Implementation of Domestic Minimum Top-Up Tax on Multinational Enterprises in UAE

In alignment with global efforts to curb tax avoidance and ensure fair taxation, the UAE has introduced a Domestic Minimum Top-Up Tax (DMTT) on Multinational Enterprises (MNEs). This initiative is part of the broader framework established by the Organization for Economic Co-operation and Development (OECD) under its Base Erosion and Profit Shifting (BEPS) project. The UAE's approach mirrors the recent steps taken by various GCC countries which have also introduced a DMTT to comply with the OECD guidelines.

Background and Rationale

The OECD's BEPS project, launched in 2013, aimed to address tax avoidance strategies that exploit gaps and mismatches in tax rules. The project introduced 15 action plans to enhance coherence in domestic tax rules, reinforce substance requirements, and improve transparency. Despite these measures, the risk of profit shifting to low or no-tax jurisdictions persisted, especially with the rise of digital business models and reliance on intellectual property.

To further combat these challenges, the OECD developed the BEPS 2.0 project, which includes a two-pillar solution:

Pillar 1: Focuses on profit allocation and nexus rules, ensuring that profits are taxed where economic activities occur and value is created.

Pillar 2: Introduces the Global anti-Base Erosion (GloBE) rules, establishing a global minimum tax rate of 15% for MNEs with annual consolidated revenue over EUR 750 million.

The GloBE rules operate through two interlocking mechanisms: the Income Inclusion Rule (IIR) and the Undertaxed Payments Rule (UTPR).

The IIR operates on a top-down approach. Initially, it mandates the Ultimate Parent Entity (UPE) of the group to collect and remit the total Top-up Tax due by the group across all jurisdictions that have not taxed the profits at a minimum rate of 15%. If the UPE's jurisdiction has not implemented a Qualifying IIR, the responsibility then falls to the next intermediate parent entity down the ownership chain to collect the Top-up Tax from its Constituent Entities (CEs). This process continues down the group chain. Any remaining Top-up Tax after the application of the IIR is collected through the UTPR which acts as a back stop to IIR.

To safeguard its own taxing rights, a jurisdiction may also consider imposing a DMTT. If a jurisdiction implements a DMTT that aligns with the outcomes of the GloBE Rules, such a DMTT will be regarded as a Qualified Domestic Top-up Tax (QDMTT). This QDMTT can be deducted from the Top-up Tax liability under the GloBE Rules for that jurisdiction. This agreed rule order allows a jurisdiction to maintain the primary right of taxation over profits derived within its jurisdiction.

In light of the above, the UAE has now introduced the DMTT.

UAE's Domestic Minimum Top-Up Tax

The UAE's DMTT is designed to align with the GloBE rules, ensuring that MNEs operating within its jurisdiction are subject to a minimum effective tax rate of 15%. This measure aims to prevent profit shifting and ensure that MNEs contribute their fair share of taxes.

Determining the Top-up Tax liability for an MNE Group under UAE’s DMTT Rules

In order to determine the Top-up Tax liability, an MNE Group will have to undertake the following action steps:

Step 1: Identify whether the MNE Group is within scope of the Pillar 2 regulations.
Step 2: Compute the Pillar 2 Income or Loss of each Constituent Entity.
Step 3: Compute the amount of Adjusted Covered Taxes for each Constituent Entity.
Step 4: Calculate the Effective Tax Rate of all Constituent Entity located in UAE.
Step 5: Determining Top-up Tax by comparing the Effective Tax Rate with Minimum Tax Rate.

Step 1: Identify whether the MNE Group is within the scope of the Pillar 2 regulations

The DMTT applies to Constituent Entities of MNE Groups (other than excluded entities) with annual revenue of EUR 750 million or more in at least two of the four fiscal years preceding the tested fiscal year (threshold to be proportionally adjusted to correspond with the length of the Fiscal Year).

Constituent Entities are defined to include any entity within an MNE Group or a permanent establishment of a main entity that is part of an MNE Group whereas the Ultimate Parent Entity (UPE) is defined to cover an entity that holds controlling interest in other entities and is not owned or controlled by another entity.

Certain entities are excluded from the scope of the Pillar 2 rules, these include:

Governmental Entities (Sovereign Wealth Funds which are UPEs may fall under this category)
International Organizations
Non-profit Organizations
Pension Funds
Investment Funds (if they are the Ultimate Parent Entity)
Real Estate Investment Vehicles (if they are the Ultimate Parent Entity)

However, the revenues of these excluded entities are still considered when determining whether the MNE group meets the revenue threshold.

