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Global implementation of Pillar Two: Impact on deferred taxes and financial statement disclosures
Publication date: 12 Sep 2023
gx In depth INT2023-10
Key points
- In December 2021, the Organisation for Economic Co-operation and Development (‘OECD’) released the Pillar Two model rules to reform international corporate taxation that aim to ensure that applicable multinationals (global revenue exceeding €750 million) pay a minimum effective corporate tax rate of 15%.
- The rules are due to be passed into national legislation based on each country’s approach, and some countries have already enacted or substantively enacted the rules. Applying the rules and determining the impact are likely to be very complex, and this poses a number of practical challenges.
- In May 2023, the IASB issued narrow-scope amendments to IAS 12, ‘Income Taxes‘ that provide temporary relief from accounting for deferred taxes arising from the implementation of the Pillar Two model rules. Targeted disclosure requirements were also introduced. Jurisdictions subject to an endorsement process will need to endorse the amendments.
What’s inside
1. What is Pillar Two?
In October 2021, more than 130 countries – representing more than 90% of global GDP – agreed to implement a minimum tax regime for multinationals, ‘Pillar Two’. In December 2021, the Organisation for Economic Co-operation and Development (‘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 scope of the rules 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 for each jurisdiction and the 15% minimum rate. If the GloBE effective tax rate domestically is 15% or more, no GloBE top-up tax will be payable. 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.
The GloBE rules include two main components: the Income Inclusion Rule (‘IIR’); and the Undertaxed Payment Rule (‘UTPR’). Top-up tax is first imposed under the IIR on a parent entity with an ownership interest in a low-taxed subsidiary. The UTPR is a backstop mechanism if there is low-taxed income from an entity within the group that is not brought into charge under the IIR by applying a top-up tax in the jurisdiction that introduced the UTPR.
Top-up taxes calculated under the IIR 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. Top-up taxes calculated under the UTPR are to be paid by the entity that operates in a jurisdiction that has enacted the UTPR, even if this entity is not a parent entity of the group. Thus, the Pillar Two rules provide for the possibility that jurisdictions might engage in domestic tax policy reforms and introduce their own qualified domestic minimum top-up tax (‘QDMTT’) based on the GloBE mechanics to avoid any ‘tax leakage’ in anticipation of the GloBE rules becoming effective.
Notwithstanding any new local minimum tax regime which might be designed to reduce or eliminate the GloBE top-up tax, additional top-up tax under GloBE might 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.
Definitions of terms used in this publication |
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GloBE effective tax rate = GloBE tax expense/income ÷ GloBE profit/loss
Statutory tax rate = Enacted tax rate
IAS 12 effective tax rate = IAS 12 tax expense/income ÷ IFRS profit/loss
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2. Who is impacted?
The Pillar Two rules apply to multinational enterprises that have consolidated revenues (which, as defined by the OECD, include any form of income and are therefore not limited to revenue recognised in accordance with IFRS 15) of €750m in at least two of the last four years.
Pillar Two applies if a jurisdiction in which the group operates has passed the rules into national legislation – this could be the jurisdiction of the ultimate parent entity or, if the IIR Pillar Two legislation is not yet in effect in the ultimate parent entity’s jurisdiction, an intermediate parent entity in the multinational enterprise that is subject to top-up tax. For UTPR, this could even just be a subsidiary in the multinational enterprise. Enacted QDMTT rules could also increase the tax liability of the group.
A multinational enterprise might therefore be subject to Pillar Two taxes, and within the scope of the IAS 12 disclosure requirements, even if the jurisdiction of the ultimate parent entity has not yet enacted the Pillar Two rules.
Illustrative example where the jurisdiction of the ultimate parent entity has not enacted the Pillar Two rules |
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 Assume that the group has recorded consolidated revenue (as defined by the OECD) of €750m in at least two of the last four years, which would result in the group being within the scope of the Pillar Two rules. The GloBE effective tax rates in jurisdictions A, B and C are 25%, 22% and 5% respectively.
The status of Pillar Two rules implementation for each of the jurisdictions is as follows:
Question In this scenario, is the consolidated group in jurisdiction A considered to be impacted by the Pillar Two rules for purposes of the disclosure requirements under IAS 12?
Answer
Yes. The Pillar Two rules do not apply to the ultimate parent entity, and so no GloBE top-up tax is collected in jurisdiction A. Instead, the jurisdiction of the next intermediate parent entity (jurisdiction B in this example) applies the IIR and imposes top-up tax on the intermediate parent entity for the low-tax jurisdiction C.
Since the group has been impacted by the Pillar Two rules, the disclosure requirements of IAS 12 would be applicable to the consolidated financial statements prepared by the ultimate parent entity.
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3. What is the issue?
