Are you ready for Pillar 2?

Pillar 2 will establish a global minimum tax regime which will apply to both public and privately held multinational groups with consolidated revenues of over EUR750m. Global agreement has been reached to bring these rules into law, and the Organisation for Economic Co-operation and Development (OECD) has released model rules with related commentary and the UK has released draft legislation to implement the Pillar 2 Income Inclusion Rules (IIR) in Finance Bill 2022/23 with a commencement date of accounting periods beginning on or after 31 December 2023.

Given the tight timeline, and the fact that transactions undertaken today can have a future Pillar 2 impact, the key actions for groups falling within the scope of the rules will be to:

• Assess the impact
• Prepare disclosure for group consolidated accounts
• Restructure if appropriate
• Prepare resources for the additional reporting and compliance requirements
• Communicate the effects to stakeholders
• Train teams

Process update and key dates

The UK government has released draft Pillar 2 legislation in respect of the IIR with a commencement date of accounting periods beginning on or after 31 December 2023. This deferral from a Spring 2023 implementation was in response to concerns that organisations had insufficient lead-time before the rules were implemented. The deferral is a recognition of the sheer complexity of the rules, and the fact that important policy and administrative issues require discussion within the OECD Implementation framework. Businesses need to take steps and build systems to ensure reporting and rule compliance.

Even with a UK deferral to 2024, there is still the possibility that UK headed groups will need to comply with Pillar 2 rules earlier, due to the global agreement to implement in 2023 and the construction of the rules. If a lower tier sub-holding company, or a company with a foreign permanent establishment, was based in a jurisdiction that implemented the rules in 2023, then a Pillar 2 return would be required for these sub-groups. Further, the model rules allow countries to introduce a Qualifying Domestic Minimum Tax (QMDT) that would effectively levy Pillar 2 top-up tax locally, instead of it being taxed by a foreign parent company. This means if a country introduced a QMDT in 2023, Pillar 2 calculations would be required for that territory.

The UK commencement date is aligned with the draft EU directive commencement date, such that this should not be an issue for group companies based in the EU. To date, no countries have said that they will introduce a QMDT in 2023 but Australia, Canada, Japan, Singapore, South Korea and UAE have all announced that they will introduce Pillar 2 rules in 2023, albeit they may also choose to defer implementation to 2024 to align with the EU and the UK. Consequently, groups need to monitor the progress of Pillar 2 legislation globally.

As alluded to above, the OECD still has significant work to do, specifically agreeing the Implementation Framework (IF). The IF’s stated aim is to facilitate the co-ordinated implementation and administration procedures of the rules, such as filing obligations, and multilateral review processes, as well as developing safe-harbours to facilitate reduced compliance and administrative burdens. It should also be noted that, in response to the public consultation on IF, stakeholders have requested changes to both the model rules and associated commentary. The OECD website currently notes that the IF issues are to be agreed by the end of 2022, which suggests that the IF will be unlikely to be released until early 2023.

Impact assessment - why, when and how?

Given that accounting periods commencing on or after 31 December 2023 may be the first returned under Pillar 2, can groups wait to assess the impact of the framework until there is more clarity on the precise application of the rules and the required reporting and compliance process? In our view, it is advisable to commence the assessment phase now, and develop a plan for the reporting and compliance workstreams, as:

• Disclosures may be required in the 2022 group financial statements which would need to be reviewed by the audit firm.
• The calculation creates operational complexity requiring new data points and revisions to existing systems and processes to collect and process them.
• Transitional provisions mean that asset transfers undertaken now can potentially have ongoing adverse Pillar 2 consequences and it is necessary to track certain tax deductions taken between 1 December 2021 and commencement.
• Reorganisations and group simplifications that can be undertaken tax-neutrally today, are potentially taxable under Pillar 2 model rules.
  

