Pillar Two Compliance: Why Your Due Diligence Must Include a “Top-Up Tax” Assessment
For years, UAE transactions followed a simple assumption. Free Zone meant low tax. Often zero.That assumption no longer survives scrutiny. The global move to a 15% minimum tax under Pillar Two has reshaped how UAE acquisitions must be evaluated. Especially from 2025 onward. What appears tax-free under UAE Corporate Tax can still generate a real cash tax cost once Pillar Two is applied at the group level.
This shift matters most in UAE Free Zones. A target may show a 0% ETR locally. Yet, once acquired by a large multinational group, that same profit can trigger a 15% top-up tax.
The problem is not visibility. It is valuation. Traditional models still rely on headline ETRs. Pillar Two forces deal teams to confront the difference between a reported tax position and post-acquisition tax leakage. That difference flows straight into cash flows, IRR, and pricing.
This is why top-up tax assessment is no longer a compliance exercise. It is a deal lever. If Pillar Two is ignored during due diligence, it will still appear – just later, and at a higher cost.
Pillar Two Explained for Dealmakers (Not Tax Technicians)
Pillar Two is often described as technical. For dealmakers, it is structural.
Who is in scope
Pillar Two applies to multinational groups with consolidated revenues of €750 million or more. The threshold is tested at the group level. Not the target level.
This is critical for acquiring UAE company tax risks. A UAE business may be fully domestic today. The moment it becomes part of a large group, Pillar Two exposure can arise.
How the 15% minimum ETR is tested
The effective tax rate is calculated at the jurisdiction level. All UAE entities are aggregated. Free Zone and mainland are not tested separately. Incentives under UAE Corporate Tax law do not change this calculation.
The three moving parts that matter in deals
Income Inclusion Rule (IIR)
Allows the parent jurisdiction to collect the top-up tax where local tax is insufficient.
Undertaxed Profits Rule (UTPR)
Acts as a backstop. If the tax is not collected under IIR or locally, other group jurisdictions can collect it.
UAE Domestic Minimum Top-Up Tax (DMTT)
Introduced to ensure the UAE collects the top-up tax before foreign tax authorities do.
Together, these rules determine whether the tax arises, where it is paid, and when cash leaves the group. That is why Pillar Two directly affects IRR, valuation, and post-deal cash flows.
It is now central to serious m&a services and m&a advisory in uae engagements.
UAE Domestic Minimum Top-Up Tax (DMTT): What Changed From 2025
The UAE Domestic Minimum Top-Up Tax (DMTT) applies to large multinational groups and ensures that UAE profits are effectively taxed at 15%, even where local corporate tax incentives reduce the headline tax rate.
From financial years beginning 1 January 2025, the UAE implemented a 15% Domestic Minimum Top-Up Tax (DMTT).
This was not a defensive move. It was strategic. By introducing DMTT, the UAE ensured that top-up tax on UAE profits is collected locally rather than being ceded to foreign jurisdictions under UTPR.
Which UAE entities are in scope
The DMTT applies to UAE entities that are part of in-scope multinational groups. This includes:
- Mainland companies
- Free Zone companies
- Groups benefiting from Qualifying Free Zone Person top-up tax positions
Free Zone status does not exclude an entity from DMTT.
Why the UAE chose DMTT over IIR
The UAE is often a subsidiary jurisdiction, not the ultimate parent location. An IIR-only approach would have shifted taxing rights abroad. DMTT reverses that outcome. For foreign buyers, this means the tax is paid in the UAE. But paid nonetheless.
The strategic purpose
The policy objective is clear. Prevent erosion of the UAE tax base. Provide certainty to inbound investors. For deal teams, the implication is equally clear.
DMTT must be modelled before signing, not discovered after closing.
This has become a core issue in m&a tax & reorganisation services in uae and increasingly appears in lender and IC questions during acquisition reviews.
4. UAE Free Zones: Why 0% Still Becomes 15% Under Pillar Two
UAE Free Zones were designed to attract capital, talent, and regional headquarters.
They were not designed with a global minimum tax in mind.
Under UAE Corporate Tax law, a Free Zone entity that qualifies as a Qualifying Free Zone Person (QFZP) can continue to apply a 0% rate on qualifying income. From a domestic perspective, this remains valid.
Pillar Two looks at the same profit very differently.