Applying the Pillar Two rules and determining the impact are likely to be very complex, and this poses a number of practical challenges. Additionally, how to account for the top-up tax (whether GloBE or a GloBE qualifying domestic minimum top-up tax) under IAS 12 was not immediately apparent.
On 23 May 2023, the IASB issued narrow-scope amendments to IAS 12. The amendments provide a temporary exception from the requirement to recognise and disclose deferred taxes arising from enacted or substantively enacted tax law that implements the Pillar Two model rules published by the OECD, including tax law that implements QDMTT described in those rules.
The amendments to IAS 12 make it clear that entities subject to Pillar Two rules must ignore the deferred tax implications of enacted or substantively enacted Pillar Two legislation in their IFRS® financial statements. However, for annual reporting periods beginning on or after 1 January 2023, these entities will need to provide some additional disclosures about current taxes in their annual financial reports, as described below.
4. What is the impact?
As explained above, the one impact is that entities are prohibited from recognising or disclosing deferred tax implications arising from Pillar Two. A second impact is that the narrow-scope amendments to IAS 12 introduced targeted disclosure requirements for affected companies. They require entities to disclose:
- the fact that they have applied the exception to recognising and disclosing information about deferred tax assets and liabilities related to Pillar Two income taxes [IAS 12 para 88A];
- their current tax expense (if any) related to the Pillar Two income taxes [IAS 12 para 88B]; and
- during the period between the legislation being enacted or substantively enacted and the legislation becoming effective, entities will be required to disclose known or reasonably estimable information that would help users of financial statements to understand an entity’s exposure to Pillar Two income taxes arising from that legislation. If this information is not known or reasonably estimable, entities are instead required to disclose a statement to that effect and information about their progress in assessing the exposure. [IAS 12 paras 88C-88D].
Due to the complexity of the Pillar Two 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 effects. 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.
Disclosure example – legislation substantively enacted but not in effect |
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A parent entity might be in a jurisdiction where the Pillar Two legislation is substantively enacted, but not yet in effect at the group’s reporting date. For example, as of 31 December 2023 the jurisdiction of the parent entity might have substantively enacted the Pillar Two legislation that will become effective from 1 January 2025.
To meet the disclosure requirements of IAS 12 above, an entity that is within the scope of the Pillar Two rules should disclose qualitative and quantitative information about its exposure to Pillar Two income taxes in its annual financial statements as of 31 December 2023. That information need not necessarily reflect all of the specific requirements of the legislation and could be provided in the form of an indicative range.
Disclosures that might be considered are as follows:
To the extent that information is not known or reasonably estimable, the entity should instead disclose a statement to that effect and information about its progress in assessing its exposure. Management will need to be able to support any statement that Pillar Two will not have a material impact. An illustrative example of what an entity might consider disclosing in its financial statements for the year ended 31 December 2023 is as follows.
OECD Pillar Two model rules
The group is within the scope of the OECD Pillar Two model rules. Pillar Two legislation was enacted in country X, the jurisdiction in which the company is incorporated, and will come into effect from 1 January 2025. Since the Pillar Two legislation was not effective at the reporting date, the group has no related current tax exposure. The group applies the exception to recognising and disclosing information about deferred tax assets and liabilities related to Pillar Two income taxes, as provided in the amendments to IAS 12 issued in May 2023.
Under the legislation, the group is liable to pay a top-up tax for the difference between its GloBE effective tax rate per jurisdiction and the 15% minimum rate. All entities within the group have an effective tax rate that exceeds 15%, except for one subsidiary that operates in jurisdiction A.
For 2023, the average effective tax rate (calculated in accordance with para 86 of IAS 12) of the entity operating in jurisdiction A is:
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Group entity operating in
jurisdiction A CU’000 |
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Tax expense for year ending 31 December 2023
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250
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Accounting profit for year ending 31 December 2023
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3,000
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Average effective tax rate
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8.3%
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The group is in the process of assessing its exposure to the Pillar Two legislation for when it comes into effect. This assessment indicates for jurisdiction A that the average effective tax rate based on accounting profit is 8.3% for the annual reporting period to 31 December 2023. However, although the average effective tax rate is below 15%, the group might not be exposed to paying Pillar Two income taxes in relation to jurisdiction A. This is due to the impact of specific adjustments envisaged in the Pillar Two legislation which give rise to different effective tax rates compared to those calculated in accordance with paragraph 86 of IAS 12.
Due to the complexities in applying the legislation and calculating GloBE income, the quantitative impact of the enacted or substantively enacted legislation is not yet reasonably estimable. Therefore, even for those entities with an accounting effective tax rate above 15%, there might still be Pillar Two tax implications. The group is currently engaged with tax specialists to assist it with applying the legislation.
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Entities might consider disclosing the expected impact of Pillar Two 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)].
