What does Pillar 2 mean for tax accounting?

Pillar 2 needs integration of taxation concepts and consolidated financial statements reporting

The Introduction of Pillar 2 rules for large MNEs will further highlight the impact of accounting on tax. Successful adoption of the rules will require teaming between finance and tax teams in two key areas. Firstly (‘inputs’); the calculation of the Globe ETR (GETR) requires detailed knowledge of both tax accounting and the makeup of the consolidated profit. Group accounting functions need to be engaged early, as this will be the first time the ultimate parent entity consolidated financial statements are going to directly drive tax payments and returns.

Secondly (‘outputs’); whilst there remains some uncertainties over Pillar 2 including the date of its application and publication of detailed guidance & accounting rules, the timeline is really tight for preparing any potentially required disclosure in 2022 financial statements. Organisations and stakeholders need to quickly build their knowledge and make decisions on policies, processes and technology to be ready.

Changes will come with Pillar 2

Pillar 2 (‘input’) calculations are derived from consolidated financial statements. This is the first time that tax payments/returns will have been directly driven from those accounts. Remember, the ultimate parent entity (UPE) falls within scope if the €750m consolidated revenue threshold is met. For some MNEs, this will be a challenging question. Who is the UPE? and do they prepare consolidated financial statements? Those with complex ownership structures, including private equity or investment funds or large private companies that don’t prepare consolidated accounts will need to determine their grouping under the model rules.

For those groups that don’t have readily available consolidated financial statements for the UPE, a decision will need to be made around which GAAP should be applied. For groups that have consolidated financial statements, understanding the bridge of adjustments from local ledgers in local GAAP through to the consolidated group GAAP financial statements is a good starting point to understand how difficult the process is going to be. GAAP adjustments, late adjustments, consolidation adjustments, purchase price adjustments and centrally booked items are all going to need to be analysed.

What can I do now? To reduce the risk of surprises in the GETR, attributes carried forward into the Pillar 2 regime need to be disclosed in the year of transition to be considered a good GloBE attribute; they must also be consistent with the Pillar 2 rules. Having a correct deferred tax position prior to the transition year will help avoid unexpected surprises in the GETR. In addition, understanding any historic business combinations and purchase price accounting will help ease the transition.

Preparers of financial statements will need to consider some complex accounting concepts of how Pillar 2 calculations feed into local statutory and group account level tax accounting (“outputs”). Any potential ‘top up’ tax will clearly have a current tax impact, but also any existing attributes or temporary differences may also require deferred tax to be re-measured. For example, in the case of a loss in a 0% tax jurisdiction, post-Pillar 2 it may have an 15% value (subject to election), so should a deferred tax asset be booked? What if it is in a 10% tax jurisdiction? How does it work when the Pillar 2 calculation mechanism is different to your underlying tax regime? Currently, the answers are unclear. There is currently no consensus on how the accounting standards apply to Pillar 2. It is important that preparers think widely about the possibilities and implications so that when consensus is reached, they are ready.

Preparing the tax team for the challenge

Tax teams will need to understand in more detail than ever before the process and adjustments in the consolidation of entity or jurisdictional financial data based on the group GAAP. The end-to-end consolidated financial statement reporting process will need to be understood in the context of the Pillar 2 rules in order for the calculations to be performed. This could have multiple ramifications. It may require data to be cut in different ways than previously, it may require more granularity or it may require a more detailed understanding of the GAAP accounting policies and how they are applied at entity versus consolidated. All of this requires more integration of those with tax responsibilities with the group finance function. Our Tax Accounting specialists have deep knowledge of these complex calculations and can support MNEs in peeling back the layers and making the right choices.

Pillar 2 is coming, and companies need to be prepared for the volume of work that is coming with it. The preparation of the jurisdictional consolidations/aggregations is just the start of the Pillar 2 calculation process. To determine the impact of the various adjustments made on consolidation to the Pillar 2 calculations will require significant financial reporting experience. Our expertise in accounting, tax and technology means we can help with the complex calculations that will be required to comply with Pillar 2 and assist with financial statements disclosures. We are ready to partner with you on this new challenge as your project takes shape.