Top 10 Pillar Two Year-End Considerations for Large Multinational Companies

Pillar Two is a new complex global tax regime that is based on a combination of both tax and accounting data and concepts, with a significant number of data points that were previously not part of organizations’ tax reporting and compliance process. Collaboration across the organization is necessary for preparing the complicated and data-intensive calculations required by the global anti-base erosion (GloBE) rules, and coordination between the tax and accounting departments is critical. The starting point for the Pillar Two calculations is the consolidated financial statements of the ultimate parent entity; therefore, accounting is the foundation of the GloBE rules computation. Understanding the organization's accounting policies and having timely discussions with the accounting team is key. 

Late accounting entries can add pressure to the financial statement reporting deadlines and impact the Pillar Two calculations. The tax department should work closely with the accounting department to understand the impact of accounting entries on the GloBE rules calculation and the time needed to properly analyze adjustments.  

Pillar Two calculations require data points that traditionally haven’t been needed by the tax department, and some data might live in systems that are not readily accessible to the tax department. Moreover, some of the necessary data may not be currently tracked, necessitating updates to the organization's systems for data collection and mapping. Cross-functional team collaboration (involving tax, finance, accounting, IT, HR, and other departments) and having the right solutions in place are key to determining where the necessary data sits and pulling it in a consistent and efficient manner. Businesses must develop a repeatable and scalable method to pull data needed for Pillar Two analysis and a similarly replicable way of incorporating that data into updated calculations and processes. 

Once an organization has implemented proper data management and automation, the tax provision and compliance processes should move more efficiently. Companies should be careful not to underestimate the time it takes to gather the necessary data and perform the calculations. Tax teams still need to identify which GloBE adjustments apply to an entity and in which jurisdictions, as well as determine which taxes are covered. MNEs should evaluate how these additional steps will impact the quarterly and annual close process and look to mitigate the additional time needed with a mix of technology, additional resources, and outsourcing. 

The complexity of the Pillar Two calculation necessitates an organized process not only to meet deadlines, but to ensure the completeness and accuracy of the calculation. Moreover, auditors require evidence of the procedures undertaken to assess the accuracy of the calculations. Companies will therefore need to have audit-ready process documentation evidencing that the company has considered and complied with all the applicable rules. 

Proactive engagement with the auditors to set out the approach taken and any key risks identified will reduce the number of late requests for additional documentation and should streamline the reporting and audit process.

The OECD introduced safe harbors to reduce the complexity and cost of Pillar Two in the first three years after implementation. To take advantage of the transitional country-by-country (CbC) reporting safe harbor (TCSH), an organization must prepare a "qualified CbC report" (QCbCR) that meets specific requirements. Whether a CbC report is considered a QCbCR is determined separately for each tested jurisdiction based on whether it is prepared using qualified financial statements (QFS). QFS include both the consolidated financial statements of the ultimate parent entity and the separate financial statements of each constituent entity, provided these are prepared in accordance with an acceptable or authorized financial accounting standard. 

Common areas of concern that may potentially result in financial statements not being 'qualified' (and thus resulting in the MNE not being able to avail itself of  the TCSH) include:   

• Incorrect allocation of revenue and profit between entities and their permanent establishments; 
• Incorrect adjustment for elimination adjustments or aggregation of data; and
• Incorrect entity classification for CbC report purposes.

Also, adjustments made to the QFS in preparing the QCbCR will disqualify a tested jurisdiction from the TCSH (unless explicitly required under the rules).

It is also important to note the "once out, always out" rule under the TCSH. If a multinational entity (MNE) group has not elected the TCSH with respect to a given jurisdiction in a fiscal year in which the MNE group is subject to the GloBE rules, the MNE group cannot qualify for the TCSH for that jurisdiction in a subsequent year. This applies even if the MNE group would meet the TCSH tests in the following years. In other words, the first year a jurisdiction is subject to the GloBE rules is crucial for determining the extent of the potential relief provided by the TCSH. 

Given the newfound importance of the CbC report, companies wanting to benefit from the TCSH should assess whether their CbC report is "qualifying." Moreover, auditors will want to understand the work that groups have undertaken to conclude that the CbC report is qualifying for each jurisdiction where it’s intended to be relied on; thus, companies should be documenting these steps in an audit-ready process memo.  

Changes in a company’s legal entity structure due to M&A activity and intragroup transactions may impact its Pillar Two exposure. That means that the Pillar Two consequences of any prospective transaction, restructuring, or event should be analyzed in parallel to the corporate tax, state tax, VAT, or stamp duty consequences prior to implementation. This analysis will need to be built into group tax governance processes, and appropriate training provided to the team to enable them to identify potential Pillar Two effects and to seek support when needed. Additionally, prior period transactions/restructurings (even those that occurred prior to the years when Pillar Two became effective), must also be analyzed to ensure any necessary adjustments (e.g., excluding deferred taxes related to book step-ups from nontaxable transactions) are made for the current year.  

