BEPS Pillar Two: Impact on Philippine companies

By: Carlo Navarro

AS global tax reforms advance, the Organization for Economic Cooperation and Development's (OECD) Pillar Two initiative is reshaping the tax landscape for multinational enterprises (MNEs) worldwide. In response, in November 2023, the Philippines became a member of the OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting (BEPS) to uphold tax fairness and protect the country's tax base from aggressive tax avoidance schemes. While the Philippines has not formally adopted Pillar Two rules, some Philippine companies face new compliance requirements and possible additional tax liabilities beginning January 2024.

This article provides a comprehensive overview of the OECD's BEPS 2.0 Pillar Two requirements and their impact on Philippine entities. Pillar Two mandates that large MNEs (i.e., operating in more than one jurisdiction with annual consolidated group revenue of at least 750 million euros in two of the four immediately preceding fiscal years) pay a global minimum effective tax rate (ETR) of 15 percent. The objective of this rule is to stop the race to the bottom in tax rates and to reduce profit-shifting to low-taxed jurisdictions.

This new international tax framework introduced three main rules:

– Income Inclusion Rule: Applies on a top-down basis wherein top-up tax is collected at the Ultimate Parent Entity/intermediate parent entity level if a subsidiary's ETR falls below the 15 percent threshold.

– Undertaxed Payments Rule: Acts as a backstop, enabling other jurisdictions to collect top-up taxes when IIR does not apply.

– Qualified Domestic Minimum Top-Up Tax (QDMTT): Allows jurisdictions to collect top-up taxes and capture additional tax revenues locally.

This new rule will affect Philippine-headquartered companies with foreign subsidiaries and Philippine subsidiaries of foreign MNEs where the foreign subsidiaries or MNEs are located in jurisdictions that have implemented the rules in 2024.

Since the ETR is computed on a jurisdictional basis, all Philippine subsidiaries of an MNE group need to coordinate to arrive at their Philippines' ETR. Philippine companies enjoying Philippine Economic Zone Authority or Board of Investments incentives are likely to feel the impact of the new rule. Their ETR may likely fall below the 15 percent minimum rate. Hence, these Philippine companies, which are enjoying tax incentives, may see the benefits received from these incentives mitigated.

To illustrate, if an MNE has two subsidiaries in the Philippines where Company A is taxed at 25 percent and Company B is taxed a 5 percent special corporate income tax, their combined or jurisdictional ETR could be lower than 15 percent. In this scenario, the MNE group would need to pay a top-up tax liability to bring their jurisdictional ETR to 15 percent.

The top-up tax is likely to be settled in another jurisdiction in the absence of QDMTT legislation in the Philippines. Hence, the current tax incentives enjoyed by Philippine companies will be undermined and negated by top-up taxes collected in another jurisdiction where the MNE Group has presence, and that has legislated Pillar Two rules. Thus, even without adopting Pillar Two, the Philippine companies benefiting from such incentives could still be liable for top-up taxes.

Both Philippine-headquartered MNEs and subsidiaries of foreign MNEs will need to support the broader group's compliance. They need to start preparing a host of data for BEPS Pillar Two calculations. Global Anti-Base Erosion (GloBE) compliance requires around 110 core data to calculate the jurisdictional ETR. It also demands data integration across accounting and tax systems.

Computing the jurisdictional ETR involves more than just dividing income tax expense by profit before income tax. It requires adjustments to arrive at the GloBE Income and Adjusted Covered taxes, which can create significant complexity. The OECD acknowledges the intricacy of Pillar Two calculations and adjustments to income tax expense and profit before income tax, and in response, has introduced Transitional Country-by-Country Reporting Safe Harbor (TCSH) rules.

Although these rules are designed as a short-term measure, applicable only during the initial years of Pillar Two rules (i.e., 2024 to 2026), the Philippine subsidiaries of foreign-headquartered MNEs should connect with their headquarters to check and assess if TCSH tests have been conducted. Should the Philippine entities jurisdictionally elect to apply and pass any of the three TCSH tests, they are not required to perform a detailed Pillar Two impact assessment, and their top-up tax is deemed zero for that specific year. However, reassessment is required in the subsequent years to confirm eligibility.

Philippine companies should ensure that their IAS 12 disclosures reflect potential Pillar Two impact, specifically regarding top-up tax risks and future tax obligations. Comprehensive disclosures in financial statements will support stakeholders in assessing Pillar Two implications on their operations.

Given the complexity of GloBE calculations, Philippine companies should conduct a data assessment to identify reporting gaps and ensure that their systems can capture GloBE-aligned data. Robust data diagnostics are crucial to support the parent company's GloBE filings, particularly with the need for jurisdictional ETR calculations and deferred tax adjustments. As a result, it may be essential to further modify existing accounting or enterprise resource planning systems or integrate specialized tax software, to ensure data accuracy.

With the continuous development of Pillar Two rules globally, the Philippines has yet to adopt and implement Pillar Two rules. While there has been no formal announcement on implementation timeline, the Philippine government has committed to consultations to address the implementation complexities, with a particular focus on the effects of QDMTT and its potential impacts on current tax incentives.

It is no longer a question of "whether" but "when" these rules will be implemented in the Philippines, as Philippine taxpayers will inevitably be affected by Pillar Two rules.

As published in The Manila Times on 18 November 2024. The author is the Tax & Legal Leader of Deloitte Philippines.