Step 2: Compute the Pillar 2 Income or Loss of each Constituent Entity

The ‘Pillar 2 Income or Loss’ of each Constituent Entity is calculated based on the ‘Financial Accounting Net Income or Loss’ as per the entity's standalone financial statements prepared in accordance with the International Financial Reporting Standards (IFRS). However, if using IFRS is impracticable, any other acceptable accounting standard may be adopted, subject to satisfaction of certain criteria. This income is then adjusted for specific items & elections. These include:

Specific Adjustments

Net Taxes Expense
Excluded Dividends
Excluded Equity Gain or Loss
Included Revaluation Method Gain or Loss
Gain or loss from disposition of certain assets and liabilities
Asymmetric Foreign Currency Gains or Losses
Policy Disallowed Expenses
Prior Period Errors and Changes in Accounting Principles
Accrued Pension Expense
Accrued Pension Income
Excluded Insurance Reserves Expense
Exclusion of International Shipping Business Income & Expenses
Allocation of Income or Loss between Main Entity & its Permanent Establishment
Allocation of Income or Loss from a Flow-Through Entity

Specific Elections

Stock-Based Compensation
Intragroup Transactions
Tax Credits
Realization Principle
Aggregate Asset Gain
Intragroup Financing Arrangements
Consolidated Accounting Treatment
Insurance Company Adjustments
Distributions Related to Capital
Qualified Debt Release
Dividends from Portfolio Shareholdings
Foreign Exchange Gains or Losses

Step 3: Compute the Adjusted Covered Taxes for each Constituent Entity

The Adjusted Covered Taxes of a Constituent Entity for the Fiscal Year are equal to the current tax expense accrued in its Financial Accounting Net Income or Loss with respect to Covered Taxes for the Fiscal Year, adjusted by:

The net amount of its Additions & Reductions to Covered Taxes for the Fiscal Year.
The Total Deferred Tax Adjustment Amount.
Impact of Covered Taxes recorded in equity or Other Comprehensive Income

Additions & Reductions to Covered Taxes

The additions to Covered Taxes of a Constituent Entity for the Fiscal Year is the sum of the following:

Any amount of Covered Taxes accrued as an expense in the profit before taxation in the financial accounts.
Any amount of Pillar Two Loss Deferred Tax Asset used.
Any amount of Covered Taxes paid in the Fiscal Year related to an uncertain tax position previously treated as a Reduction to Covered Taxes.
Any amount of credit, refund, or transferable amount in respect of a Qualified Refundable Tax Credit or Marketable Transferable Tax Credit recorded as a reduction to the current tax expense.

The Reductions to Covered Taxes of a Constituent Entity for the Fiscal Year include:

The amount of current tax expense with respect to income excluded from the computation of Pillar Two Income or Loss.
Any amount of credit, refund, or transferable amount in respect of a tax credit not recorded as a reduction to the current tax expense and not derived from a Qualified Refundable Tax Credit or Marketable Transferable Tax Credit.
Any amount of Covered Taxes refunded or credited to a Constituent Entity, or the amount received for the transfer of a tax credit, not treated as an adjustment to current tax expense in the financial accounts, except those derived from a Qualified Refundable Tax Credit or Marketable Transferable Tax Credit.
The amount of current tax expense related to an uncertain tax position.
Any amount of current tax expense not expected to be paid within three years of the last day of the Fiscal Year.

Total Deferred Tax Adjustment Amount

The Total Deferred Tax Adjustment Amount for a Constituent Entity for the Fiscal Year is equal to the deferred tax expense accrued in its Financial Accounting Net Income or Loss if the applicable tax rate is below the Minimum Rate or, in any other case, such deferred tax expense recast at the Minimum Rate, with respect to Covered Taxes for the Fiscal Year, subject to specific exclusions and adjustments.

The Exclusions from the Total Deferred Tax Adjustment Amount include:

Deferred tax expense with respect to items excluded from the computation of Pillar Two Income or Loss.
Deferred tax expense with respect to Disallowed Accruals and Unclaimed Accruals.
The impact of a valuation adjustment or accounting recognition adjustment with respect to a deferred tax asset.
Deferred tax expense arising from a re-measurement due to a change in the applicable domestic tax rate.
Deferred tax expense with respect to the generation and use of tax credits.