Regarding intragroup financing arrangements, in determining whether a jurisdiction qualifies for the TCSH, adjustments must be made to the jurisdiction’s profit (loss) before income tax (PBT) and income tax expense in respect to any hybrid financing arrangements (HFAs) entered into after December 15, 2022. Pillar Two guidance lists three categories of HFAs: (i) deduction/non-inclusion arrangements (D/NI); (ii) duplicate loss arrangements; and (iii) duplicate tax recognition arrangements. The jurisdiction’s TCSH calculation must be adjusted by: (i) excluding any expense or loss arising as a result of a D/NI arrangement or duplicate loss arrangement from the jurisdiction’s PBT; and (ii) excluding any income tax expense arising as a result of a duplicate tax recognition arrangement from the jurisdiction’s income tax expense. 

The importance of entity classification and jurisdiction location to the TCSH and GloBE calculations cannot be overstated. The attribution of profit and taxes to permanent establishments (PEs) and flow-through entities is not aways a straightforward exercise. Common errors in the TCSH analysis often revolve around these issues -- incorrect reporting of entities and jurisdictional allocations, as well as attribution of profit/tax/revenue to flow-through or tax transparent entities and PEs. To the extent the jurisdictional analysis results in a stateless entity, the TCSH will not be available, thus requiring full GloBE calculations. 

In addition to complicated calculations, Pillar Two increases the complexity of income tax financial reporting by introducing more variables and data points for MNEs to factor in to achieve accurate income tax accounting calculations. Deferred tax accounting in particular is rendered more complicated by Pillar Two. MNEs must now consider the potential impact of a top-up tax when calculating deferred tax assets and liabilities. If a deferred tax asset or liability is recognized in a jurisdiction where the effective tax rate is above 15%, the company may need to reassess the value of that asset or liability, which requires additional calculations, time, and resources.

Read more about deferred taxes under Pillar Two 

The GloBE rules implementing Pillar Two are complicated and include multiple, interconnected component parts. Not all components are being implemented at the same time, and not all jurisdictions have legislated to introduce the GloBE rules domestically. To complicate matters further, the OECD continues to issue guidance to clarify, and in some cases amend or augment, the Pillar Two framework. Countries are then legislating and issuing guidance at different paces. It is possible that there will be significant practical divergence from what should be a ‘model’ set of rules due to the approaches adopted by different legislatures and competing domestic requirements. A recent example was Belgium’s deviation from the OECD recommended timeline for registration for Pillar Two reporting processes, with the Belgium authorities requiring a significant amount of information on the global group (not just the Belgium operations) on short notice. More such deviations from the OECD suggested approach may crop up as jurisdictions move forward with domestic implementation. Thus, tracking the timing and extent of implementation of the GloBE rules, and assessing subtle differences across relevant jurisdictions is critical, but remains exceptionally difficult. Companies within the scope of Pillar Two will have to navigate these transitional challenges, staying nimble and monitoring closely OECD guidance and legislative developments in all jurisdictions in which they operate. 

Pillar Two can have an impact on local country taxation, even when a jurisdiction hasn't implemented Pillar Two legislation. Thus, domestic tax law guidance addressing the interaction of local country rules with Pillar Two must also be closely monitored. 

In the U.S., for example, the Treasury Department has issued guidance addressing the effect of Pillar Two on the dual consolidated loss (DCL) and foreign tax credit provisions. On August 6, 2024, Treasury and the IRS released proposed regulations on the DCL rules and their interaction with Pillar Two. (For prior coverage, see IRS Proposes Dual Consolidated Loss Regulations). The DCL rules generally aim to prevent double-deduction outcomes when the same loss reduces taxable income in the U.S. (a "domestic use") and a foreign country (a "foreign use"). Under the GLoBE rules, top-up taxes are calculated and imposed on a jurisdictional basis, which can have the effect of combining the GLoBE loss of one MNE group entity with the GloBE income of another MNE group entity in that same jurisdiction. Under the proposed DCL regulations, losses that offset income under the income inclusion rule (IRR) or a qualifying domestic top-up tax (QDMTT) may be considered a foreign use of a DCL, thus preventing a domestic use of the DCL for U.S. tax purposes. The Treasury also issued guidance in December 2023 (IRS Notice 2023-80) on the creditability of Pillar Two taxes for U.S. foreign tax credit purposes, indicating that a QDMTT is generally creditable, whereas an IIR may or may not be creditable depending on the facts. 

Although the new U.S. administration’s response to Pillar Two is yet to be determined, Pillar Two has been enacted in many other jurisdictions and is applicable for 2024. Large MNEs in scope of Pillar Two with operations in any jurisdiction that adopts the rules will be subject to the minimum tax provisions regardless of whether the U.S. fully adopts its own Pillar Two legislation. Even if an MNE is not currently in scope of Pillar Two or does not expect it to have a material impact on its operations, as previously noted, it is important to continuously monitor changes in both the MNE's structure and the tax laws in the jurisdictions in which the MNE operates. As more jurisdictions enact Pillar Two laws, MNEs that were not previously in scope may come within the scope of Pillar Two.