Pillar Two— Enhanced clarification on tax disclosure requirements

At a glance

The Luxembourg law implementing the minimum effective tax rate (ETR) of 15% for multinational enterprises (MNEs) and large-scale domestic groups (DGs) with consolidated annual revenue exceeding EUR 750 million (referred to as the “Pillar Two law”) was published in the Official Journal on 22 December 2023. Effective for fiscal years commencing on or after 31 December 2023, any group falling within the scope of the Pillar Two rules must prepare to apply these new regulations. This process starts with the inclusion of relevant disclosures in annual financial statements, according to the transition rules outlined in the Pillar Two law.

A closer look

When an MNE group or DG is within the scope of the Pillar Two rules, an additional amount of tax (top-up tax) must be paid in relation to each jurisdiction in which the ETR is below the agreed 15% minimum level of taxation. To ascertain the necessity for any top-up tax, the ETR per jurisdiction (jurisdictional ETR) must be assessed annually.

The Pillar Two transitional rules stipulate, however, that, when calculating the jurisdictional ETR in a transition year (being defined as the first fiscal year during which the MNE group or DG is subject to the Pillar Two rules) and for each subsequent fiscal year, the MNE group or a DG entity must take into account all deferred tax assets (DTAs) and deferred tax liabilities (DTLs) reflected or disclosed in the financial accounts of all constituent entities within that jurisdiction.

DTAs are commonly associated with tax attributes and deductible temporary differences of constituent entities. Using these tax attributes or reversing deductible temporary differences can have a positive impact on the ETR in Luxembourg. Specifically, the ETR is determined by dividing the adjusted covered taxes by the net qualifying income of all Luxembourg constituent entities. As the reversal of DTAs associated with the use of tax attributes or the reversal of a deductible temporary difference should be incorporated into the covered tax amount, they could improve the ETR and thus help in reaching the 15% minimum rate.

However, achieving this positive impact is contingent upon proper disclosure of the DTAs in the annual accounts of the constituent entity at the commencement of the transition year. Consequently, when preparing the financial statements of Luxembourg entities subject to the Pillar Two rules, various questions may arise, including: What specific information should be disclosed? Where should this information be disclosed, i.e., in standalone accounts, consolidated accounts, or both? And finally, when are such disclosures required?

Two recent Q&As (24/31 and 24/32) published by the Luxembourg Accounting Board (Commission des Normes Comptables or CNC), along with Frequently Asked Questions (FAQ) issued by the Luxembourg tax authorities on 25 March 2024 concerning the Pillar Two law, provide guidance in addressing these questions.

What type of information should be disclosed?

In Q&A 24/31 regarding “the implications of the Pillar Two law on the notes to the annual and consolidated accounts for the 2023 financial year prepared under Lux GAAP or Lux GAAP – FV,” the CNC asserts that Luxembourg companies and groups affected by the Pillar Two law should provide thorough information in the notes to their accounts. This is intended to ensure a true and fair presentation of the company’s and/or group’s assets, liabilities, financial status, and performance, in accordance with the requirements of Luxembourg’s commercial and accounting laws.

To meet this objective, the company or Luxembourg group should include in the notes to its accounts any known or reasonably estimated information that would assist users in understanding the company’s or group’s exposure to income tax resulting from the application of the Pillar Two rules. Both qualitative and quantitative details concerning its Pillar Two income tax exposure as of the closing date should be provided. This information may be presented in the form of an estimated range. If the necessary information is unavailable or cannot be reasonably estimated, the company or group should acknowledge this and provide updates on the progress of its assessment.

In this regard, the CNC refers to International Accounting Standards (IAS) 12 (Income Taxes) as amended on 23 May 2023 to address the impact of Pillar Two. The CNC suggests that the accounts may include the following information:

• Qualitative information, particularly addressing the potential impact of the Pillar Two law on the Luxembourg company and/or group, including the main countries where an income tax exposure might be triggered further to the implementation of the Pillar Two law.
• Quantitative information, such as:
  • An estimate of the portion of the its profits that could be subject to income taxes as a result of the Pillar Two law and the average ETR applicable to these profits; and
  • An assessment of how the implementation of the Pillar Two law, if enacted, would have affected its overall ETR.