The Adjustments to the Total Deferred Tax Adjustment Amount include:

Increase by the amount of any Unclaimed Accrual paid during the Fiscal Year.
Increase by the amount of any Recaptured Deferred Tax Liability determined in a preceding Fiscal Year and paid during the Fiscal Year.
Reduction by the amount that would be a reduction to the Total Deferred Tax Adjustment Amount due to recognition of a loss deferred tax asset for a current year tax loss, where a loss deferred tax asset has not been recognized because the recognition criteria are not met.
Recapture adjustment for deferred tax liability that is not paid within five subsequent fiscal years.

(Alternatively, the Constituent Entity may apply for Pillar 2 Loss Adjustment that offers a specialized mechanism to handle the impact of losses. Under this election, instead of applying the standard deferred tax rules, an entity can make an election to establish a deemed deferred tax asset when there is a net Pillar 2 GloBE loss for a jurisdiction and suitably dispense it over future years).

Impact of Covered Taxes recorded in equity or Other Comprehensive Income

Any increase or decrease in Covered Taxes recorded in equity or Other Comprehensive Income relating to amounts included in the computation of Pillar Two Income or Loss must be suitably factored in the computation for adjusted covered taxes if such amounts will be subject to tax under local tax rules.

Step 4: Calculate the Effective Tax Rate of all Constituent Entity located in UAE

The ETR for Constituent Entities in the UAE is calculated by dividing the adjusted covered taxes by the net Pillar 2 Income income of the Constituent Entities.

Effective Tax Rate = Sum of Adjusted Covered Taxes of each Constituent Entity
Net Pillar Two Income of the UAE

Net Pillar Two Income: This is the positive amount computed as the difference between the Pillar Two Income of all Constituent Entities and the Pillar Two Losses of all Constituent Entities located in the UAE. (for more details Refer Step 2 above)
Adjusted Covered Taxes: These are the current tax expenses accrued in the financial accounts of the Constituent Entities suitably adjusted for specific items. (for more details Refer Step 3 above).

Step 5: Determine Top-up Tax by comparing the Effective Tax Rate with Minimum Tax Rate

If the ETR is below the minimum rate of 15%, an additional tax is to be imposed to bridge the gap. This is referred to as the Top-up Tax. This Top-up Tax Percentage is to be applied to excess profits computed as the difference between the Net Pillar Two Income (computed as per Step 2) and the Substance-based Income Exclusion. Further there are certain instances wherein there may be an enhanced Top-up Tax recovery. Thus, the amount of Total Top-up Tax Liability to be discharged by the MNE Group can be computed as follows:

Top-up Tax = (Top-up Tax Percentage × Excess Profit) + Additional Current Top-up Tax

Substance-based Income Exclusion

The Substance-based Income Exclusion is a mechanism designed to reduce the Net Pillar Two Income of a MNE Group by excluding certain income derived from substantial activities within a jurisdiction. This exclusion aims to ensure that income generated from genuine economic activities is not subject to additional top-up tax. Further, for the benefit of the MNE Groups, the Substance-based Income Exclusion will be provided at enhanced rates during the Transitional Period until FY 2032. (for more details, refer the discussion on ‘Transitional Relief for Substance Based Income Exclusion’ below).

The exclusion is calculated based on two main components: the payroll carve-out and the tangible asset carve-out.

Payroll Carve-out

The payroll carve-out is calculated as 5% of the Eligible Payroll Costs of Eligible Employees who perform activities for the MNE Group in the jurisdiction. Eligible Payroll Costs include salaries, wages, and other direct employee benefits, excluding costs that are:

Capitalized and included in the carrying value of Eligible Tangible Assets.
Attributable to a Constituent Entity's International Shipping Income and Qualified Ancillary International Shipping Income.

Tangible Asset Carve-out

The tangible asset carve-out is calculated as 5% of the carrying value of Eligible Tangible Assets located in the jurisdiction. Eligible Tangible Assets include:

Property, plant, and equipment.
Natural resources.
A lessee's right of use of tangible assets.
Licenses or similar arrangements from the government for the use of immovable property or exploitation of natural resources.

The carrying value of these assets is based on the average value at the beginning and end of the fiscal year, net of accumulated depreciation, amortization, depletion, or impairment losses.

