BDO Corporate Tax News

The UK government released a policy paper and draft legislation on 21 July 2025 that set out proposed changes to the Multinational Top Up Tax and Domestic Top Up Tax (UK Pillar 2 rules), which was enacted under the Finance (No. 2) Act 2023. In addition, a notice published on 24 July adds Spain and Guernsey to the list of Pillar Two territories that have qualifying income inclusion rules and domestic top-up taxes. The common theme underlying the changes is alignment of UK legislation with the OECD GloBE rules following the release of OECD administrative guidance in January 2025.

The UK introduced its Pillar Two legislation—in the form of a multinational top-up tax and domestic top-up tax—in Finance (No. 2) Act 2023, which applies for accounting periods beginning on or after 31 December 2023. An undertaxed profit rule was subsequently introduced for accounting periods beginning on or after 31 December 2024.

The proposals in the draft legislation will be included in the 2025-26 Finance Bill and once enacted, would generally take effect for accounting periods beginning on or after 31 December 2025, with certain provisions having retrospective effect for accounting periods starting on or after 31 December 2023. 

Key Points of the Draft Legislation 

 ​Simplified Calculations for Non-Material Members

• Multinational groups can elect simplified calculations for non-material members in a territory for an accounting period. This election assumes a nil top-up amount for the territory, affecting the liability for the multinational top-up tax. 
• Qualifying conditions for this election include meeting routine profits and de minimis or effective tax rate tests. The source of information for these tests is the country-by-country reporting rules, which should also be used to determine the revenue and adjusted profits of each specified member. 

​Election to Exclude Intragroup Transactions 

• If an entity makes an election under section 164 Finance (No. 2) Act 2023, the underlying profits of standard members of the group are adjusted so they do not include amounts of income, expenses, gains or losses arising from transactions between two or more standard members located in the same territory. These transactions must be granted tax-neutral treatment under the law of the territory as a result of the tax consolidation group. The draft legislation revises the rules relating to an election to exclude intragroup transactions.
• Notably, the draft legislation provides that the election does not apply to joint venture groups, investment entities or minority-owned constituent entities. 

​Exclusion of Certain Deferred Tax Assets and Deferred Tax Liabilities 

• Section 185 Finance (No. 2) Act 2023 details the exclusion of deferred tax assets and liabilities and specifies conditions under which deferred tax assets or liabilities are considered excluded. The draft legislation introduces provisions focused on such assets and liabilities arising from certain transactions or elections made by multinational group members following the introduction of the Pillar Two rules. 

​Adjustments for Flow-Through Ultimate Parent Entities (UPEs) 

• Section 170 Finance (No. 2) Act 2023 relates to adjustments for a UPE that is a flow-through entity and the proposed changes seek to revise how the adjusted profits of a flow-through UPE should be calculated. 
• Under this section, the adjusted profits of the UPE that is a flow-through entity should exclude profits that represent certain profits of the holder of the direct ownership interest in the UPE that meets further requirements. 
• The proposed changes clarify how the profits of the holder of the direct ownership interest in the UPE as a result of the ownership interest will be determined. 
• Each holder of a direct ownership interest in the UPE will be treated as entitled to a proportion of that entity’s adjusted profits. This proportion is based on what the holder would have been entitled to if the actual profits accruing to the UPE were equal to its adjusted profits. 
• An additional provision will allow the profits of the UPE to be adjusted if the holder of the ownership interest in the UPE (due to timing differences) is not subject to tax in respect of its profits ending within 12 months of the relevant accounting period of the group provided the profits subject to the timing difference would have been fully taxable and the owner was subject to a headline rate of tax of at least 15%. 

​Other Proposed Changes

• A permanent establishment will be included in the definition of an intermediate parent entity and partially owned parent entity. 
• The top-up tax amount to which a “responsible member” is charged will be expanded to include the top-up tax amount of a permanent establishment of which the responsible member is not the main entity. 
• The payments for group relief will be taken into account in the covered tax amount for the domestic top-up tax.
• The treatment of a hybrid financial instrument would be clarified where the accounting treatment should be based on the accounting treatment of the issuer of the instrument. 

 Ross Robertson
 BDO in United Kingdom