OECD Pillar Two: Further guidance

22 December 2023 - On 18 December 2023, the OECD/G20 Inclusive Framework on BEPS (OECD Inclusive Framework) published a third set of administrative guidance on the implementation of the Global Anti-Base Erosion Model Rules (Pillar Two) (“GloBE rules”).

This latest release follows the statement on the components of the GloBE rules, agreed by more than 135 members of the OECD Inclusive Framework in October 2021, and the subsequent publication of Pillar Two Model Rules, Commentary, Safe Harbors, and Administrative Guidance.

GloBE rules 

GloBE rules apply to large multinational (MNE) groups with annual consolidated group revenue of at least EUR 750 million to ensure they are subject to a minimum effective tax rate (ETR) of 15% in each jurisdiction where they operate. To achieve this, any top-up tax will be collected through any of the following mechanisms: 

• Income Inclusion Rule (IIR), which applies on a top-down basis such that tax due is (in most cases) calculated and paid by the ultimate parent entity (UPE) to the tax authority in its country. The tax due is the “top-up” amount needed to bring the overall tax on the profits in each country where the group operates up to the minimum ETR of 15%.
• Undertaxed Profits Rule (UTPR, sometimes referenced as the undertaxed payments rule), which applies as a secondary (backstop) rule in cases where the ETR in a country is below the minimum rate of 15%, and the IIR has not been fully applied. The top-up tax will be allocated to countries which have adopted the UTPR, based on a formula and is to be implemented by countries either by denial of a deduction for payments or by making an equivalent adjustment.
• The GloBE rules also allow for countries to introduce a qualified domestic minimum top-up tax (QDMTT) aligned with Pillar Two. Under a QDMTT, top-up taxes in respect of any low-taxed profits of a group’s entities in that country are payable domestically, rather than to other countries under the IIR or UTPR.

New Administrative Guidance

The third set of administrative guidance has been released to further clarify the interpretation and operation of the model rules.

Transitional Country-by-Country (CbC) Reporting Safe Harbour

The transitional CbC Reporting Safe Harbour uses information taken from a business’s CbC Report to exclude a group’s operations in lower-risk countries from the compliance obligation of preparing full Pillar Two calculations, for up to three years.

Further guidance is provided on the requirement that the business’s CbC Report must be prepared and filed using Qualified Financial Statements (QFS), including:

• Consistent use of data: All of the data used in the Transitional CbC Reporting Safe Harbour calculations for a country must come from the same QFS (i.e., accounts used to prepare the Consolidated Financial Statements (CFS) of the UPE or the separate financial statements of each group entity).
• Using different accounting standards: It is possible to use data from the accounts used to prepare the CFS of the for some countries and data from the separate financial statements of each group entity for other countries.
• A CbC Report may be considered a Qualified CbC Report for some jurisdictions and not for others. This is because the MNE group should assess if the CbC Report is prepared based on QFS in each jurisdiction.
• A Permanent Establishment (PE) should use its own QFS. However, if they are not available, the MNE group may determine the portion of the Main Entity’s Total Revenue and PBT that is attributable to the PE using separate financial statements. 
• Unless explicitly required, adjustments to QFS data are not permitted, even if the adjustments are intended to increase consistency with the Pillar Two rules.
• Groups in scope of the Pillar Two rules, but not required to file CbC Reports, are eligible for the Transitional CbC Reporting Safe Harbour if they prepare calculations using data from QFS that would have been included in a CbC Report.

The guidance also includes confirmation that the definition of “Simplified Covered Taxes” for the Safe Harbour’s Simplified ETR computation taken from includes adjustments to the income tax expense provision of prior periods (but amounts in respect of any uncertain tax positions must be removed).

When calculating the routine profits test, the substance-based income exclusion amount should be calculated using the model rules’ transitional rate applicable for the period, i.e., 9.8% for payroll and 7.8% for tangible assets in 2024.

An anti-avoidance rule will prevent the Transitional CbC Reporting Safe Harbour from applying if targeted “hybrid arbitrage arrangements” (e.g., deduction/non-inclusion arrangements, duplicate loss arrangements, or duplicate tax recognition arrangements), are entered into after 15 December 2022 (or 18 December 2023 in some circumstances).

Purchase Price Accounting adjustments

Additional guidance has been issued regarding Purchase Price Accounting adjustments in the context of the Transitional CbC Reporting Safe Harbour. Adjustments to amounts reported in QFS are not generally permitted under the safe harbor. Specific rules will apply where Purchase Price Accounting adjustments are allocated and incorporated into the financial accounts of an acquired group entity that are used in the preparation of the CFS of the UPE, or the separate financial statements of the group entity. In order to be considered “QFS,” a goodwill impairment adjustment must be made to add back the impairment if it relates to transactions entered into after 30 November 2021 and a consistent CbC reporting condition must also be met.

Consolidated revenue threshold

Further guidance has been provided on the definition of revenue for the EUR 750 million consolidated revenue threshold. Revenue includes the inflow of economic benefits from the group’s ordinary activities reflected in the profit and loss statement of the UPE’s CFS, and should be determined before deducting cost of sales and other operating expenses. Ancillary interest income outside of a group’s ordinary activities is not included in revenues, whereas interest would be included if a business offers customer loans as part of its ordinary business and reports interest income in net revenues in the profit and loss statement. 

