Real estate businesses with global revenues of EUR 750 million or more may already be within the first in-scope accounting period for Pillar Two (i.e., accounting periods starting on or after 31 December 2023). We are awaiting further guidance to clarify the Pillar Two framework for REITS, albeit at this stage there is no imminent expectation of further guidance from the OECD. This creates particular uncertainty due to unique structures in real estate groups and the status of REITS within the structure. Implementing countries are issuing legislation and guidance at different paces and groups will need to monitor the evolving position.
The Pillar Two rules are complex in their application, and the OECD has recognised the potential compliance burden they can create for in-scope businesses. The OECD has therefore drafted a series of safe harbours to simplify compliance with the Pillar Two rules. The most broadly relevant safe harbour is the transitional country-by-country reporting safe harbour (TCSH), which enables simplified calculations to be undertaken by utilising figures drawn from country-by-country reports (or that would be contained in such reports if they were required to be prepared) and other data from the accounts used in the preparation of such reports. However, a number of requirements must be met, including a need for the country-by-country report to be “qualifying” in the relevant jurisdictions where the safe harbour is sought to be applied. Our experience is that group processes often require remediation to ensure this safe harbour can be relied upon.
Further, the TCSH cannot be applied to certain entity types, including trusts and funds that are common in the real estate sector, and alternative approaches are needed to navigate the rules in a compliant way with a real risk that top-up tax could arise unless groups plan well.
Safe Harbour Application
The Pillar Two rules contain provisions that categorise entities based on the manner in which they are subject to tax, both in the jurisdiction in which they are established and the jurisdictions in which their investors are located. This interacts with the determination of the territory in which entities are considered to be located for Pillar Two purposes.
Real estate groups often contain entities subject to specific tax regimes in their territory of incorporation (e.g., REITs). Such entities are often not subject to tax on their profits as they arise, but rather there is a mechanism to collect tax (often at a reduced rate) on distribution. These entities are typically viewed as “investment entities” for Pillar Two purposes. An investment entity cannot apply the TCSH, which means calculations under the “full GloBE” rules may be required on their results. In practice, as these entities do not pay corporation tax in their own right by policy design, this can give rise to an inherent risk of Pillar Two top-up tax arising. In addition, due to the typical tax profile of an investment entity, there are numerous elections under the full GloBE rules that will need to be considered, which adds to the compliance burden from a Pillar Two perspective.
Are REITS Excluded Entities?
The Pillar Two rules provide for the concept of “excluded entities,” i.e., entities to which the Pillar Two rules under an Income Inclusion Rule (IIR) do not need to be applied. This exclusion is tested on an entity-by-entity basis and does not exclude the whole group—the only way a group is not in scope is if it does not meet the EUR 750 million revenue threshold. An investment entity may qualify as an excluded entity only if:
Application of the GloBE Rules to REITs
There are three primary charging mechanisms under Pillar Two:
The QDMTT in the territory where the REIT is established is therefore likely to be the most important provision to consider for most REITs. Where a REIT is an excluded entity, that should generally be respected for Pillar Two purposes such that no QDMTT calculation should be required for the REIT. However, where the REIT is not an excluded entity (e.g., where the UPE is not itself an excluded entity or the REIT is not a qualifying service entity), a QDMTT calculation is likely to be necessary. In this instance, the REIT itself may not be chargeable to top-up tax under the QDMTT. However, it may be necessary to compute any top-up tax that could arise to the REIT as if it were liable, and then allocate that top-up tax to other members of the group located in the same territory as the REIT. The treatment of such potential top-up tax amounts may be dependent on the interaction with the TCSH in the territory for those entities that qualify. These rules are complex and should be reviewed in the context of particular facts.
A challenge that can arise when such calculations are required is that the REIT itself is often not subject to tax. Whilst it may be possible to allocate withholding tax arising on distributions by the REIT to the REIT for the purposes of this calculation, that withholding tax may only be 15%, and further there will typically be a timing mismatch as the dividends declared often reflect the prior period profits, which may or may not be similar to the current year profits, and the tax can only be reflected in the Pillar Two calculation on a paid basis. So, for example, if a REIT declares a distribution in 2025 in respect of 2024 profits, the tax arising on that distribution is treated as a covered tax in the 2025 period, and not the 2024 period. Where the REIT does not fully distribute all of its income and gains, this can further exacerbate the issue. Some REITs may, therefore, need to reconsider their distribution policies to mitigate the risk of top-up tax arising (e.g., by accelerating full or partial distributions of profit to occur in the same period as the underlying profits arise).