Pillar Two’s view of Free Zone profits
Pillar Two ignores incentives. It tests outcomes.
If a UAE Free Zone entity earns profit and pays little or no covered tax, that profit is tested against the 15% minimum ETR at the UAE jurisdictional level. If the ETR falls short, a top-up tax arises.
This is where many buyers misunderstand the risk. They rely on domestic tax positions. Pillar Two operates above them.
Why QFZP status does not override the minimum ETR
QFZP status affects UAE Corporate Tax. It does not exempt the entity from Pillar Two. For M&A purposes, this means that Qualifying Free Zone Person top-up tax exposure must be modelled even when the target is fully compliant locally.
The Free Zone “ETR trap”
Certain profiles are consistently high risk:
- High-margin trading or IP entities
- Limited employees or tangible assets in the UAE
- Key decision-makers located offshore
- Profits booked in the UAE for commercial or historical reasons
From a Pillar Two lens, this creates a mismatch between profit and substance. The result is a low ETR and an unavoidable top-up tax.
This is why Acquiring free zone company ETR analysis is now a core part of advanced m&a advisory in uae work.
Common misconception corrected
“Free Zone = outside Pillar Two.” It does not.
Free Zones still matter. But under Pillar Two, they must be defended with data, modelling, and substance – not assumptions.
The Undertaxed Profits Rule (UTPR): The Silent Deal Killer
UTPR is the least understood Pillar Two rule. It is also the most dangerous in transactions.
UTPR in simple terms
If a group does not pay the minimum tax in one jurisdiction, other jurisdictions are allowed to collect it instead.
This means that if UAE profits are undertaxed and the UAE Domestic Minimum Top-Up Tax (DMTT) does not fully absorb the exposure, the tax can be reallocated to other countries where the group operates.
The tax will be paid somewhere.
How UTPR reallocates tax
UTPR does not follow ownership. It follows presence. Countries where the group has employees, assets, or payroll can be allocated a share of the top-up tax. This often creates unexpected liabilities in jurisdictions that were never part of the original valuation model.
Why inbound buyers are still exposed
Some buyers assume the UAE DMTT solves everything. It does not.
If the DMTT calculation differs from foreign interpretations, or if transitional rules apply, UTPR exposure can still arise. In cross-border acquisitions, this creates uncertainty that lenders and investment committees increasingly scrutinise.
This is why deal teams must model where the 15% tax will be paid, not just whether it exists.
Failing to do so is one of the fastest ways to misprice a transaction.
Why Traditional Tax Due Diligence Misses Pillar Two Risk
Most tax due diligence processes were not built for Pillar Two.
What standard tax DD focuses on
Traditional reviews typically cover:
- Corporate tax and VAT registrations
- Filing history and penalties
- Transfer pricing documentation
- VAT due diligence in UAE including historic compliance
- Exposure under Federal Decree-Law No. 17 of 2025 and UAE Tax Procedures Law 2026 amendments
These checks remain essential. But they do not answer the Pillar Two question.
What Pillar Two DD requires instead
Pillar Two analysis looks forward, not backward. It requires:
- Jurisdictional ETR calculations
- GloBE income adjustments
- Identification of covered taxes
- Interaction with UAE Domestic Minimum Top-Up Tax DMTT
- Impact on post-acquisition group structure
This is fundamentally different from compliance-based reviews.
The core mismatch
The seller sees a 0% tax profile.
The buyer inherits a 15% minimum tax obligation.
That mismatch explains why boards, lenders, and ICs now ask a new question:
“What is the post-deal Pillar Two ETR?”
This question increasingly drives purchase price adjustments, deal structure decisions, and even go/no-go outcomes.
Traditional tax due diligence checklists simply do not capture this risk.
The Core Solution: Post-Acquisition ETR & Top-Up Tax Modelling
Pillar Two does not punish poor compliance. It punishes poor modelling.
For M&A, the real risk is not misunderstanding the rules. It is failing to translate those rules into post-deal cash flow projections. This is where Post-Acquisition ETR & Top-Up Tax Modelling becomes indispensable.
What a Post-Acquisition ETR Simulation actually means
A post-acquisition ETR simulation is not a compliance calculation. It is a valuation tool.
It answers one question: What is the effective tax rate of the group after the deal closes, once Pillar Two is fully applied?