Revenues are determined in line with the relevant accounting standard, which may allow for netting for discounts, returns, and allowances. If different types of revenue are separately presented, they must be aggregated. Revenue includes both realized and unrealized net gains from investments reflected in the profit and loss statement of the UPE’s consolidated financial statements, as well as income or net gains separately presented as extraordinary or non-recurring items. Adjustments can be made for investment losses if they are shown separately from investment gains in the consolidated financial statements to align with net treatment.

Where a financial entity does not record gross amounts from transactions in its financial statements, the items considered similar to revenue under the accounting standards of the UPE should be used, e.g., “net banking product” or “net revenues.” For example, for a financial entity, revenue includes the net amount of income/gains from a financial transaction such as an interest swap.

Mismatches between financial reporting years

Where there is a mismatch between the financial reporting year of the UPE and a Constituent Entity, the GloBE rules follow the approach taken in the UPE’s CFS. Similarly, where there is a mismatch between the taxable period of a Constituent Entity and the financial reporting year of the MNE  group, the Constituent Entity should apply the approach used in the UPE’S CFS to determine its adjusted covered taxes for the year.

Allocation of blended controlled foreign company (CFC) taxes

Administrative Guidance was released in February 2023 on allocating blended CFC taxes (such as US GILTI (global intangible low-taxed income)) to Constituent Entities for the purposes of the Pillar Two calculations using a formulaic approach based on “blended CFC allocation keys.” Further guidance has now been released, including clarification that where multiple jurisdictional ETR are computed for a country (e.g., because a separate ETR calculation has been required for an investment entity) the allocation key for an entity is calculated using the jurisdictional ETR applicable to the blending group to which that entity belongs. Guidance is also provided on how to calculate the blended CFC allocation key if there is no other requirement to calculate an ETR for the country, e.g., the simplified ETR calculation should be used where an election has been made to use the transitional CbC Reporting Safe Harbour. Guidance is also provided in respect of the allocation of blended CFC taxes to entities that are not group members (or joint ventures) for Pillar Two purposes.

Administrative relief for groups with short reporting years

For groups with short reporting Fiscal Years ending before 31 March 2025, the due date for compliance and filing obligations will not be before 30 June 2026 (the earliest filing date for groups with full reporting years).

Simplified Calculation Safe Harbour for Non-material Constituent Entities

The Guidance includes a permanent Simplified Calculation Safe Harbour for Non-material Constituent Entities (NMCEs), which is based on a Simplified Income, Revenue and Tax calculations.

Broadly, an NMCE is an entity that is not consolidated in the UPE’s CFS solely on size or materiality grounds, but is still considered a Constituent Entity for Pillar Two purposes. A number of conditions must be met in relation to the NMCE, including that the UPE’s CFS have been externally audited. An annual election is required for each individual NMCE.

Under this Safe Harbour, groups can use CbC Reporting information for an NMCE to determine whether the country where the NMCE is located meets one or more of the routine profits, de minimis, or ETR tests such that the top-up tax for the country is deemed to be zero. The Safe Harbour uses “total revenue” and “accrued income tax (current year)” (with no deferred tax) as used for CbC Reports as a proxy for the NMCE’s profit and covered taxes, respectively.

Next steps

The OECD inclusive framework will continue to release further Agreed Administrative Guidance on an ongoing basis. Guidance is expected to be released in the first half of 2024, including on the application of deferred tax liability recapture rules and the allocation of deferred taxes to other constituent entities (e.g., in relation to CFC regimes or PEs). A Government peer review process will also be implemented to monitor countries’ implementation of the Pillar Two rules, and work will continue on the Pillar Two Administrative Framework and Dispute Resolution Mechanisms.

The Administrative Guidance will be incorporated into a revised version of the Commentary to the Pillar Two model rules to be released in 2024.

Countries are in the process of implementing the Pillar Two model rules in their domestic legislation. IIRs and QDMTTs will begin to apply from 2024 in some countries, with UTPRs starting to apply from 2025.

How can Deloitte help? 

Our team of International Tax experts can support you in understanding the potential impact of Pillar Two, and how this may affect your business. This could involve the following:  

• Delivering a dedicated workshop to your financial and tax teams to discuss the implication of Pillar Two rules on your business. 
• Evaluating the applicability of Pillar Two to define whether a particular business would be considered within the scope of the rules and impact analysis to determine the high-risk subsidiaries, based on their location.
• Evaluating the application of the Transitional CbCR Safe Harbour rules to your group, and other GloBE Safe Harbours agreed by the OECD Implementation Framework.
• Scenario planning and looking at the different responses countries may adopt and the impact of each of these responses on your business.  
• Discussing the application of the disclosure rules in the financial statements in relation to Pillar Two.
• Modelling of tax costs and impact on cashflow.
• Advising on appropriate tax governance, tax function design and resourcing models.