Deferred Tax and Timing Mismatches
The Pillar Two rules incorporate the concept of deferred tax for the determination of the effective tax rate. In principle, deferred tax should reduce or eliminate effective tax rate volatility arising as a result of timing differences between tax and accounting rules. However, there is a quirk in the treatment of tax on undistributed earnings that can be particularly relevant for real estate groups with REITs.
There is often a timing mismatch between the accounting treatment of the earnings of a REIT and the tax treatment of those same earnings. Accounting principles seek to manage this timing mismatch through deferred tax accounting. Specifically, deferred tax may be recognised on undistributed earnings in a parent entity. However, the rules do not provide for an effective mechanism for allocation of this deferred tax to the REIT. In fact, any movement in deferred tax expense reflected in the profits of a member that relates to distributions from another member of that group, are treated as a disallowed accrual.
Further, the elections within the Pillar Two rules that are available to investment entities (e.g., the tax transparency election or the taxable distribution method election) that seek to address timing mismatches do not apply to REITs in many cases due to their specific tax profiles, i.e., that their tax arises by way of a withholding tax in the distributing territory rather than by way of tax imposed in the parent jurisdiction.
This leaves a potentially adverse outcome for REIT groups, and it is unclear if this was the policy intent given the role that REITs play in the real estate sector. The OECD and many local tax authorities are aware of these challenges but, as no legislative action has been taken to alleviate them, REIT groups should plan on the basis of the rules as drafted.
Compliance Requirements
A number of compliance requirements will apply for in-scope groups, irrespective of whether there is any top-up tax liability. Most territories that have implemented Pillar Two require some form of registration for Pillar Two purposes. There is no standardised procedure for registration, and both the information required and the deadlines for registration vary by territory. Some of these registration deadlines have passed for many groups, others are fast approaching.
The UPE (or another nominated group member) will be required to file a GloBE information return in relevant territories that have implemented Pillar Two rules. Where information sharing agreements are in place, it may be possible to file the GloBE return in a single territory and submit notifications to tax authorities in other territories.
The information to be included in the GloBE information return will be substantially reduced for a territory where a safe harbour is applied. Where no safe harbour is applied, the information requirements are extensive. Many groups are looking to technology solutions to help manage the required data, though it is worth noting that technology alone does not resolve the challenge; it will also require significant human intervention in both the set-up and use of the technology.
Most territories that have implemented Pillar Two are also requiring self-assessment returns to be filed to report information in respect of the domestic implementation of Pillar Two rules (e.g., local IIR or DMTT rules). Whilst these returns are expected to primarily draw data from the GloBE information return or be more focused on administrative matters (such as identification and allocation of tax between entities) and be much simpler, many territories have not yet published templates for these returns.
Any real estate group that falls within the scope of the Pillar Two rules should carry out a detailed impact assessment. Some may have simplified reporting by virtue of having a UPE that is an excluded entity with qualifying service entities below, but groups with corporate UPEs or mixed real estate activities may, at best, find they have complex reporting obligations or, at worst, face top-up tax liabilities.
For those with REITs that are not excluded entities, it may be beneficial to revisit distribution policies of the REITs to seek to mitigate the risk of top-up tax arising.
We recommend close monitoring of the OECD/tax authorities’ position on REITs as changes may be expected given the potential adverse impact on the real estate sector.
Ross Robertson
BDO in United Kingdom
The Pillar Two rules are complex in their application, and the OECD has recognised the potential compliance burden they can create for in-scope businesses. The OECD has therefore drafted a series of safe harbours to simplify compliance with the Pillar Two rules. The most broadly relevant safe harbour is the transitional country-by-country reporting safe harbour (TCSH), which enables simplified calculations to be undertaken by utilising figures drawn from country-by-country reports (or that would be contained in such reports if they were required to be prepared) and other data from the accounts used in the preparation of such reports. However, a number of requirements must be met, including a need for the country-by-country report to be “qualifying” in the relevant jurisdictions where the safe harbour is sought to be applied. Our experience is that group processes often require remediation to ensure this safe harbour can be relied upon.
