestic tax purposes certain income is exempt, but is not for calculating Pillar Two GloBE income.

In this case, there would be a deferred tax asset created which would reduce adjusted covered taxes for Pillar Two GloBE purposes in the year of creation, whilst increasing adjusted covered taxes when it is released. For more information on deferred tax, see Deferred Tax.

The Pillar Two GloBE rules retain the deferred tax asset treatment but provide that any amount of the deferred tax asset created that exceeds 15% of net Pillar Two GloBE income is treated as additional top-up tax.

Note that this only applies where the domestic tax loss exceeds the Pillar Two loss and this results from a permanent difference. If it arose from a timing difference, the deferred tax provision would take account of this.

Excess Domestic Tax Loss – Example

Company A has a domestic tax loss of 1,000,000 euros and a Pillar Two GloBE loss of 750,000 euros due to income not being taxed for domestic tax purposes. The loss is available for carry-forward for tax purposes.

The domestic tax rate is 15%.

The deferred tax asset for domestic tax purposes is 150,000 euros. This exceeds 15% of the net Pillar Two GloBE loss (112,500 euros). Therefore, additional top-up tax of 37,500 euros is calculated. This does not change the general deferred tax approach.

So adjusted covered taxes in year 1 would still be a negative 150,000 euros. If the loss is fully offset in year 2, the deferred tax asset would unwind and adjusted covered taxes would be increased by 150,000 euros.

Note, that this adjustment is calculated on a jurisdictional basis, however, the top-up tax is allocated to the constituent entity that generated the difference.

Additional tax is added to the initial top-up tax calculated by applying the low-tax percentage to the GloBE income. It is the penultimate step in the top-up tax calculation, with any qualified domestic minimum top-up tax being deducted after this. 

Additional tax can arise in two situations. Firstly where there is a requirement to calculate the effective tax rate of a previous year, and secondly where a domestic tax loss is greater than a GloBE Loss (under Article 4.1.5 of the OECD Model Rules).

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