Additionally, there are certain specific adjustments that need to be made while determining the exclusion for Permanent Establishments, Flow-through Entities, partially located assets/employees.

Additional Current Top-up Tax

Additional Current Top-up Tax refers to extra Top-up Tax that becomes due under specific circumstances. This essentially includes cases where the Effective Tax Rate and Top-up Tax for a prior Fiscal Year need to be recalculated due to adjustments in Adjusted Covered Taxes or Pillar Two Income or Loss. It may also arise in a scenario where there is no Net Pillar Two Income in the UAE and the Adjusted Covered Taxes are less than zero as well as the Expected Adjusted Covered Taxes Amount. The Additional Current Top-up Tax in such cases will be equal to the difference between the actual & expected Adjusted Covered Taxes amounts.

Other Key Provisions of the UAE's DMTT

Safe Harbors and Transitional Provisions

The UAE has introduced several ‘Safe Harbors’ and ‘Transitional Provisions’ to simplify compliance and reduce the administrative burden on MNE groups. These include:

Permanent De-Minimis Exclusion Safe Harbor: The top-up tax for Constituent Entities based in UAE, upon an annual election, will be deemed to be zero if the MNE Group reports average Pillar 2 Revenue of less than EUR 10 million and the average Pillar 2 income of less than EUR 1 million in the UAE.
Permanent Simplified Calculations Safe Harbor: Upon specific election, the Top-up Tax (other than Additional Current Top-up Tax) of the MNE Group in the UAE shall be deemed to be zero upon satisfaction of one of the following tests with respect to the UAE operations:

Routine Profits Test: The Pillar Two Income in the UAE as determined under the simplified approach is equal to or less than the amount of Substance- based Income Exclusion for the UAE.
De-Minimis Test: The Average Pillar Two Revenue in the UAE as determined under the simplified approach is less than EUR 10 million, and the Average Pillar Two Income in the UAE is negative or less than EUR 1 million.
Effective tax Rate Test: The Effective Tax Rate of the UAE as determined under the simplified approach is at least 15%.

Transitional CbCR Safe Harbor: During the transition period (i.e., until June 30, 2028), upon specific election, the Top-up Tax of the MNE Group in the UAE shall be deemed to be zero if:

The MNE Group reports total revenue of less than EUR 10 million and a profit (loss) before income tax of less than EUR 1 million in the UAE on its Country-by-Country (CbC) Report; or
The MNE Group has a Simplified Effective Tax Rate equal to or greater than the Transition Rate (16% for Fiscal Years beginning in 2025 and 17% for Fiscal Years beginning in 2026) in the UAE for the Fiscal Year.
The MNE Group's profit (loss) before income tax in the UAE is equal to or less than the Substance-based Income Exclusion for entities reported in the UAE in the Country-by-Country Report.

Transitional Relief for Deferred Tax Assets and Liabilities: All deferred tax assets and liabilities reflected in the financial accounts of Constituent Entities in the UAE for the Transition Year must be taken into account at the lower of the Minimum Rate or the applicable domestic tax rate while determining the covered taxes. Further, deferred tax assets recorded at a rate lower than the Minimum Rate may be taken into account at the Minimum Rate if attributable to a Pillar Two Loss.
Transitional Relief for Initial Phase of International Activity: The Top-up Tax Liability will be effectively reduced to zero if the MNE Group has Constituent Entities in no more than six jurisdictions and the net book value of tangible assets in all jurisdictions, excluding the reference jurisdiction, does not exceed EUR 50 million, provided that none of the ownership interests of the Constituent Entities located in the UAE are held by a Parent Entity subject to a Qualified IIR in another jurisdiction. (This relief applies for up to five years after the MNE Group first meets the threshold).
Transitional Relief for Substance Based Income Exclusion: Enhanced Substance-based Income Exclusion will be available during the initial fiscal years until 2032. During this period, deductions will gradually decrease from 7.6% in 2025 to 5.4% in 2032 for tangible assets, and from 9.6% in 2025 to 5.8% in 2032 for payroll costs.

Tax Registration and Filing Requirements

Any entity subject to the Top-up Tax must register with the Federal Tax Authority (FTA) within the prescribed timeframe, form, and manner. These entities (or their Domestic Designated Filing Entity) are required to file a 'Top-up Tax Return' and appropriately discharge their Top-up Tax liability. The return must be filed within 15 months following the end of the reporting fiscal year. However, for the first transitional year, the return must be filed within 18 months of the end of the reporting fiscal year. This timeline also applies to the discharge of the Top-up Tax liability.