Further, the TCSH cannot be applied to certain entity types, including trusts and funds that are common in the real estate sector, and alternative approaches are needed to navigate the rules in a compliant way with a real risk that top-up tax could arise unless groups plan well.
Key Considerations for Real Estate Groups
Safe Harbour ApplicationThe Pillar Two rules contain provisions that categorise entities based on the manner in which they are subject to tax, both in the jurisdiction in which they are established and the jurisdictions in which their investors are located. This interacts with the determination of the territory in which entities are considered to be located for Pillar Two purposes.
Real estate groups often contain entities subject to specific tax regimes in their territory of incorporation (e.g., REITs). Such entities are often not subject to tax on their profits as they arise, but rather there is a mechanism to collect tax (often at a reduced rate) on distribution. These entities are typically viewed as “investment entities” for Pillar Two purposes. An investment entity cannot apply the TCSH, which means calculations under the “full GloBE” rules may be required on their results. In practice, as these entities do not pay corporation tax in their own right by policy design, this can give rise to an inherent risk of Pillar Two top-up tax arising. In addition, due to the typical tax profile of an investment entity, there are numerous elections under the full GloBE rules that will need to be considered, which adds to the compliance burden from a Pillar Two perspective.
Are REITS Excluded Entities?
The Pillar Two rules provide for the concept of “excluded entities,” i.e., entities to which the Pillar Two rules under an Income Inclusion Rule (IIR) do not need to be applied. This exclusion is tested on an entity-by-entity basis and does not exclude the whole group—the only way a group is not in scope is if it does not meet the EUR 750 million revenue threshold. An investment entity may qualify as an excluded entity only if:
- it is itself the ultimate parent entity (UPE); or
- it is substantively (i.e., 95%+) owned by a UPE that is an excluded entity; and
- broadly, it only carries out activities that are ancillary to the activities of those owners, or all, or almost all, of its activities, consist of the holding of assets or the investment of funds for the benefit of those owners (a qualifying service entity).
Application of the GloBE Rules to REITs
There are three primary charging mechanisms under Pillar Two:
- Income Inclusion Rule: This is applied by a UPE in respect of all of its subsidiary entities and is generally only applicable at one level within each direct holding chain. The IIR provides for the right of taxation by the parent territory of the low-taxed profits of subsidiaries in which the UPE holds an ownership interest.
- Qualifying Domestic Minimum Top-up Tax (QDMTT): This applies at the level of a local jurisdiction to low-taxed profits arising in that jurisdiction. The QDMTT applies in priority to the IIR (or the UTPR) as it is credited against any IIR or UTPR tax that may be due. It therefore effectively protects the domestic territory’s right of taxation.
- Undertaxed Profits Rule (UTPR): This may be applied in respect of low-taxed profits of entities within the same group where top-up tax is not wholly collected under an IIR or a QDMTT mechanism. It is therefore “switched off” where an IIR or a QDMTT applies.
The QDMTT in the territory where the REIT is established is therefore likely to be the most important provision to consider for most REITs. Where a REIT is an excluded entity, that should generally be respected for Pillar Two purposes such that no QDMTT calculation should be required for the REIT. However, where the REIT is not an excluded entity (e.g., where the UPE is not itself an excluded entity or the REIT is not a qualifying service entity), a QDMTT calculation is likely to be necessary. In this instance, the REIT itself may not be chargeable to top-up tax under the QDMTT. However, it may be necessary to compute any top-up tax that could arise to the REIT as if it were liable, and then allocate that top-up tax to other members of the group located in the same territory as the REIT. The treatment of such potential top-up tax amounts may be dependent on the interaction with the TCSH in the territory for those entities that qualify. These rules are complex and should be reviewed in the context of particular facts.
