Global implementation of Pillar Two and the disclosure implications

Key points

• In October 2021, more than 130 countries agreed to implement a minimum tax regime for multinationals (global turnover over €750 million).
• Pillar Two aims to ensure that applicable multinationals pay a minimum effective corporate tax rate of 15%.
• The Organisation for Economic Co-operation and Development (OECD) provided key information on the application of Pillar Two in December 2021, with the release of its ‘model rules’.
• The rules are due to be passed into national legislation based on each country’s approach, but the OECD recommended 2023 and some countries are currently expected to adopt the rules in 2023.
• Applying the rules and determining the impact are likely to be very complex and poses a number of practical challenges.
• Entities will need to consider the disclosure implications in advance of the rules becoming effective.

What is the issue?

In October 2021, more than 130 countries agreed to implement a minimum tax regime for multinationals, ‘Pillar Two’. In December 2021, the OECD released the Pillar Two model rules (the Global Anti-Base Erosion Proposal, or ‘GloBE’) to reform international corporate taxation. Large multinational enterprises within the rules’ scope are required to calculate their GloBE effective tax rate for each jurisdiction where they operate. They will be liable to pay a top-up tax for the difference between their GloBE effective tax rate per jurisdiction and the 15% minimum rate. It is the ultimate parent entity of the multinational enterprise that is primarily liable for the GLoBE top-up tax in its jurisdiction’s territory.

The goal is to end the ‘race to the bottom’ on tax rates worldwide, under which countries had been competitively cutting corporate taxes to attract businesses with the impact that other countries felt forced to cut taxes to compete.

Top-up taxes calculated under GLoBE are to be paid in the jurisdiction of the parent entity of the multinational group, rather than in the low tax territory that triggers the excess payment. Thus, the Pillar Two rules provide for the possibility that jurisdictions introduce their own domestic minimum top-up tax based on the GloBE mechanics to avoid any ‘tax leakage’. If the GLoBE effective tax rate domestically is 15% or more, no GLoBE top-up tax will be payable.

Therefore, some countries may engage in domestic tax policy reforms in anticipation of the GloBE rules becoming effective. Notwithstanding any new local minimum tax regime which may be designed to reduce or eliminate the GloBE top-up tax, additional top-up tax under GLoBE may still be due. This will depend on the local effective tax rate calculation according to the specific rules set out in the Pillar Two regulations.

The Pillar Two rules are intended to be implemented as part of a common approach, as agreed by the OECD, and to be brought into domestic legislation as from 2023. However, each jurisdiction will need to determine if and when the rules will be enacted. For example, the EU currently has plans to implement the rules in member states in 2023 with an effective date for accounting periods starting on or after 31 December 2023.

Applying the rules and determining the impact are likely to be very complex and pose a number of practical challenges. Additionally, how to account for the top-up tax under IAS 12 is not immediately apparent. Entities that have to pay a top-up tax (whether GLoBE or a domestic minimum tax) need to consider whether these additional taxes impact the recognition and measurement of their deferred tax assets and liabilities.

Entities will also need to consider the disclosure implications of the Pillar Two rules. The requirement to provide disclosure would depend on whether the changes in tax rates and laws have been announced or enacted before the financial statements are issued.

If the rules are announced or enacted before the financial statements are issued, entities will be required to disclose the significant effect of the change on current and deferred tax assets and liabilities. [IAS 10 para 22(h)]; [IAS 12 para 88].

The term ‘announcement’ is not defined by IFRS, therefore reporting entities will need to apply judgement to determine whether changes in tax rates or laws have been announced in their territory. Factors that might be considered in making this judgement could include:

• the specificity of the proposed tax changes;
• previous history in changes to proposed tax legislation post announcement; and
• the legislative process in a particular territory.

Due to the complexity of the Pillar 2 rules, we expect that it will take time for some entities to carry out their impact assessments following the legislation’s announcement. As a result, management might be unable to quantify and therefore, disclose the detailed effect. Indeed, as noted above, it is not immediately apparent how to account for the top-up tax under IAS 12. So, disclosing quantitatively the effect on current and deferred taxes is unlikely to be possible at this stage. However, an entity might be able to provide qualitative information, for example, if a material portion of its business operates in relatively low tax jurisdictions that are likely to be impacted.

Where entities are still evaluating the impact of the rules, they would be required to make a statement to that effect. Management will need to be able to support any statement that Pillar Two will not have a material impact.

Entities might consider disclosing the expected impact of Pillar 2 if the local jurisdiction has not yet announced or enacted the changes before the financial statements are authorised for issue. [IAS 1 para 17(c)]. Indeed, further to the release by the OECD of the Pillar Two model rules, but before local announcement, some entities for which this is likely to have a material impact to their future group taxes have been making disclosures already. Here is an example of what we have seen to date:

“In December 2021, the OECD issued model rules for a new global minimum tax framework and the UK has announced the intention to bring these into effect from 2023. While the overarching framework has been published, we are awaiting the legislation and detailed guidance to assess the full implications.”

For reporting dates after substantive enactment of the legislation, entities will need to account for the impact Pillar Two has on the recognition and measurement of their deferred tax assets and liabilities. [IAS 12 paras 47]. Further guidance on the deferred tax accounting will be issued in due course.

The cash tax impact of the Pillar Two rules on going concern should be reflected in that assessment once the local legislation is announced rather than from when it is substantively enacted. This is because the going concern assessment includes all “expected” future cash outflows and takes into account all available information about the future. [IAS 1 para 26].

What is the impact and for whom?

The impact at this stage is typically a disclosure issue.

The Pillar Two rules apply to multinational enterprises that have consolidated revenues of €750m in at least two out of the last four years. The following entities are excluded and not subject to the rules:

• government entities;
• international organisations;
• non-profit organisations; and
• pension funds or investment funds that are ultimate parent entities of a multinational group (and certain holding vehicles of such entities).

However, this exclusion does not affect the multinational group owned by such entities. The group will remain in the rules’ scope if it as a whole otherwise meets the consolidated revenue threshold.

When does it apply?

What disclosures (if any) are required or recommended would depend on whether the Pillar Two rules have been announced or enacted in the territories in which an entity operates.

If the legislation has not been announced or enacted at the date the financial statements are issued, entities might consider providing material disclosure of the expected future effects to the extent that this is reliable and relevant. [IAS 1 para 17(c)].

An entity would be required to provide as much quantitative and qualitative information about the expected future effects as possible, if legislation has been announced or enacted before the financial statements are issued. [IAS 10 para 22(h)]; [IAS 12 para 88].

If legislation has been enacted or substantively enacted before the end of the reporting period, entities will need to account for the impact the additional top-up taxes have (if any) on the recognition and measurement of their deferred tax assets and liabilities. [IAS 12 para 47].