Further, in its second Q&A, 24/32, titled “Pillar Two law and the option to disclose deferred tax assets and liabilities in the notes to the 2023 annual accounts,” the CNC affirms that Luxembourg entities within an MNE group have the choice to disclose their DTAs and DTLs in the notes to the accounts. The CNC suggests that DTAs and DTLs should be computed based on the gross amount of tax attributes/temporary differences, using the income tax rate applicable in Luxembourg, which is 24.94% for companies located in Luxembourg city. Additionally, the Q&A clarifies that there is no need to analyze the recoverability of DTAs, and companies can calculate them based on the gross amount of the tax attributes or temporary differences.

Where should the information be disclosed?

Continuing with Q&A 24/32, the CNC affirms that Luxembourg entities within an MNE group can choose to disclose their DTAs and DTLs in the notes to their standalone annual accounts for the financial year preceding the first year of application of the Pillar Two law. This disclosure provides enhanced traceability, on a per-entity and per-jurisdiction basis, compared to solely presenting the information in the consolidated accounts of the parent company.

The FAQ maintains this stance and affirms that the relevant financial statements for the purpose of disclosing Pillar Two DTAs and DTLs could be either the standalone annual accounts of the concerned Luxembourg constituent entity and/or the consolidated financial statements of the ultimate parent entity (UPE). In cases where the consolidated financial statements of the UPE are used, the FAQ further emphasizes the importance of ensuring that the information related to the disclosures is reliably and consistently traceable to the respective Luxembourg constituent entity.

Finally, the Pillar Two law does not state where precisely in the annual accounts the DTAs/DTLs should be presented. In this respect, the FAQ further clarifies that the term “reflected” refers to DTAs or DTLs that are recognized in the annual accounts, while the term “disclosed” refers to DTAs or DTLs that are presented in the notes to the annual accounts. Therefore, the FAQ emphasizes that either the recognition in the annual accounts or disclosure in the notes to the annual accounts should be sufficient to meet the requirements of the Pillar Two law transitional measures.

When are such disclosures required?

As outlined in the FAQ, to take advantage of the transitional provisions of the Pillar Two law, all DTAs and DTLs must be disclosed in the annual accounts (as described previously) for the financial year preceding the transition year. The transition year refers to the initial fiscal year in which the MNE group or DG becomes subject to the Pillar Two rules.

For instance, in the case of an MNE group falling within the scope of Pillar Two as from fiscal year 2024, the transition year would be fiscal year 2024. Accordingly, in this case, it is recommended that DTAs and DTLs be reflected or disclosed in the annual accounts for the financial year ending on 31 December 2023.

Key takeaways
 

The Pillar Two Law and the FAQ suggest that including DTAs and DTLs in the consolidated accounts of the UPE should suffice, provided that the information related to these disclosures is reliably and consistently traceable to each relevant constituent entity. However, ensuring compliance with this requirement may pose practical challenges, especially when the UPE is located in a different jurisdiction from the concerned constituent entity.

Therefore, it is highly recommended to include disclosures in the notes to the Luxembourg statutory accounts, detailing DTAs associated with tax attributes and deductible temporary differences in the standalone accounts of each affected Luxembourg entity. This proactive approach aims to reduce the likelihood of disputes regarding the validity of these tax attributes or deductible temporary differences for Pillar Two purposes.

If you require assistance navigating the complexities of tax disclosure requirements, our team of tax and audit professionals is here to support you.
In recent months, they have worked closely and acquired practical experience to effectively address these disclosure needs. Our dedicated team is committed to delivering comprehensive solutions tailored to your specific circumstances.