Pillar 2: Deceptively complex?
The concept underlying Pillar 2 is relatively straightforward; a globally consistent 15% minimum tax regime. The reality is one of the most complex international tax measures ever implemented. Some of the complexity is driven by the challenge of homogenising long established domestic tax regimes, but some is driven by design and policy.
It was never going to be simple! A per-country minimum tax system has long been recognised as highly complex when compared to other systems with similar objectives; primarily to reduce pressure from tax competition.
Inherent complexity
The need for a common way of calculating the income/loss and the effective tax rate (ETR) across different jurisdictions which use different principles and bases, drives the inherent complexity of a jurisdictional minimum tax system. Any common system will always, by definition, be different to the current domestic regime and businesses (and regulators) will be required to prepare (and assess) new determinations in each territory. Subject to any safe harbours, for which we have to wait until the release of the implementation framework later in the year, this is expected to significantly increase the compliance burden of an impacted multinational enterprise (MNE).
For example, many jurisdictions offer tax incentives for expenditure on research and development. However, they adopt different mechanisms to achieve that fiscal policy. Some of those regimes will give rise to adjustments as qualifying refundable credits as part of the Pillar 2 calculation so that they do not distort the ETR. Other regimes will not and could adversely impact the ETR.
Furthermore, despite the inherent complexity, the EU and the UK in particular have announced very ambitious timelines for the implementation of the rules - the most significant changes in the corporate tax system of the last few decades. The UK plans to have the Income Inclusion Rule (IIR) in force on 1 April 2023 and applied to financial years ending after that date, with calculations based on the full period of account but potentially time apportioning the period after 1 April 2023 in arriving at a top-up tax liability.
Complexity by design
Some specific design choices have further increased the underlying complexity of GloBE. For example, the treatment of deferred taxes is proving one of the most difficult points to initially comprehend and then comply with. Deferred tax is included in the computation of the jurisdictional ETR for GloBE purposes. However, starting from the consolidated accounting figures, a lot of additional calculations and classifications are required to correctly account for deferred taxes under Pillar 2. First, deferred tax assets and liabilities need to be recalculated at 15% (or the relevant statutory rate, if lower). The taxpayer will then have to monitor whether the deferred tax liabilities reverse within 5 years. Those that do not will need to be recaptured (subject to certain exceptions) and then brought back into account when they subsequently reverse.
Top-up tax in higher rate jurisdictions
The application of the model rules to certain situations also reveals complexity from a policy intent perspective. Many MNEs might be forgiven for thinking that they should not suffer top-up tax in jurisdictions where they are in a loss position from both a tax and accounting perspective (and are also subject to tax at rates considerably higher than the 15% minimum rate). However, as a result of the recalculation of deferred tax at 15%, where a constituent entity utilises losses (or has other deferred tax debits), any permanent difference that reduces the tax base (for example a non-taxable foreign exchange gain, a notional interest deduction or a super deduction) will potentially result in top-up tax. In other words, a loss-making company is not immune from top-up tax.
There remains a concern that taxpayers and tax authorities will neither have the time to fully appreciate all the implications and the pitfalls of the new rules, nor to understand what can be efficiently simplified. In addition, the GloBE rules and the related policy responses (e.g., domestic minimum taxes) will increase the cost of investing in the UK and overseas via higher taxes and higher compliance costs, slowing growth down.
The only antidote for MNEs to the high costs coming from the application of Pillar 2 is to start engaging with its architecture, calculations and outcomes as soon as possible, as suggested here. The novelty and complexity of the new system together with the typical lead time to develop or upgrade compliance and reporting systems indicate that the 2023 planned implementation will be a substantial challenge for many MNEs.
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