2022 Financial Statement disclosure

As a consequence of the release of draft legislation, groups signing or releasing accounts after that date may need to make a disclosure in their consolidated accounts. For UK groups, disclosure is required under IAS 10, where the published draft legislation would have had a material impact on the balance sheet, or income statement, in the accounts just released if it had been substantively enacted at that balance sheet date.

We expect it will take time to undertake a full impact assessment. As a result management may be unable to quantify and therefore disclose the effect. Indeed, it is not immediately apparent how to account for the top up tax and so disclosing the impact on current and deferred taxes is unlikely to be possible at this stage. Further guidance on the deferred tax accounting will be issued in due course.

Where entities are still evaluating the impact of the rules, a statement to that effect would be required. Management will need to be able to support any statement that Pillar 2 will not have a material impact and we would expect the impact assessments to be complete if this is being asserted.

Operational complexity and unexpected top-up tax

The Pillar 2 effective tax rate (P2 ETR) is calculated at a jurisdictional level using the ultimate parent GAAP. However, in calculating the P2 ETR, both the accounting income and the accounting tax charge are significantly modified. This makes for a complicated calculation using data points not required for current financial or tax reporting purposes.

Two of the key learning points from the numerous impact assessments we have undertaken are:

• Whilst not all groups have had a Pillar 2 top up tax liability, all have had a significant operational impact. This adds additional workload to clients’ finance and tax teams and requires considerable amounts of financial data, a proportion of which may not be easily extractable/available from their systems.
• Due to the mechanics of the Pillar 2 calculation, it is possible to have a P2 ETR in a jurisdiction with a statutory rate significantly in excess of 15%. For example, in a number of instances, we have identified potential top-up taxes in ‘high tax’ territories, such as the US, UK and India.

The administrative safe-harbours being developed under the IF may partially mitigate the reporting and compliance burden, but the precise form of the safe-harbours is yet to be agreed. We understand at least three types of safe-harbour are under discussion:

Whilst the existence of safe harbours will clearly impact the extent of a group’s Pillar 2 reporting and compliance processes, unfortunately, the above timeline means that groups may not be able to wait until the exact details of these safe harbours are known, before commencing their work on their systems/processes reconfiguration.

Asset transfers, reorganisations and transitional period tracking

The draft UK legislation includes a transitional provision for asset transfers undertaken after 31 November 2021 and before commencement. The provision prevents an accounting step-up, or change in the deferred tax profile of the asset, regardless of whether the disposal is taxable, such that it will likely have a reductive impact on the acquiring jurisdictions P2 ETR. Consequently, modelling is required to determine whether a transfer would give rise to a future Pillar 2 charge and if so, explore other approaches to achieving the commercial goal.

Post commencement, a cross-border asset transfer will give rise to a Pillar 2 profit based on the market value of the asset Pillar 2, unless it qualifies as a ‘GloBE reorganisation’. This is a very narrowly drafted provision, requiring amongst other things that the acquiring jurisdiction inherits the tax basis of the disposing entity. Consequently many transactions that could be undertaken today under existing tax neutral reorganisation rules could trigger a Pillar 2 charge.

Therefore, we recommend that groups considering future entity simplifications or reorganisations assess the Pillar 2 impact now so as to determine the optimum time to implement. Then it can be monitored whether the transitional provisions are altered as part of the IF and restructuring undertaken if either insufficient time to wait for the IF outcome or the provisions are ultimately not revised through the IF.

In addition to the above, there is a specific rule that precludes the utilisation of a deferred tax asset for Pillar 2 purposes that has arisen in the transition period where it relates to an item of expense that would not be included in GloBE income. Examples of such expense are super deductions for capital expenditure and notional interest deductions. Consequently, it is necessary to track such items from 1 December 2021 through to commencement.

Act now!

Undertaking an impact assessment now will allow Pillar 2 adoption to be managed effectively. It will identify data gaps and process changes that would be required, allow for timely restructuring, facilitate a roadmap of what your organisation needs to do to be ‘Pillar 2 ready’ for reporting and compliance, and allow time to engage with stakeholders to build the necessary teams to deliver on the required process and system changes.