This requires moving beyond entity-level analysis. The model must reflect the buyer’s group structure, jurisdictional footprints, and profit allocation after acquisition.
Without this, any headline tax rate used in valuation is incomplete.
Modelling steps that matter for M&A
Pre-deal jurisdictional ETR
The first step is to calculate the standalone UAE ETR under Pillar Two rules. This involves adjusting accounting profit to GloBE income and identifying covered taxes. For many Free Zone entities, the result is a materially lower ETR than expected.
This is where Acquiring free zone company ETR risk becomes visible.
Post-deal profit and substance alignment
The second step is structural. Once the target joins the group, profit may shift due to:
- Management re-alignment
- Centralised decision-making
- Changes in transfer pricing
- Integration of shared services
Pillar Two is highly sensitive to substance. A post-deal structure that increases profit in the UAE without a corresponding increase in people or assets increases top-up exposure.
This is why ETR simulation UAE M&A must be forward-looking, not static.
DMTT vs foreign IIR / UTPR outcomes
Finally, the model must determine where the tax will be paid.
- How much is absorbed by UAE Domestic Minimum Top-Up Tax DMTT
- How much remains exposed to foreign Income Inclusion Rule or Undertaxed Profits Rule UAE allocations
This distinction affects cash timing, withholding considerations, and even covenant calculations in financing documents.
How a “hidden” 15% cost reshapes deal economics
Once modelled correctly, Pillar Two reshapes the deal in measurable ways:
- IRR declines due to higher recurring tax
- NPV reduces as future cash flows are compressed
- Payback periods extend, affecting investment committee thresholds
These impacts are often large enough to change pricing negotiations or structure choices.
Why safe harbours cannot be relied on for valuation decisions
Safe harbours are transitional. Valuations are permanent. While UAE QDMTT Safe Harbour rules may reduce compliance burdens in certain periods, they do not eliminate economic exposure. No serious buyer relies on temporary relief to justify a long-term investment thesis.
For M&A, modelling must assume full Pillar Two application. Anything less is optimistic at best.
Red Flags That Signal a Pillar Two Problem in UAE Targets
Some Pillar Two risks are subtle. Others are visible the moment the data is reviewed.
Experienced deal teams now recognise specific red flags during tax due diligence checklist reviews.
High-profit 0% entities with limited people or assets
This is the most common risk profile.
Entities earning substantial profits under 0% regimes, particularly in Dubai free zone company setup structures, attract immediate Pillar Two scrutiny. High margins without operational depth almost always lead to top-up tax exposure.
Profit booked in the UAE while key decision-makers sit offshore
Decision-making matters. Pillar Two does not ignore governance.
If profits are booked in the UAE but strategic control sits elsewhere, substance challenges arise. This is increasingly relevant in regional headquarters structures and holding companies.
No Pillar Two readiness or DMTT analysis
Targets that have not undertaken any Pillar Two assessment signal a broader governance gap. This often correlates with weak reporting, limited data quality, and underdeveloped tax controls.
Weak CbCR or group reporting data
Pillar Two relies on consistent, reconciled group data. Weak Country-by-Country Reporting or inconsistent segment reporting complicates ETR calculations and increases uncertainty.
This risk frequently emerges in mid-market acquisitions where compliance infrastructure has not kept pace with growth.
Heavy reliance on Free Zone incentives without substance alignment
Free Zone incentives remain valid. But reliance without substance is no longer defensible.
This is particularly relevant in dubai free zone business setup structures used for trading, IP, or financing activities.
When multiple red flags appear together, Pillar Two exposure is almost guaranteed.
Deal Structuring & SPA Protections in a Pillar Two World
Pillar Two has not changed deal-making. It has changed deal protection and tax competition.
Share deal vs asset deal - Pillar Two consequences
A share deal typically transfers historical and structural Pillar Two exposure to the buyer. An asset deal may allow partial ring-fencing, but it rarely eliminates group-level ETR effects post-integration.
Deal structure alone does not solve Pillar Two risk. It must be combined with modelling.
Pillar Two-specific reps, warranties, and indemnities
SPAs increasingly include representations covering:
- Accuracy of Pillar Two calculations
- Completeness of data used for ETR modelling
- Absence of undisclosed UAE Domestic Minimum Top-Up Tax DMTT exposure
Where uncertainty remains, indemnities are negotiated. This is now standard practice in sophisticated mergers and acquisitions (m&a) services.
