Corporate Tax News Issue 62 - May 2022

Impact of the OECD Pillar Two model rules on natural resource companies

As part of its two-pillar framework to counteract base erosion and profit shifting (BEPS), the OCED is consulting on ways to exclude extractive industries from its Pillar 1 proposals of market jurisdiction taxation of digital transactions. However, all natural resources companies will be affected by the Pillar 2 proposals and this article considers some areas of immediate concern.

Pillar Two global minimum tax local implementation

On 20 December 2021, the OECD released model rules to assist the 137 jurisdictions that agreed to the OECD/G20 Inclusive Framework with the implementation of Pillar Two into domestic legislation (for an overview of the model rules, see our tax alert dated 21 December 2021). The OECD commentary and the detailed rules will be released by mid-2022.

Pillar Two seeks to establish a 15% global minimum tax rate through the introduction of two interlocking rules, i.e., an income inclusion rule (IIR) and an under-taxed payments rule (UTPR), collectively referred to as the GloBE rules. Under the IIR, the ultimate parent entity is primarily liable for all “top-up tax” that is applied to profits if the effective tax rate in any jurisdiction is below the minimum 15% rate. As a backstop, the UTPR can apply by way of a disallowance of a tax deduction to low-taxed income not brought into charge under the IIR. Pillar Two broadly applies where a company has consolidated revenue in excess of EUR 750 million.

The model rules also include a subject to tax rule (STTR) designed to allow source jurisdictions to impose a top-up withholding tax on certain types of outbound payments (e.g., royalties) when such payments are made between related parties and are not subject to a minimum tax rate.

The jurisdictions that have agreed to apply this framework are working through how they will implement it into their domestic legislation. In addition, they are also seeking to ensure that they do not lose out on tax revenues through the application of the IIR at the parent company level, for example, with the introduction of domestic minimum taxation. Significantly, certain jurisdictions are looking to implement those changes as early as in 2023 or 2024. As such, natural resource companies should carefully monitor worldwide developments in this area.

The Pillar Two model rules are very complex, and we are working with businesses to help them understand their potential implications. The new provisions may prove particularly challenging for natural resource companies, which have largely been outside the scope of most of the digital service taxes/equalisation levies to date.

Re-design of tax incentives in the natural resource industry?

To attract foreign investment in the natural resources sectors, developing countries typically have   offered tax incentives to companies considering activities in their jurisdictions. These countries may now find themselves in the position where they have granted an investor a local tax holiday but, as a result of the IIR, a top-up tax is collected in another jurisdiction, thus reducing or negating the incentive. This may encourage such countries to consider the introduction of a minimum tax to protect their own tax base.

However, such tax incentives are often contained in individual investment contracts, which frequently incorporate stabilisation provisions that prevent governments from unilaterally changing contract terms and conditions. This could cause potential issues for the relevant governments and lead to arbitration risks. It remains to be seen how governments will choose to respond to protect their commitments to investors without losing tax revenues to other jurisdictions.

Going forward, to ensure optimal outcomes, international tax and investment policy will have to go hand in hand and be coherent. While this could result in a significant detriment to developing countries that had granted tax incentives to attract foreign investment, there is a general expectation that such countries will start looking at other types of incentives to avoid losing revenues. For example, countries may opt to reduce regulation or compliance burdens in other areas, provide new incentives in areas outside the scope of Pillar 2 (such as employment incentives), or increase direct grants being offered. These expected changes in local approaches to tax incentives means that there will be consequences of Pillar Two for all natural resource companies, even for those that are not directly impacted by the tax rules.

Impact of long-term timing differences

The Pillar Two model rules provide that the effective jurisdictional tax rate is calculated by reference to the accounting net income and current tax expense accrued. While deferred taxes are taken into account, certain adjustments are required, one of which limits allowable timing differences to those that will reverse in five years.

Natural resource companies typically make large investments in capital expenditure that take a long time to be recovered, and domestic rules often allow some form of accelerated tax depreciation. This creates substantial timing differences, often in excess of five years, at the country level.

The approach of the Pillar 2 rules in this area is not yet clear. However, the risk is that deferred tax is not sufficiently taken into account for natural resource groups and, as a result, they fail the 15% effective tax rate test. In turn, this will trigger the GloBE IIR and means that the group will be subject to a top-up tax at the parent level, negating the benefit of accelerated tax depreciation to the investor and the local country unnecessarily loses tax revenues.


Long, early loss-making periods are relatively common for natural resource companies, e.g., during the exploration and initial production phases, etc. Consideration of pre-GLoBE losses and transitional rules will be key to ensuring that top-up tax is not imposed on such timing differences.

Significant compliance burden

The Pillar Two model rules will apply only to constituent entities that are members of a multinational group with annual revenue of EUR 750 million or more in at least two of the four fiscal years immediately preceding the tested fiscal year. However, there is a concern that even those larger groups will be required to undertake a significant and costly compliance exercise to find the source data, apply the required adjustments and perform calculations to establish how and when tax is going to be collected.

Significantly, the threshold of EUR 750 million has nothing to do with the margin. Therefore, defining the required compliance processes and balancing the group and local compliance responsibilities will be key to ensuring that the correct data is captured and that the deferred tax balances are tracked as and when they arise. Undertaking a modelling exercise to understand the range of potential implications will enable multinationals to consider the variety of elections available under the Pillar Two model rules to optimise compliance and cash tax.

Comments and suggested action steps

The above discussion illustrates the significant complexity in the Pillar Two rules. Groups with income over EUR 750 million will need to perform complicated calculations and there will remain a significant degree of uncertainty in the interpretation of the rules. Even where there is no jurisdiction with an effective tax rate below 15%, compliance costs will be substantial. Domestic minimum taxes that may be implemented by various jurisdictions to protect their tax bases may increase the compliance costs even more and increase the risks of double taxation.

While not directly relevant to the Pillar Two considerations, it is worth noting that the OECD recently released a public consultation document on Pillar One – Amount A: Extractives Exclusion. This exclusion would apply where a group derives revenue from the exploitation of extractive products and the group has carried out the relevant exploration, development or extraction activities.

Natural resource groups should consider taking the following actions now:

  • Working through Pillar Two model rules and tracking policy responses in those countries where they have taxable presence;
  • Undertaking modelling exercises to understand the range of potential implications, as well as estimating the cost of compliance; and
  • Keeping their C-suite informed of the potential tax and compliance costs, as well as risks associated with global implementation of Pillar Two.

Julia McCullagh

Ross Robertson