Key Takeaways
- The UTPR applies only when the Income Inclusion Rule fails to collect the full top-up tax from low-taxed entities.
- Top-up tax under the UTPR is allocated to implementing jurisdictions based on tangible assets and employee headcount in those jurisdictions.
- EU Member States were required to apply the UTPR for fiscal years beginning on or after 1 January 2025.
- Entities are exempt from recognising deferred tax on Pillar Two but must disclose their top-up tax exposure in the notes.
What is the Undertaxed Profits Rule (UTPR)?
The UTPR operates as a second line of defence. Under the Pillar Two framework, the Income Inclusion Rule (IIR) gives the ultimate parent entity's jurisdiction first right to impose a top-up tax on any constituent entity with a jurisdictional effective tax rate below 15%. If the parent jurisdiction has not implemented the IIR, or if the IIR does not cover the full shortfall (because an intermediate parent is itself in a low-tax jurisdiction, for instance), the UTPR activates.
Article 2.5 of the GloBE Model Rules requires UTPR jurisdictions to deny deductions or require equivalent adjustments so that the group's constituent entities in those jurisdictions bear their allocated share of the remaining top-up tax. The allocation follows a two-factor formula under Article 2.6: half weighted by the net book value of tangible assets in the jurisdiction, half weighted by employee headcount. The substance-based income exclusion (5% of tangible asset carrying values plus 5% of payroll costs) reduces the jurisdictional GloBE income before the top-up tax is calculated.
For the auditor, the IAS 12 amendment issued in May 2023 is the starting point. Paragraph 4A provides a mandatory temporary exception from recognising deferred tax arising from Pillar Two legislation. Paragraphs 88A–88D then require the entity to disclose that the exception has been applied and to separately present current tax expense from Pillar Two. Paragraphs 88C–88D add a further obligation: qualitative and quantitative information about the entity's top-up tax exposure.
Worked example: Groupe Lefevre S.A.
Client: Belgian holding company, FY2025, revenue EUR 185M, IFRS reporter. Groupe Lefevre is the ultimate parent entity of a group with subsidiaries in Belgium, the Netherlands, Ireland, and Luxembourg. The group exceeds the EUR 750M consolidated revenue threshold. The Irish subsidiary (a shared services centre) reports GloBE income of EUR 4.2M and adjusted covered taxes of EUR 420,000, producing an ETR of 10%.
Step 1 — Calculate the top-up tax percentage
The minimum rate is 15%. The Irish subsidiary's ETR is 10%. The top-up tax percentage is 5% (15% minus 10%).
Documentation note: record the jurisdictional GloBE income, adjusted covered taxes, and the ETR calculation for the Irish subsidiary. Confirm the GloBE income adjustments per Articles 3.1–3.5 of the Model Rules.
Step 2 — Apply the substance-based income exclusion
The Irish subsidiary holds tangible assets with a carrying value of EUR 1.8M and incurs payroll costs of EUR 2.6M. The exclusion is (5% of EUR 1.8M) plus (5% of EUR 2.6M) = EUR 90,000 + EUR 130,000 = EUR 220,000. Excess profit is EUR 4.2M minus EUR 220,000 = EUR 3.98M.
Documentation note: record the tangible asset carrying values and payroll costs used for the exclusion. Cross-reference to the Irish subsidiary's fixed asset register and payroll records.
Step 3 — Calculate the top-up tax
EUR 3.98M multiplied by 5% = EUR 199,000. Ireland has implemented a QDMTT, so the Irish QDMTT absorbs the top-up tax first. If the QDMTT covers the full EUR 199,000, no IIR or UTPR charge arises. Assume Ireland's QDMTT covers EUR 150,000. The residual top-up tax is EUR 49,000.
Documentation note: record the QDMTT amount collected by Ireland and the residual top-up tax remaining. Confirm the QDMTT qualifies under Administrative Guidance so it offsets the GloBE liability.
