Countdown to Pillar Two

Administrative Guidance

On 18 December 2023, the OECD released a third set of ‘Administrative Guidance’ relating to Pillar Two. A significant portion of the new guidance relates to the transitional CbCR Safe Harbour rules, which offers a simplified approach for MNE Groups in a transitional period. The CbCR Safe Harbour in principle uses only data from the country-by-country report (“CbCR”) and Qualified Financial Statements, and required limited adjustments thereto. Under the new guidance, the CbCR Safe Harbour calculations are made more complicated since these will require additional adjustments, which may also alter the outcome of earlier performed CbCR Safe Harbour analyses.

The most important changes and/or clarifications concern (1) the application of the CbCR Safe Harbour, which is made conditional to certain requirements for groups that prepare a CbCR that includes purchase price accounting adjustments; (2) clarifications and changes on the CbCR Safe Harbour itself, providing for instance for;

i) uncertainties with regards to which data inputs can be used in preparing the CbCR,

ii) the treatment of certain items of income or tax that may be duplicated in the CbCR and/or the GloBE Income computation and

iii) the use of voluntary CbCR’s for the CbCR Safe Harbour.

QDMTT Developments

In the basis, the Effective Tax Rate (“ETR”) calculations required for Pillar Two rely on figures taken from an MNEs financial statements (under their Group GAAP, but potentially also local GAAP) and their local (corporate) tax returns. Financial accounting, local tax systems and principle-based accounting standards sometimes offer multiple alternatives on how certain assets and/or liabilities should be recorded on the (tax) balance sheet. 

Historically, these policy choices often resulted in a complex interaction between financial accounting and local tax, as the effects of certain choices might have an opposite desirability from both perspectives. With Pillar Two around the corner, this interaction is further complicated by a third perspective as Pillar Two itself also provides for various choices to be made with respect to, amongst others, the calculation of GloBE Income and the determination of Covered Taxes. Also, Accounting rules and policy decisions can directly impact cash tax under Pillar Two rules, which is not the case under most corporate tax systems.

Our placemat – please refer to the visual below – emphasizes topics that could have a strong impact on a jurisdiction’s ETR and/or in which policy choices might be present within the realm of corporate taxation, financial accounting as well as Pillar Two. The placemat provides for an indicative (but not limitative) list of topics which often have, or post-Pillar Two will result in, a cross-functional dynamic.

Disclosure requirements

Pillar Two is a major reporting challenge for large MNE groups since most major accounting standards require a disclosure on the expected Pillar Two impact in countries whereby Pillar Two legislation is (substantively) enacted. Disclosures are not only required at the ultimate parent entity (“UPE”), but also at sub-consolidation level and even in the statutory accounts.

UPE-level

In the consolidated accounts of a TopCo (UPE) there is a disclosure requirement on the impact of Pillar Two for the group. Under IFRS, a specific disclosure requirement is introduced that requires a qualitative and quantitative disclosure on the expected Pillar Two impact. Under other standards we would generally expect a disclosure if the expected impact from Pillar Two is significant. In both situations this means an analysis must be done to substantiate the disclosure or the decision not to include a disclosure note.  

Sub-Consolidation level

The disclosure requirement also applies at sub-consolidation level. Depending on the composition of the group, the estimate of the Pillar Two impact at sub consolidation level may be different compared to the UPE-level. A tax sharing agreement in relation to Pillar Two taxes may also influence the Pillar Two exposure and thereby the disclosure note. 

Statutory accounts

A Pillar Two disclosure may also be required at statutory level. The impact assessment at a statutory level is likely different compared to a consolidated level. If there are multiple entities in a jurisdiction of which one or more entities may be subject to top-up tax, a tax sharing agreement in relation to Pillar Two taxes may influence the Pillar exposure for the company and thereby the disclosure note.

Further complications arise in case there are multiple businesses operating in a country part of the same MNE Group under Pillar Two which are in practice operated as separate businesses. This might for example apply to MNEs with a divisional operating model or in case of a private-equity company /investment fund that manages multiple investments. Entities that for all intends and purposes seem unrelated, might still be included in the same Pillar Two calculation in a jurisdiction. If this results in a top-up tax, the amount due is subsequently allocated to all entities in that jurisdiction based on their GloBE Income entities may be impacted unexpectedly. For this reason concluding a tax sharing agreement could be relevant to these entities. Although this does not release entities from their Pillar Two obligation, the tax sharing agreement will allow for a deviating (intergroup) allocation if agreed upon between the parties involved.

Our team is more than happy to discuss the Pillar Two requirements with you. They can provide additional insights in what we have been doing with Deloitte Audit clients and provide more details about our audit readiness offering(s) for our advisory clients. 

The need for a proactive approach

Given the complexity and potential impact of the new requirements, MNEs will need to take an informed, proactive approach implementing these rules. To make sure your business is prepared:

Address data needs.
Pillar Two returns include many new data points, which require time and effort to identify, access, or create. You’ll need to know where this data is coming from, and which tools you need to access it. A data gap analysis is a good place to start.

Set expectations.
To manage internal and external expectations, you will need to generate and communicate estimates of future impact on an established timeline.

Inform tax planning.
Scenario analysis can offer insights into projected impacts and risk areas, and help you model restructuring options, election impacts, and technical interpretations.

Advocate and communicate.
Working closely with taxing jurisdictions can help you articulate questions and needs—and keep internal stakeholders aligned and up to date on potential impacts.