Complexities for Swiss Companies under Pillar Two
Navigating Return to Provision - Part 2
In our first blog, we discussed the fundamentals of the RTP process, highlighted why differences arise between tax provisions and filed returns or final tax assessments, and how timely reconciliation can prevent surprises. In this second blog, we explore the unique complexities Swiss companies face when operating across multiple cantons and the critical role of the RTP process. We then connect these Swiss-specific challenges to the broader global context by examining how RTP adjustments interact with the Pillar Two requirements under the OECD’s Global Anti-Base Erosion (GloBE) Model Rules (commonly referred to as Pillar Two). In our third blog, we will focus on leveraging technology to support and streamline RTP as well as share our views on the important role of data and process in an efficient and effective RTP process.
Swiss RTP Complexities: Navigating Multiple Cantonal Tax Regimes
Companies operating across multiple locations in Switzerland may face a complex RTP process. Each of the 26 cantons has its own tax laws and distinct procedures for tax assessment and collection. Furthermore, the final tax liability is not determined at the time of filing the tax return but only upon receipt of the final tax assessment from the respective cantonal tax authorities. Consequently, a robust RTP process is essential to accurately monitor the current tax liabilities at both cantonal and federal levels.
During the year-end closing, the current tax liability is estimated using a “blended” tax rate. This blended rate is typically calculated based on the cantonal tax rates applied to the previous year’s tax apportionment. After filing the cantonal tax returns with the final tax apportionment, an initial RTP adjustment is made to update the apportionment and, accordingly, the tax liabilities by canton. Subsequently, when a final assessment is received from a canton, the remaining cantonal tax liability is removed from the balance sheet through the income statement. It is therefore critical to track all payments made to cantonal tax authorities within the accounting system to accurately determine the balance to be removed.
Given the involvement of multiple tax authorities, a meticulous RTP process is vital in Switzerland, particularly for tracking payments to the various tax authorities. Without this tracking, a company may find it difficult, if not impossible, to reconcile the current tax liability recorded in its books.
These Swiss-specific RTP challenges are further compounded when considering the global minimum tax rules under Pillar Two, which require companies to true-up tax provisions based on actual outcomes by jurisdiction. Understanding how RTP adjustments at the local Swiss level interact with Pillar Two’s global framework is critical for multinational enterprises operating in Switzerland.
Pillar Two RTP Adjustments: An Overview
Under the Pillar Two global minimum tax rules, companies are required to true-up their Pillar Two tax provisions for prior years once actual tax outcomes become known. These true-ups adjust the Pillar Two tax expense in the current year to reflect any over- or under-accruals in prior years. In this section of the blog, we explain how these adjustments work, focusing on cases where a true-up results in a reduction in tax expense that exceeds €1 million, which triggers a special Pillar Two rule. We also discuss the impact on Effective Tax Rate (ETR) restatement, top-up tax liabilities, and recovery possibilities, assuming a Qualified Domestic Minimum Top-up Tax (QDMTT) is in place.
True-ups vs Prior year Errors
It is important to distinguish between true-ups and prior year errors. True-ups are adjustments made to reflect updated or actual tax outcomes based on new information or developments after the original provision was made. They are considered normal accounting estimates and adjustments. In contrast, prior year errors relate to mistakes or omissions in the original accounting or tax calculations, such as misstatements or incorrect application of accounting principles or tax laws.
For IFRS reporters, IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors provides guidance:
- True-ups are treated as changes in accounting estimates and are adjusted prospectively in the current period.
- Prior year errors require retrospective restatement of prior period financial statements to correct the error.
This discussion focuses exclusively on true-ups and not on prior year errors.
True-ups and their impact on top-up tax
True-up adjustments under Pillar Two primarily relate to the ordinary income tax charge —the actual tax paid or payable to domestic tax authorities on a company’s ordinary income. The top-up tax is a calculated residual amount that arises only if the ordinary income tax charge falls below the minimum effective tax rate threshold. It is not a separate tax charge subject to accrual or payment in all cases but is determined based on the ordinary income tax charge.
Adjustments to the ordinary income tax charge affect the calculation of the top-up tax, which may result in additional top-up tax being due or, theoretically, overpaid. However, under the current Pillar Two framework and as clarified in the Consolidated Commentary, any re-determination of top-up tax can only be carried back to the extent that it does not result in a refund of top-up tax. If a re-determination would otherwise lead to a refund, this adjustment is instead recognised in the year of re-determination (i.e., the current fiscal year). Consequently, top-up tax that has already been paid or accrued is generally not recoverable, even if subsequent adjustments increase the underlying ordinary income tax liability.
This means that while ordinary income tax true-ups may reduce or increase tax expense, any top-up tax already recognised remains largely non-recoverable in prior periods and must be accounted for in the current period if a refund would otherwise arise. Therefore, it is important to maintain a robust tax provision process to accurately estimate tax provisions and thereby minimise RTP adjustments.