Step 4 — Allocate under UTPR
Assume Belgium's IIR implementation contains a gap that prevents collection of the EUR 49,000. The residual flows to UTPR jurisdictions. The Netherlands (tangible assets EUR 12M, 80 employees) and Belgium (tangible assets EUR 8M, 120 employees) split the EUR 49,000 under the two-factor formula in Article 2.6, based on their relative shares of tangible assets and headcount.
Documentation note: record the UTPR allocation calculation per Article 2.6, the tangible asset values and headcount by jurisdiction, and the resulting top-up tax charge allocated to each UTPR entity. This amount flows into IAS 12 current tax expense with separate disclosure per paragraph 88B.
Conclusion: the total Pillar Two charge of EUR 199,000 is defensible because the jurisdictional ETR, substance-based exclusion, QDMTT offset, and UTPR allocation are each traceable to the GloBE Model Rules and supported by entity-level data from the Irish, Dutch, and Belgian subsidiaries.
Why it matters in practice
Teams apply the IAS 12 paragraph 4A deferred tax exception without providing the disclosures that paragraphs 88A–88D require as its counterpart. The exception and the disclosure obligation are a package. An entity that applies the exception but omits the qualitative and quantitative exposure information in the notes has incomplete financial statements under IAS 12.88C.
The UTPR allocation depends on tangible asset carrying values and employee headcount at the entity level in each UTPR jurisdiction. Practitioners sometimes use group-level figures or exclude leased assets that qualify as tangible under the GloBE rules, which distorts the allocation and shifts the top-up tax charge to the wrong entities within the group.
UTPR vs. Income Inclusion Rule (IIR)
| Dimension | UTPR | IIR |
|---|---|---|
| Who pays | Constituent entities in UTPR jurisdictions, allocated by tangible assets and headcount | The parent entity (ultimate or intermediate) in the jurisdiction that enacted the IIR |
| Priority | Backstop: applies only to residual top-up tax not collected by the IIR or QDMTT | Primary rule: has first right to collect top-up tax |
| Mechanism | Denial of deductions or equivalent adjustment in the UTPR jurisdiction | Inclusion of top-up tax in the parent entity's tax return |
| Trigger | Low-taxed constituent entity income not covered by IIR | Jurisdictional ETR below 15% for any constituent entity |
| Allocation | Two-factor formula (tangible assets, headcount) across all UTPR jurisdictions | Follows ownership chain from parent to low-taxed entity |
The practical consequence on an engagement is that the IIR creates a single tax adjustment in the parent's jurisdiction, while the UTPR scatters adjustments across every group entity in a jurisdiction that has enacted the rule. For the auditor, this means a UTPR charge can appear in the local statutory accounts of subsidiaries that have no direct relationship with the low-taxed entity.
Related terms
Frequently asked questions
Does the UTPR apply if the parent jurisdiction has implemented the IIR?
The UTPR activates only for residual top-up tax that the IIR does not collect. If the ultimate parent entity's jurisdiction has a fully functioning IIR, no UTPR charge arises. Article 2.4 of the GloBE Model Rules establishes this ordering rule. The UTPR becomes relevant when the parent jurisdiction has not enacted Pillar Two or when intermediate holding structures create collection gaps.
How do I disclose Pillar Two top-up tax in the financial statements?
IAS 12.88A requires the entity to state that it has applied the deferred tax exception. Paragraph 88B requires separate disclosure of Pillar Two current tax expense. Paragraphs 88C–88D require qualitative and quantitative information about top-up tax exposure, including the jurisdictions where the ETR falls below 15% and the aggregate low-taxed income in those jurisdictions.
When does the UTPR safe harbour apply?
The OECD's transitional CbCR safe harbour allows a jurisdiction to avoid the full GloBE calculation if the entity demonstrates a simplified ETR at or above the transitional rate (15% for fiscal year 2024, 16% for 2025, 17% for 2026) based on country-by-country reporting data. If a jurisdiction qualifies for this safe harbour, no top-up tax arises for that jurisdiction, and the UTPR is not triggered in respect of that jurisdiction's income.