GLOBAL MINIMUM TAX SERIES – PART 15 Need for GloBE Pillar 2 Impact Assessment

[Amit Jalan]

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The Global Minimum Tax work around the world is progressing at a rapid pace, as jurisdictions prepare to amend their local tax laws to introduce the global minimum top-up tax in line with the GloBE Rules. It cannot be assumed that just because a jurisdiction has a high headline corporate income tax rate that the jurisdictional effective tax rate (ETR) for Pillar Two will be above 15%. The Pillar Two ETR calculation requires a significant number of adjustments to financial accounting income and tax expense for GloBE purposes which can significantly reduce the ETR. In this edition, we highlight the advantages of an early impact assessment of Pillar Two on in-scope MNE Group’s and also provide a high-level assessment mechanism. We hope this bulletin adds Value in your professional Sphere. Although the GloBE Pillar Two rules are proposed to be applicable from 2024, in-scope MNE Groups should carry out a Pillar Two Impact Assessment, unless any safe harbour provision applies to them. This would essentially allow MNE Groups to:

• Highlights at-risk jurisdictions where there could be a potential top-up tax under GloBE Rules;
• Initially determine the extent of any potential top-up tax liabilities which provides an early opportunity to assess any measures that can be undertaken to reduce any potential liability;
• Identify deferred tax adjustments that need to be tracked from December 2021;
• Ascertain and implement changes to processes and systems as data for Pillar Two will be required not only from ERP or the Performance Management System, but also from the domestic tax computation and the MNE Group Structure (e.g., tax residency, minority-owned groups, PE’s, etc);
• Plan for any accounting disclosures in advance of the implementation of Pillar Two rules;
• Assess any impact of Pillar Two on future reorganizations and intra group asset transfers; 

A high-level approach to impact assessment could be carried out by using the CbCR data. However, in order to have a more reliable impact assessment, the general approach should be followed to determine the effective tax rate (“ETR”) based on the GloBE Rules. The starting point for this will be a review of the MNE Group structure to identify not just entities but also permanent establishments in jurisdictions. Next would be to identify any excluded entities and income that is potentially exempt (e.g., qualifying shipping income). Given the significant impact on the jurisdictional ETR of both of these the GloBE rules should be reviewed to identify if a respectable level of certainty can be obtained as to the status of the entity/income. The group structure should also identify investment entities and minority owned entities. This is important as they are not taken into account in the standard jurisdictional blending calculation. Similarly, tax transparent entities should also be identified as this may affect the allocation of the income/tax for Pillar Two purposes. The next step is to determine the GloBE Income and the Covered Taxes, for which the financial accounting profit and tax expense will need to take into account the GloBE adjustments. The GloBE Rules include a number of adjustments. As per Chapter 3 of the GloBE Rules, the accounting profit needs to be adjusted for:

• Net Taxes Expense
• Excluded Dividends
• Excluded Equity Gain or Loss
• Included Revaluation Gain or Loss
• Gain or loss from disposition of assets and liabilities excluded under Article 6.3 of GloBE Rules
• Asymmetric Foreign Currency Gains or Losses
• Policy Disallowed Expenses
• Prior Period Errors and Changes in Accounting Principles
• Accrued Pension Expense If transactions between entities in different jurisdictions are not on arm’s length basis, they would need to be adjusted to account for this.