Pillar Two rules specify that true-up or RTP adjustments are generally adjusted in the current year. However, when there is a decrease in covered taxes (i.e., a credit to the current year income tax charge) due to over-accrual of tax in prior years, and this decrease exceeds €1 million for a jurisdiction, the ETR and top-up tax must be recalculated for the prior year(s) concerned. If the true-up amount is less than €1 million, no adjustment is required under Pillar Two rules. The difference is considered immaterial for Pillar Two purposes and can be absorbed in the current year without restatement or separate disclosure, although an annual election under Article 4.6.1 must be made.
For example, if a company estimated a prior year ordinary income tax provision of €4.8 million but the actual liability was €4.0 million, the €0.8 million over-accrual is below the €1 million threshold. No Pillar Two true-up adjustment is required for the prior year, but an election needs to be made. However, when absorbed in the current year, this over-accrual reduces the current year covered taxes, potentially increasing the current year’s top-up tax liability.
Thresholds and currency considerations
When the tax liability or covered tax is denominated in a currency other than Euro, the €1 million threshold must be applied on a converted Euro equivalent basis. The conversion should use the OECD-prescribed exchange rate or the applicable exchange rate used for Pillar Two calculations, typically the average exchange rate for the relevant period or the rate used in the Global Information Return (GIR).
For instance, if a company’s prior year estimated ordinary income tax provision was CHF 1.2 million and the actual liability CHF 0.9 million, the difference is CHF 0.3 million. Assuming an exchange rate of 1 EUR = 1.05 CHF, the difference in Euro is approximately €0.29 million. Since this is below the €1 million threshold, no Pillar Two true-up adjustment is required but the election requirement remains.
Simplified Illustrative Examples (for ease of understanding the examples are in Euro):
Consider a company with income of €100 million, a minimum Pillar Two effective tax rate of 15% (implying minimum tax of €15 million), and an actual ordinary income tax rate of 12%, which is below the minimum. Suppose the prior year estimated ordinary income tax provision was €13.5 million (for example, due to estimated non-tax deductible expenses); the resulting RTP is an over-accrual of €1.5 million compared to the actual liability of €12.0 million.
Before the true-up, the estimated ordinary tax rate was 13.5%, and the top-up tax was €1.5 million. After true-up, the actual ordinary tax rate is restated downward to 12.0%, increasing the top-up tax to €3.0 million. This means an additional €1.5 million top-up tax is due for the prior year.
Accounting for this involves two journal entries. First, the company reverses the over-accrued ordinary income tax provision by debiting the accrued liability and crediting the tax expense by €1.5 million. Second, it recognises the additional top-up tax liability by debiting top-up tax expense and crediting the accrued top-up tax, each by €1.5 million.
Now consider the same company but with a prior year estimated ordinary income tax provision of €10.2 million, an under-accrual of €1.8 million compared to the actual liability of €12.0 million.
The estimated ordinary tax rate before true-up was 10.2%, with a top-up tax of €4.8 million. After true-up, the actual ordinary tax rate is 12.0%, reducing the top-up tax to €3.0 million. However, because the Pillar Two rules do not require restatement of the prior year ETR for under-accruals, the company cannot recover the €1.8 million overpaid top-up tax from the prior year.
The company recognises the additional €1.8 million ordinary income tax expense in the current year by debiting tax expense and crediting the provision for tax. No adjustment is made to the prior year top-up tax liability.
Summary
Over-accruals require restatement of the prior year ETR and may trigger additional top-up tax liabilities, however, any top-up tax already paid or accrued in the prior year is generally not recoverable and instead is adjusted in the current year.
- By means of an annual election, immaterial true-ups that reduce the current year tax charge can be adjusted in the current year.
- Under-accruals increase current year tax expense but do not require ETR restatement or allow recovery of overpaid top-up tax.
- Taxes denominated in currencies other than Euros must be converted to Euros for threshold assessment.
Article 4.6.1 of the OECD Pillar Two rules introduces complexities. The inconsistent treatment of increases versus decreases in prior year tax creates challenges in accounting and compliance. Additionally, the timing of true-up adjustments relative to the filing of the Global Information Return (GIR) adds uncertainty. The GIR is filed 18 months after the first year and 15 months after subsequent years, delaying clarity on tax positions.
This delay raises questions about when to recognise true-up adjustments, especially for the first year of Pillar Two application. There is also uncertainty about how to treat RTP adjustments for periods before Pillar Two’s effective application, such as 2022 or 2023, for which no GIR will be filed.
Jurisdictional Guidance on Pre-Transition Years
Ireland and Germany are two jurisdictions that have issued detailed guidance (Ireland) and a draft bill (Germany) on the treatment of post-filing adjustments and tax expense relating to pre-transition fiscal years under Pillar Two (i.e., years before Pillar Two’s effective application).
Given the complexity and evolving nature of Pillar Two rules, companies are strongly advised to seek professional tax advice to ensure compliance with local regulations and to apply the guidance appropriately to their specific circumstances.
For further guidance or questions on RTP processes and Pillar Two compliance, please contact our tax accounting specialists.
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