The impact of OECD Pillar 2 GloBE tax legislation on financial reporting

This financial and corporate reporting update focuses on the impact arising from Pillar 2 GloBE (Pillar 2) tax legislation.

The Pillar 2 model rules published by the OECD in December 2021 have been agreed by jurisdictions representing more than 90% of global GDP.  The rules aim to ensure that large multinational groups pay a minimum amount of tax (15%) on income arising in each jurisdiction in which they operate.  If there are group entities established in jurisdictions where the income tax charge (current and deferred) is below 15%, then a top-up tax will be paid by other entities in the group, provided that the jurisdictions of those other group entities have enacted Pillar 2 into domestic law.

There are two main taxing provisions. In 2024, the UK, EU and other jurisdictions will start to collect tax from low-taxed subsidiaries under the Income Inclusion Rule (“IIR”), other jurisdictions have announced they will follow in 2025. From 2025, the UK, EU and other early adopter jurisdictions will also collect tax from any other low-taxed jurisdiction in the group, whether it is a subsidiary or not. Other countries will follow in 2026.

As and when jurisdictions substantively enact local tax law to introduce the rules, noting that Pillar 2 legislation (“the legislation”) was substantively enacted in the UK in June 2023, accounting consequences arise both from a current and deferred tax perspective.

Following concerns raised by stakeholders about these consequences, the International Accounting Standards Board amended IAS 12 Income Tax on 23^rd May 2023 to introduce an exception to the requirement to measure and recognise deferred tax on temporary differences arising from Pillar 2 tax legislation (“the amendment”). The UK Endorsement Board in turn endorsed the amendment for use in the UK on 19^th July 2023.

Where a multinational group has no top-up tax (i.e. it does not operate in any jurisdiction where the income tax charge is less than 15% or it does not have global revenue exceeding €750 million in two of the last four years), then the amendment is of no consequence.  However, for the many UK companies that are impacted by the legislation, the publication and its subsequent prompt endorsement provide welcome relief as the potential work needed to determine the deferred tax position in annual and interim financial statements may otherwise have been proved considerably onerous. Indeed, as an exception not an exemption from the requirements of IAS 12, companies are prohibited from recognising deferred tax on the temporary differences arising from the enactment of Pillar 2 legislation.  This not only aids comparability but also eliminates the risk of entities inadvertently developing accounting policies inconsistent with IAS 12’s principles and requirements.

Despite this welcome relief from having to account for deferred tax, entities cannot disregard Pillar 2 in their financial statements.  Firstly, the amendment introduces new, potentially burdensome, disclosure requirements in annual financial statements for accounting periods beginning on or after 1 January 2023 and so processes will need to be implemented to capture the relevant information.  Specifically:

• the fact the exception has been applied;
• the current tax expense (income) related to Pillar 2 taxes.  This disclosure will only apply when the legislation is in force, which for UK entities is periods beginning 1 January 2024;
• in periods in which Pillar 2 legislation is enacted or substantively enacted but not yet in effect (for UK entities this will be relevant for the 31 December 2023 year-end), known or reasonably estimable information that helps users of financial statements understand the entity’s exposure to Pillar 2 income taxes.  The amendment is not prescriptive as to what must be disclosed to meet this objective, although does suggest including both:
  • qualitative information, such as information about how an entity is affected by Pillar 2 legislation and the main jurisdictions in which exposures to Pillar 2 income taxes might exist; and
  • quantitative information, such as (i) an indication of the proportion of an entity’s profits that might be subject to Pillar 2 income taxes and the average effective tax rate applicable to those profits; or (ii) an indication of how the entity’s average effective tax rate would have changed if Pillar 2 legislation had been in effect.

Secondly, the exception from recognition and measurement of deferred tax introduced by the amendment is described as being only temporary.  It is not known how long the exception from measurement and recognition will last, how much notice will eventually be given in advance of its ultimate withdrawal, nor the extent to which comparatives will need to be restated in the first financial statements prepared following such withdrawal.  Entities will therefore need to consider when to start to prepare for any future withdrawal.

Published November 2023