MTT32040 - Calculating top-up amounts: Substance based income exclusion: Permanent establishments and flow-through entities

This page discusses the position for accounting periods beginning on or after 31 December 2024 or, where a retrospection election has been made, accounting periods beginning on or after 31 December 2023. These rules can be found in sections 198, 198ZA, 198ZB and 198ZC Finance (No.2) Act 2023, as amended (or inserted) by Finance Act 2025.

Permanent establishments

Under the Pillar Two rules a permanent establishment exists where it meets one of four conditions (see MTT10130). These conditions are in section 232 Finance (No.2) Act 2023.

Normally, when determining the eligible payroll costs of a permanent establishment the only amounts to be included are those that are included when calculating the adjusted profits of the permanent establishment.

Similarly, when determining the eligible tangible asset amount of a permanent establishment the only assets to be taken into account are those used in the business of the permanent establishment.

However, where a permanent establishment for Pillar Two purposes exists only due to the fourth condition being met, then the eligible payroll costs and eligible tangible asset amounts are nil. The fourth condition is met where none of the other three conditions are met, and the territory of the main entity exempts the income attributable to the operations of the place of business (see MTT10130).

Flow-through entities that are not ultimate parent entities

A flow-through entity that is not a UPE cannot receive an amount of substance-based income exclusion. Instead, the eligible payroll costs and eligible tangible asset amounts that a flow-through entity would have received are distributed to the entities that are:

  • allocated a proportion of the flow-through entity’s underlying profits, and
  • are located in the same territory as the flow-through entity.

This distribution is in proportion to the amount of underlying profits that each entity is allocated under section 168 Finance (No.2) Act 2023 or would have been allocated if the underlying profits weren’t nil (see MTT41440).

Flow-through entities that are ultimate parent entities

An adjustment should be made to the eligible payroll costs and eligible tangible asset amount of a flow-through entity that is also a UPE.

They should be reduced by the proportion of the flow-through entity’s adjusted profits that are excluded as a result of the adjustments set out in section 170 Finance (No.2) Act 2023, (see MTT41460).