Why obtaining Transfer Pricing certainty also becomes important for Pillar II? - Tax and Legal blog


The purpose of the blog is to discuss the importance of obtaining Transfer Pricing certainty from the perspective of the Pillar II rules (GloBE / QDMTT rules). Failure to obtain certainty on Transfer Pricing positions could expose the MNE Group to double taxation not only in the current corporate income tax framework but potentially also double taxation / over taxation because of the interaction of the current corporate income tax / transfer pricing framework with the new Pillar II system.

To recap, the GloBE or QDMTT rules require every In-Scope MNE to calculate their Effective Tax Rate (ETR) per country on a jurisdictional blending basis when they operate therein through subsidiaries or permanent establishments.

The formula to calculate the ETR is Adjusted Covered Taxes / Adjusted GloBE income. When it comes to calculation of Adjusted GloBE income for an entity, the starting point is the separate entity financial statements. However, it could well be possible that intragroup prices recorded in these financial statements differ from those which are reported for taxable income purposes because of transfer pricing rules. This could be due to Advance Pricing Arrangements (APAs), Compensating Adjustments that are routed through the Tax Return or Tax Audits (including Mutual Agreement Procedures and Arbitration).

In this regard, Article 3.2.3 of the Model Rules (MR) and its related commentary provides for adherence to the Arm’s Length Principle (ALP) requirement. This means that, in some situations, transfer pricing figures (reported for taxable income purposes) would flow into the calculations of Adjusted GloBE income per jurisdiction as opposed to the information reported in the financial statements. Against this background, we now illustrate the issue with a simple case study.

The issue illustrated through an example

A Co is tax resident in Country A and subject to a tax rate slightly above the minimum rate of 15%. A Co provides Intellectual Property (IP) to B Co, a licensed manufacturer in Country B. The manufacturer makes a royalty payment on an annual basis to A Co. B Co is set up in a Country where the nominal tax rate is 25%. However, due to a tax incentive in place (income or expenditure-based tax incentive) it is subject to a tax rate below the minimum rate of 15%.

In Year 1, as B Co’s ETR is less than 15%, its undertaxed profits are subject to a Top-Up Tax under the GloBE / QDMTT framework. The MNE Group thus pays a Top-Up Tax in this year.

In Year 4, the tax administration of Country B initiates a primary adjustment for Year 1 and increases the taxable profit of B Co for corporate income tax by adjusting the intercompany royalty transaction downwards. This leads to an extra payment of corporate income taxes for B Co with respect to Year 1.

From a GloBE / QDMTT perspective (Article 4.6.1 MR), these additional taxes need to be added to covered taxes of B Co for Year 4 (although related to Year 1). However, if the ETR of B Co is equal to or more than 15% in Year 4 (e.g., due to a change in the tax rate in this year or if the incentive is repealed) then the additional payments of taxes seem to be meaningless from a GloBE / QDMTT perspective. In other words, the extra corporate income taxes paid in Year 4 for Year 1 are not taken into account in the ETR calculations of B Co for Year 1. Thus, the MNE Group could be subject to over taxation.

On the other hand, assume that the tax administration of country A agrees to provide a corresponding adjustment (e.g., pursuant to a mutual agreement procedure) for Year 1. They decrease the taxable profit of A Co by adjusting the intercompany transaction. This leads to a refund of corporate income taxes for A Co with respect to Year 1.

If these taxes are a material decrease of taxes then the GloBE / QDMTT rules (Article 4.6.1 MR) provide that the ETR of A Co needs to be recalculated (post-filing adjustment). It could well be possible that re-calculation leads to the result that the ETR of A Co is now below 15% for Year 1. In this case, A Co could be exposed to a Top-up Tax which would then be considered as an additional current Top-up tax. Once again, the MNE Group could be subject to over taxation. It should be noted that the procedure for such post-filing adjustments is not yet defined, neither in the Model Rules nor in the draft Swiss legislation for Pillar 2. The procedural aspects could be relevant when A Co is finally assessed for GloBE / QDMTT. The current Swiss corporate income tax law generally only allows to "open" finally assessed tax years for a period of 10 years. However, the resolution of transfer pricing disputes can take many years.

The example above represents one simple case wherein the MNE is exposed to Top-Up Taxes as it did not obtain certainty with respect to its Transfer Pricing positions on the royalty payment in advance. The situation is even more complex when unilateral adjustments are made (due to unilateral APAs or unilateral tax audits). In these scenarios, the Commentary on the GloBE rules provides that the Transfer Pricing numbers will flow into the GloBE calculations only to the extent that those adjustments help in avoiding double taxation or double non-taxation. On the other hand, the financial accounting numbers will flow into the GloBE calculations when the unilateral adjustments create double taxation or double non-taxation outcomes with respect to low-tax countries. This position expressed in the commentary differs from the simple wording of Article 3.2.3 MR and this mismatch could, depending on the jurisdiction, lead to unnecessary disputes as discussed later.

Misinterpretation of Pillar II rules and enhanced tax uncertainty

The interaction between TP rules and Pillar II rules represents a highly complex area. In addition to interpreting the ALP related requirements differently, jurisdictions could also interpret the wording of, for example, Article 3.2.3, Article 3.4 and Article 4.6.1 differently. Thus, several disputes are likely to arise from inconsistent application of these rules by tax administrations of different countries when GloBE taxing rights are allocated to them.

Currently there is no cross-border dispute resolution framework with respect to the Pillar II rules. Moreover, MNEs cannot access Article 25(1) and Article 25(5) of the OECD Model (2017) for GloBE related disputes as these are not treaty disputes per se. They may perhaps access Article 25(3) of the OECD Model Tax Convention (2nd sentence) which deals with the elimination of double taxation in cases not provided for in the Convention. However, this provision is not widely used in practise and does not provide for a binding settlement mechanism.

Additionally, it is also worth mentioning that the Transitional CbCR Safe Harbours regulations, linked to Country-by-Country-Reports, do not explicitly address how to treat intragroup prices recorded in the financial statements that differ from those which are reported for taxable income purposes because of transfer pricing rules.

While the OECD continues to work on the tax certainty dimension of this project, needless to say, it becomes imperative that MNE Groups obtain advance TP certainty going forward not only for corporate income tax, but also for Pillar 2 purposes to avoid an exposure to over taxation and procedural challenges. We expect that APAs and other instruments will become even more important for MNEs in the future to manage their tax exposure.

The above issue will be explored during our invitation only Roundtable Event which is going to be held in Zurich (November 23rd) and Geneva (November 28th).

Feel free to contact us in case you would like to have more information about this event.

Key contacts

Thomas Hug_blog
Thomas Hug - Partner
Leader National Tax Office


Martin Krivinskas_110
Martin Krivinskas - Partner
International Tax/Transfer Pricing


Daniel Stutzman_Blog
Daniel Stutzmann - Partner
Global Minimum Tax

Manuel Angehrn110x110
Manuel Angehrn - Senior Manager
Global Minimum Tax


Xavier Tinguely_Blog
Xavier Tinguely - Senior Manager
Transfer Pricing


Freya slika
Freya Younes - Senior Manager
Transfer Pricing



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