Cross-border tax planning after OECD Pillar Two

Traditional planning strategies to exploit low-tax jurisdictions through tax rate arbitrage have become less effective. Furthermore, the focus of international tax planning has shifted from minimising nominal tax to controlling the location, character, and timing of taxes, while at the same time maximising returns from incentives and substance.

A low statutory tax rate no longer necessarily produces a low overall tax burden. If a jurisdiction generates a GloBE effective tax rate below 15%, top-up tax mechanisms are in place to bring the jurisdiction’s tax burden to the minimum rate. The question becomes which jurisdiction collects the top-up tax. A qualified domestic minimum top-up tax (QDMTT) allows low-tax jurisdictions to impose additional tax itself. If no QDMTT applies, the income inclusion rule (IIR) permits the jurisdiction of a parent entity to impose a top-up tax on low-taxed subsidiary entities. 

Finally, the undertaxed profits rule (UTPR) serves as a backstop, allocating top-up tax to jurisdictions where it was otherwise not collected. The interaction of these rules is critical when evaluating cross-border planning. Businesses should model the combined effect of local taxes, QDMTTs, IIR, UTPR, withholding taxes, and foreign tax credits, rather than comparing statutory rates alone.

Pillar Two also changes the economics of tax incentives. Credits that reduce covered taxes can lower a jurisdiction’s GloBE effective tax rate while increasing top-up tax. Certain refundable credits may receive more favourable treatment under the GloBE rules. Companies should therefore evaluate incentives based on their post-Pillar Two after-tax value, instead of their nominal benefit.

The substance-based income exclusion (SBIE) under the GloBE rules represents yet another tax planning consideration. Under the SBIE, a portion of income associated with qualifying payroll and tangible assets can be excluded from the top-up tax calculation. This increases the importance of genuine business substance. 

Cross-border entity structures should be evaluated for their interaction with GloBE, controlled foreign corporation (CFC) regimes, withholding taxes, and foreign tax credits. Intercompany financing, royalties, service fees, and other deductible payments may produce different results once jurisdictional GloBE calculations, and UTPR exposure are considered.

Effective planning increasingly requires jurisdictional modelling, incentive optimisation, entity rationalisation, and credit utilisation analysis. The central question is no longer simply, “Where can we pay the least amount of tax?”  

This shift from tax-rate arbitrage toward substance and after-tax economics will define international tax planning in the current Pillar Two era.

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James Duncan is a senior international tax manager with Navolio & Tallman, LLP. He has more than 20 years of experience in international taxation in both the private and public sectors. He specialises in international tax compliance for individuals and businesses, focusing on corporations, cross-border transaction planning and compliance, international business restructuring, and information reporting.