Purchase price adjustments linked to ETR outcomes
Some buyers link pricing to post-deal ETR thresholds. If the ETR falls below an agreed level, adjustments apply.
This shifts Pillar Two risk back to the seller – where it often belongs.
Escrow and holdbacks for future DMTT / UTPR exposure
Where modelling uncertainty cannot be eliminated, escrows provide protection. Funds are released once Pillar Two outcomes are confirmed.
This approach is increasingly used in cross-border acquisitions involving abu dhabi m&a consulting and international sponsors.
Covenants to preserve Free Zone status and substance
Post-closing covenants now address:
- Maintenance of substance
- Preservation of qualifying activities
- Restrictions on restructuring that increases Pillar Two exposure
These covenants reflect the reality that Pillar Two risk continues well after closing.
Conclusion
UAE M&A has entered a new phase.The market has not become less attractive. But it has become more honest. What was once marketed as “tax-efficient” must now be tested against a global minimum standard. Under Pillar Two, profits cannot hide behind incentives, Free Zone labels, or historic assumptions. The system looks through structures and measures outcomes.
This is the real shift. Pillar Two is no longer a compliance topic. It is a valuation variable. Deals no longer fail because tax was unknown. They fail because tax was unmodelled. For buyers, ignoring top-up tax distorts IRR and pricing. For sellers, failing to address it weakens credibility and negotiating power. For boards and lenders, it introduces risk that should have been visible at signing.
The message is simple and unavoidable: If Top-Up Tax is not in your due diligence, it is already in your IRR – you just have not seen it yet.
Final Thought
Pillar Two has not made UAE deals riskier. It has made weak analysis more expensive. In today’s market, Top-Up Tax assessment is not optional. It is the difference between a priced deal and a mispriced one.
FAQs:
Yes. Pillar Two operates independently of UAE Corporate Tax. A target can be fully compliant, pay 0% tax as a Qualifying Free Zone Person, and still generate UAE Domestic Minimum Top-Up Tax DMTT exposure once it joins an in-scope multinational group.
Not reliably. While an asset deal may reduce historical exposure, Pillar Two applies at the group level post-acquisition. If profits generated by the acquired assets contribute to a low UAE ETR, top-up tax can still arise. Asset deals are not a Pillar Two shield.
No. DMTT significantly reduces exposure, but it does not guarantee elimination. Differences in interpretation, timing, or transitional rules can still trigger Undertaxed Profits Rule UAE reallocations. This is why modelling where the tax is paid matters as much as whether it exists.
Yes. The threshold is tested at the group level. A target that is out of scope today may fall within Pillar Two immediately upon acquisition by a larger buyer. This is a common blind spot in mid-market deals.
Generally, no. Top-up tax is a current cash tax under Pillar Two. Treating it as deferred understates its impact on cash flows, IRR, and debt service capacity. Valuation models must reflect it as a recurring operating cost.
Significantly. If earn-outs are based on EBITDA or net profit without adjusting for top-up tax, sellers may benefit from a tax cost borne entirely by the buyer. Sophisticated SPAs now include Pillar Two-adjusted metrics or tax-neutralisation clauses.
Indirectly, it affects several areas. Pillar Two interacts with transfer pricing, substance requirements, group reporting, and even VAT due diligence in UAE where profitability and operational alignment are reviewed together. It also increases reliance on accurate group data and controls.
No. Domestic incentives remain valid under UAE law, but Pillar Two ignores them for minimum tax testing. Incentives reduce local tax – they do not reduce Pillar Two exposure.
Early. Ideally at the pre-LOI stage, and certainly before binding pricing decisions. Introducing Pillar Two analysis late limits structuring options and weakens negotiating leverage.
Rarely. Because Pillar Two is calculated at the jurisdictional and group level, exposure often affects the wider group ETR. Ring-fencing is complex and requires deliberate structural planning.
Yes. Even where no top-up tax is ultimately payable, Pillar Two requires ongoing calculations, data reconciliation, and reporting. This increases recurring compliance costs and internal resource requirements.
Holding company structures must now be assessed for substance and profit alignment. Passive holding entities with minimal activity are particularly exposed under Pillar Two, especially in Free Zones.
Yes, contractually. Through indemnities, price adjustments, escrows, and earn-out recalibrations, sellers can retain part of the Pillar Two risk – particularly where exposure arises from pre-closing structures.