After all the adjustments as required under Chapter 3 of the GloBE Rules, the adjusted GloBE income is then allocated to each relevant entity or PE. Important to note that if the entity is a tax transparent under the GloBE Rules, this would be allocated to the constituent-owners (unless the tax transparent entity is the UPE in which case it is allocated to the UPE). The next step is to determine the Adjusted Covered Taxes for each entity/PE. The starting point for this is the current tax and the deferred tax as per the financial accounts of the entity that is used to prepare the consolidated financial statement of the MNE Group, as adjusted by GloBE adjustments prescribed under Chapter 4 of the GloBE Rules. Adjustments are likely to be required for dividends and capital gains if they qualify as excluded dividends/excluded equity gains/losses for GloBE purposes, where any tax attributable to the dividends/capital gains would be excluded for GloBE purposes (as the corresponding income is excluded for GloBE Income purposes). Other covered taxes suffered by the entity should also be correctly allocated. Withholding tax for instance is generally allocated to the entity that suffered the tax (i.e. the receiving entity). However, withholding tax (and other net basis taxes) on dividends would be allocated to the payor. Similarly, if an entity is likely to be subject to tax in a foreign jurisdiction under a CFC regime, the tax for the holding company on the CFC income would be allocated to the CFC entity (subject to any CFC pushdown limitation). As stated above, adjusted covered taxes for GloBE purposes includes deferred tax expense and therefore an estimate of the deferred tax expense is also required. The carry forward deferred tax attributes from the last financial accounts can be used as a starting point. It is important to note that if the tax rate used for financial accounting purposes is more than 15%, the deferred tax expense is recast to 15% to prevent high taxed income pushing up the total adjusted covered tax figure. Once an estimate of the GloBE income and adjusted covered taxes is available for group entities/PE’s, the ETR calculations can be carried out. If the GloBE income for a jurisdiction is less than 1 million euros, the de minimis exclusion should be considered. If the ETR is less than 15%, the substance-based income exclusion should be considered to revise the ETR upwards. If the ETR is still less than 15%, the estimated top-up tax can be calculated. This is just a very high-level summary/analysis, in addition, there may be other significant transactions in the jurisdiction that should be considered if they would have a material impact on the ETR (e.g., intra-group transfers of assets and in particular if they would qualify as a GloBE reorganisation). The GloBE Model Rules along with the Commentary as well as any Administrative Guidance should be applied to undertake a reliable impact assessment. Accounting disclosure implications - amendment to IAS/IRFS To address the growing concerns of stakeholders, primarily as to whether top-up tax is in the scope of IAS 12 Income Taxes, and, if so, how to account for its deferred tax impacts; the International Accounting Standards Board (IASB) has, on 23rd May 2023, amended IAS 12 to provide a temporary relief from deferred tax accounting for top-up tax as well as provides for new disclosures to compensate for the potential loss of information resulting from the relief. The amendments in International Tax Reform — Pillar Two Model Rules (Amendments to IAS 12) are:

• An exception to the requirements in IAS 12 that an entity does not recognise and does not disclose information about deferred tax assets and liabilities related to the OECD pillar two income taxes.
• An entity has to disclose that it has applied the exception. Further, the IASB has introduced new disclosure requirements for companies to provide in their financial statements from 31 December 2023, as below, although no disclosures are required in interim periods ending on or before 31 December 2023. 
• A disclosure requirement that state that in periods in which pillar two legislation is enacted or substantively enacted, but not yet in effect, an entity discloses known or reasonably estimable information that helps users of financial statements understand the entity’s exposure to pillar two income taxes arising from that legislation. This may include quantitative and qualitative information:
• Qualitative information: For example, how the company is affected by Pillar Two taxes and in which jurisdictions the exposure arises, viz. where the top-up tax is triggered and where it will need to be paid.
• Quantitative information: For example, the proportion of profits of the MNE that may be subject to Pillar Two income taxes and the average effective tax rate applicable to those profits, or how the average effective tax rate would have changed if Pillar Two legislation had been effective.
• A disclosure requirement that an entity has to disclose separately its current tax expense / (income) related to pillar two income taxes, after the top-up tax is effective. The IASB continues to monitor developments related to the implementation of the pillar two rules. It could undertake further work to determine whether to remove the temporary exception — or to make it permanent — after there is sufficient clarity about how jurisdictions implement the rules and the related effects on entities. Additionally, the IASB has also decided that the pillar two model rules (and the amendments to IAS 12) are relevant to entities applying the IFRS for SMEs. The IASB discussed narrow-scope amendments to Section 29 “Income Tax” of the IFRS for SMEs Accounting Standard and in June 2023, published an Exposure Draft International Tax Reform—Pillar Two Model Rules—Proposed Amendments to the IFRS for SMEs Standard. It is open for comment until 17 July 2023. The proposed amendments to the IFRS for SMEs Standard:
• to introduce a temporary exception to the requirements in Section 29 of the Standard for an entity to recognise and disclose information about deferred tax assets and liabilities related to Pillar Two income taxes;
• to make the temporary exception mandatory;
• not to specify how long the temporary exception will be in place;
• to require an entity to disclose that it has applied the temporary exception; and