In addition to the above, certain specified entities must submit the 'Pillar 2 Information Return' to the FTA. This return is based on the standard template published by the OECD/G20 Inclusive Framework on BEPS and will encompass comprehensive details on the MNE group's global operations, including:

Details of Constituent Entities including their tax identification numbers.
An overview of the MNE Group's overall corporate structure.
Data necessary to compute the effective tax rate and top-up tax, along with the allocation of top-up tax to each jurisdiction.
Documentation of relevant elections made under the applicable provisions

Currency

The computation of the Top-up Tax must be conducted in the functional currency of the underlying standalone financial statements. If multiple standalone financial statements within a Domestic Group utilize different functional currencies, the Filing Constituent Entity may elect to use either the presentation currency of the Consolidated Financial Statements of the Ultimate Parent Entity or UAE Dirhams.

Furthermore, the conversion of amounts denominated in other currencies into the relevant functional or presentation currency, as well as the conversion of amounts into EUR for threshold assessments, must adhere to the prescribed conversion procedures. This ensures consistency and accuracy in tax computations.

Joint and Several Liability

All Constituent Entities of a ‘Domestic Main Group’ , ‘Domestic Minority-owned Subgroup’ and ‘Reverse Hybrid Entities’ are jointly and severally liable for the full amount of the Top-up Tax attributable to their group. Similarly, Joint Ventures and JV Subsidiaries are jointly and severally liable for the Top-up Tax attributable to their respective group.

General Anti-Avoidance Rule (GAAR)

The UAE's Pillar 2 rules include a GAAR provisions which allow the FTA to disregard any transaction or arrangement if the primary purpose of it is to obtain a tax advantage. This rule ensures that the Pillar 2 rules are not circumvented through artificial or abusive arrangements.

Other Specific Provisions

The UAE's Pillar 2 rules also incorporate specific provisions in respect of applicability of the regulations in the context of Sovereign Wealth Funds, Minority Owned Constituent Entities, Joint Ventures, Permanent Establishments, Stateless Entities, Flow-Through Entities, Non-Material Constituent Entities etc. Moreover, specific provisions have also been incorporated in respect of Corporate restructurings & holding structures, tax neutrality options & distribution regime elections.

Additional Criteria

The Minister has been entrusted with authority to issue any rules, conditions, controls and procedures to ensure that the provisions UAE Pillar 2 Regulations are aligned with the objectives of the Pillar Two Model Rules, the Commentary and the Agreed Administrative Guidance provided by OECD.

Way Forward

The UAE's introduction of the Domestic Minimum Top-Up Tax is a significant step towards aligning with global tax standards and ensuring fair taxation of MNEs. By implementing these measures, the UAE aims to prevent profit shifting and enhance its tax system's integrity.

MNE groups operating in the UAE should conduct an initial impact assessment to understand their potential obligations under the new rules and adapt their tax strategies accordingly. They should also ensure compliance with the registration, filing, and payment requirements to avoid penalties and administrative fines.

How can BDO help MNE Group’s establish Pillar 2 Readiness?

BDO can assist MNE Groups in establishing Pillar 2 readiness by providing comprehensive support to ensure compliance with the new regulations. Some of the key support areas include:

Analysis of existing tax structures to identify entities impacted by the new regulations.
Provide assistance in evaluating safe harbours and transitional provisions to leverage potential benefits.
Perform Pillar 2 Impact Assessment to identify gaps and offer actionable steps for resolution.
Assist in identifying and addressing tax accounting considerations.
Assist in identifying and addressing data collation requirements.
Assist in identifying and implementing relevant technology & automation solutions.
Assist in obtaining Pillar 2 registration and managing reporting and filing obligations in UAE.
Offer continuous advisory support to stay updated with ongoing developments in Pillar 2 implementation in the UAE.

If you have any questions or need further assistance, please feel free to contact our team of tax experts who can help you navigate the complexities of the Pillar 2 regulations.

Disclaimer

The information provided in this article is of a general nature and may not address the specific circumstances of your business. It is recommended to seek professional advice to understand the full implications of the Pillar 2 rules on your operations. BDO assumes no responsibility for decisions made based on the information provided in this article.