Yes. Comparisons now focus on post-Pillar Two ETR, not headline tax rates. This changes how UAE targets are positioned relative to other jurisdictions with higher statutory rates but similar effective outcomes.
Yes. Even minority stakes can affect group-level ETRs depending on consolidation and accounting treatment. Pillar Two analysis is increasingly included in minority and JV due diligence.
References
- Ministry of Finance – United Arab Emirates. “Top-Up Tax | Ministry of Finance – United Arab Emirates.” Accessed December 25, 2025.
https://mof.gov.ae/en/public-finance/tax/uae-domestic-minimum-top-up-tax/ - Ministry of Finance – United Arab Emirates. “Ministry of Finance Announces Amendments to the Corporate Tax Law.” accessed December 25, 2025.
https://mof.gov.ae/ministry-of-finance-announces-amendments-to-the-corporate-tax-law/ - Ministry of Finance – United Arab Emirates. “Ministry of Finance Announces the Issuance of Ministerial Decision Adopting OECD Guidance and Commentary on Global Minimum Tax Rules.” accessed December 25, 2025.
https://mof.gov.ae/en/news/ministry-of-finance-announces-the-issuance-of-ministerial-decision-adopting-oecd-guidance-and-commentary-on-global-minimum-tax-rules/ - Ministry of Finance – United Arab Emirates. “Ministry of Finance Announces OECD Transitional Qualified Status for Its Domestic Minimum Top-Up Tax (‘DMTT’).” accessed December 25, 2025.
https://mof.gov.ae/en/news/ministry-of-finance-announces-oecd-transitional-qualified-status-for-its-domestic-minium-top-up-tax-dmtt/om - Organisation for Economic Co-operation and Development (OECD). Minimum Tax Implementation Handbook (Pillar Two). Paris: OECD, 2023.
https://www.oecd.org/tax/beps/minimum-tax-implementation-handbook-pillar-two.pdf.
OECD - Organisation for Economic Co-operation and Development (OECD). “Global Anti-Base Erosion Model Rules (Pillar Two).” OECD, May 9, 2025.
https://www.oecd.org/en/topics/sub-issues/global-minimum-tax/global-anti-base-erosion-model-rules-pillar-two.html - PricewaterhouseCoopers (PwC). UAE Domestic Minimum Top-Up Tax (DMTT) Alert. PwC, 2025. https://www.pwc.com/m1/en/tax/documents/2025/uae-dmtt-alert.pdf
- Ernst & Young (EY). “UAE Issues Domestic Minimum Top-Up Tax Legislation.” EY Tax News, May 5, 2025.
https://taxnews.ey.com/news/2025-0505-uae-issues-domestic-minimum-top-up-tax-legislation - KPMG LLP. “UAE: Retroactive Implementation of OECD Pillar Two Guidance.” KPMG US TaxNewsFlash, April 30, 2025.
https://kpmg.com/us/en/taxnewsflash/news/2025/04/uae-retroactive-implementation-oecd-pillar-two-guidance.html - KPMG LLP. “UAE: FAQs on Pillar Two Domestic Minimum Top-Up Tax.” KPMG US TaxNewsFlash, March 4, 2025.
https://kpmg.com/us/en/taxnewsflash/news/2025/03/uae-faqs-pillar-two-dmtt.html - RSM UAE (RSM International). “Navigating the OECD’s Pillar Two Framework in United Arab Emirates.” RSM, 2025.
https://www.rsm.global/uae/service/tax/navigating-the-oecds-pillar-two-framework-in-united-arab-emirates - Reuters. “UAE to Impose 15% Minimum Top-Up Tax on Large Multinationals from January.” Reuters, December 9, 2024.
https://www.reuters.com/markets/uae-impose-15-domestic-minimum-top-up-tax-large-multinationals-jan-1-2024-12-09/ - Chen, Xuyang. The Global Minimum Tax, Investment Incentives and Asymmetric Tax Competition. arXiv, September 9, 2024. https://arxiv.org/abs/2409.05397
- PricewaterhouseCoopers (PwC). Pillar Two Guide for Multinational Enterprises. PwC International Tax, 2023.
https://www.pwc.com/gx/en/services/tax/assets/pwc-pillar-two-guide-for-emea-multinational-enterprises-21-11-2023.pdf