A challenge that can arise when such calculations are required is that the REIT itself is often not subject to tax. Whilst it may be possible to allocate withholding tax arising on distributions by the REIT to the REIT for the purposes of this calculation, that withholding tax may only be 15%, and further there will typically be a timing mismatch as the dividends declared often reflect the prior period profits, which may or may not be similar to the current year profits, and the tax can only be reflected in the Pillar Two calculation on a paid basis. So, for example, if a REIT declares a distribution in 2025 in respect of 2024 profits, the tax arising on that distribution is treated as a covered tax in the 2025 period, and not the 2024 period. Where the REIT does not fully distribute all of its income and gains, this can further exacerbate the issue. Some REITs may, therefore, need to reconsider their distribution policies to mitigate the risk of top-up tax arising (e.g., by accelerating full or partial distributions of profit to occur in the same period as the underlying profits arise).
Deferred Tax and Timing Mismatches
The Pillar Two rules incorporate the concept of deferred tax for the determination of the effective tax rate. In principle, deferred tax should reduce or eliminate effective tax rate volatility arising as a result of timing differences between tax and accounting rules. However, there is a quirk in the treatment of tax on undistributed earnings that can be particularly relevant for real estate groups with REITs.
There is often a timing mismatch between the accounting treatment of the earnings of a REIT and the tax treatment of those same earnings. Accounting principles seek to manage this timing mismatch through deferred tax accounting. Specifically, deferred tax may be recognised on undistributed earnings in a parent entity. However, the rules do not provide for an effective mechanism for allocation of this deferred tax to the REIT. In fact, any movement in deferred tax expense reflected in the profits of a member that relates to distributions from another member of that group, are treated as a disallowed accrual.
Further, the elections within the Pillar Two rules that are available to investment entities (e.g., the tax transparency election or the taxable distribution method election) that seek to address timing mismatches do not apply to REITs in many cases due to their specific tax profiles, i.e., that their tax arises by way of a withholding tax in the distributing territory rather than by way of tax imposed in the parent jurisdiction.
This leaves a potentially adverse outcome for REIT groups, and it is unclear if this was the policy intent given the role that REITs play in the real estate sector. The OECD and many local tax authorities are aware of these challenges but, as no legislative action has been taken to alleviate them, REIT groups should plan on the basis of the rules as drafted.
Compliance Requirements
A number of compliance requirements will apply for in-scope groups, irrespective of whether there is any top-up tax liability. Most territories that have implemented Pillar Two require some form of registration for Pillar Two purposes. There is no standardised procedure for registration, and both the information required and the deadlines for registration vary by territory. Some of these registration deadlines have passed for many groups, others are fast approaching.
The UPE (or another nominated group member) will be required to file a GloBE information return in relevant territories that have implemented Pillar Two rules. Where information sharing agreements are in place, it may be possible to file the GloBE return in a single territory and submit notifications to tax authorities in other territories.
The information to be included in the GloBE information return will be substantially reduced for a territory where a safe harbour is applied. Where no safe harbour is applied, the information requirements are extensive. Many groups are looking to technology solutions to help manage the required data, though it is worth noting that technology alone does not resolve the challenge; it will also require significant human intervention in both the set-up and use of the technology.
Most territories that have implemented Pillar Two are also requiring self-assessment returns to be filed to report information in respect of the domestic implementation of Pillar Two rules (e.g., local IIR or DMTT rules). Whilst these returns are expected to primarily draw data from the GloBE information return or be more focused on administrative matters (such as identification and allocation of tax between entities) and be much simpler, many territories have not yet published templates for these returns.
Managing the Impacts
Any real estate group that falls within the scope of the Pillar Two rules should carry out a detailed impact assessment. Some may have simplified reporting by virtue of having a UPE that is an excluded entity with qualifying service entities below, but groups with corporate UPEs or mixed real estate activities may, at best, find they have complex reporting obligations or, at worst, face top-up tax liabilities.For those with REITs that are not excluded entities, it may be beneficial to revisit distribution policies of the REITs to seek to mitigate the risk of top-up tax arising.
We recommend close monitoring of the OECD/tax authorities’ position on REITs as changes may be expected given the potential adverse impact on the real estate sector.
Ross Robertson
BDO in United Kingdom