Disclosure example – legislation not substantively enacted |
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In December 2021, the Organisation for Economic Co-operation and Development (OECD) issued model rules for a new global minimum tax framework (Pillar Two), and various governments around the world have issued, or are in the process of issuing, legislation on this. In [Country X], the government released draft legislation on Pillar Two in [July 2023]. The group is in the process of assessing the full impact of this.
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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].
Similarly, if an entity applies post-tax cash flows in a value-in-use calculation of the recoverable amount of an asset or a cash-generating unit when performing an impairment test, the cash tax impact of the Pillar Two rules should be reflected in those cash flows. The timing of this would be based on a market participant’s view which would likely be once the local legislation is announced rather than from when it is substantively enacted. Generally, the inclusion of tax cash flows would not impact the recoverable amount, because the entity would also adjust the post-tax discount rate used (see FAQ 24.87.2).
Timeline for impact of Pillar Two on accounting |
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The disclosure requirements will depend on the extent to which Pillar Two legislation has been enacted in the jurisdictions in which the group operates and whether it is in effect. The timeline below sets out the required disclosures at the various stages of the process.
It also illustrates when the impact of top-up taxes should be considered in the going concern assessment and in impairment tests.
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5. What if the IAS 12 amendments have not yet been endorsed?
Some reporting entities might need to consider the Pillar Two requirements before the amendments to IAS 12 are effective in their jurisdiction – for example, where a multinational entity within the scope of the Pillar Two model rules has a period end that falls after the date when Pillar Two legislation is enacted (or substantively enacted) in the entity’s jurisdiction, but before the date when the amendments to IAS 12 providing the exception for deferred tax accounting becomes effective or is endorsed (if there is any local endorsement process in the entity’s jurisdiction). Reporting entities that need to consider the Pillar Two requirements before the IAS 12 amendments are endorsed might still be able to avoid recognition of deferred tax that would have arisen from the implementation of Pillar Two rules.
In determining whether deferred tax should be recognised at the reporting date, entities should consider that there is an indication in the Basis for Conclusions of IAS 12 (at para BC99(b)) that the IASB did not conclude whether there would be deferred tax implications if no exception was proposed. In fact, the Basis for Conclusions paragraph highlights that respondents were unclear as to whether and how IAS 12 would be applied, confirming that the existing requirements are unclear.
Affected entities might need to develop an accounting policy in accordance with paragraph 10 of IAS 8, ‘Accounting Policies, Changes in Accounting Estimates and Errors’. In developing that policy, entities might conclude that Pillar Two legislation does not require adjustments or additions to the existing deferred tax balances. In developing an accounting policy, an entity might consider:
- the informational value that would be provided (relevance, reliability, faithful presentation) if the entity attempted to update its deferred tax balances; it was noted by many stakeholders that recognising deferred taxes related to Pillar Two could be extremely complex, and so the cost of doing so might outweigh the benefits (paras BC99(c) and BC108 in the Basis for Conclusions of IAS 12);
- the FASB interpretation which applies a similar framework to IFRS accounting standards (refer to US In brief 2023-01 FASB staff weighs in on tax accounting for OECD Pillar Two taxes), which concluded that no additional deferred tax should be recognised as a result of Pillar Two; and
- the issued narrow-scope amendments to IAS 12 that would make it clear that no deferred tax is permitted to be recognised as a result of Pillar Two; therefore, trying to estimate any deferred tax for one period, only to reverse it thereafter, does not seem to provide useful information.
Listed entities should take into account any views of their local regulator in developing an accounting policy.
6. When does it apply?
The Pillar Two rules are intended to be implemented as part of a common approach, as agreed by the OECD members, and to be brought into domestic legislation by 2023. However, each jurisdiction will need to determine if and when the rules will be enacted and effective. For example, at the time of issuing this publication, the Pillar Two rules have been enacted in the United Kingdom and are effective for accounting periods beginning on or after 31 December 2023, except for the UTPR which is still in draft and expected to be effective after 31 December 2024 at the earliest. The EU has issued a Directive to require its Member States to enact domestic legislation for the IIR from 2024 and the UTPR from 2025. For the status of Pillar Two implementation in different countries and regions, visit PwC’s Pillar Two Country Tracker.
The amendments to IAS 12 are required to be applied immediately (subject to any local endorsement processes) and retrospectively in accordance with IAS 8, including the requirement to disclose the fact that the exception has been applied if the entity’s income taxes will be affected by enacted or substantively enacted tax law that implements the Pillar Two rules. The disclosures relating to the known or reasonably estimable exposure to Pillar Two income taxes are required for annual reporting periods beginning on or after 1 January 2023, but they are not required to be disclosed in interim financial reports for any interim period ending on or before 31 December 2023.
7. Where do I get more details?
For more about Pillar Two model rules and their impact on businesses, visit PwC’s Pillar Two Readiness microsite.
For more information, contact Dave Walters or Gary Berchowitz.
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