The core principles of the international tax landscape are rapidly changing. Pillar Two introduces the first harmonisation of direct taxes globally. It brings a broad and complex set of new rules, and takes financials from consolidated reporting as the starting point. In this comprehensive guide, we discuss the steps a Multinational should take in order to remain Pillar Two compliant.
IFRS/IAS12 requires first reporting over FY23
Pillar Two requires a solid tax accounting process, which already impacts the tax reporting under IFRS IAS12 for FY23. The IFRS Board requires multinational groups to prepare the following Pillar Two disclosures (under IAS12) for fiscal years starting on or after the 1st of January 2023:
88A: An entity shall disclose that it has applied the exception to recognising and disclosing information about deferred tax assets and liabilities related to Pillar Two income taxes.
88B: An entity shall disclose separately its current tax expense (income) related to Pillar Two income taxes.
88C: In periods in which Pillar Two legislation is enacted or substantively enacted but not yet in effect, an entity shall disclose 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.
88D: To meet the disclosure objective in paragraph 88C, an entity shall disclose qualitative and quantitative information about its exposure to Pillar Two income taxes at the end of the reporting period. This information does not have to reflect all the specific requirements of the Pillar Two legislation and can be provided in the form of an indicative range. To the extent information is not known or reasonably estimable, an entity shall instead disclose a statement to that effect and disclose information about the entity’s progress in assessing its exposure.
IFRS Foundation Examples illustrating paragraphs 88C–88D
Examples of information an entity could disclose to meet the objective and requirements in paragraphs 88C–88D include:
- Qualitative information such as information about how an entity is affected by Pillar Two legislation and the main jurisdictions in which exposures to Pillar Two income taxes might exist; and
- Quantitative information such as:
- An indication of the proportion of an entity’s profits that might be subject to Pillar Two income taxes and the average effective tax rate applicable to those profits or
- An indication of how the entity’s average effective tax rate would have changed if Pillar Two legislation had been in effect
The above means that Multinational groups must reorganise and ensure their accounting and tax departments collaborate and implement new processes and systems.
Introducing a solid tax accounting process
We believe in an approach where we meet customers where they are and start the journey towards a solid tax accounting process from that point onwards. The tax accounting process types in multinational groups can be summarised as follows.
What are the tax accounting process types?
- Centralised Tax Accounting
HQ manages the tax reporting position centrally for all reporting entities, with a bulk import of consolidated financials and book-tax differences done centrally and owned by the head of accounting, consolidation manager, and/or group tax. This setup is seen with smaller, low-complexity multinational groups with limited or non-material book-tax differences. The quality of the tax reporting process ranges from weak to medium, as there are limited controls and/or systems in place to understand and reconcile local tax returns and tax positions at HQ level. Tools used for tax provisioning are typically Excel-based, managed centrally, and have a low to medium quality. - Decentralised Tax Accounting
Tax reporting positions are managed locally by finance teams, and the process is owned by group accounting, with limited review by HQ and/or group tax. This setup is seen with large diversified (often complex) multinational groups historically grown by acquisitions and/or multinational groups with limited tax (accounting) expertise and/or resources at HQ level. The quality of the tax reporting process is typically weak as there are no controls locally and at HQ to understand and reconcile local tax returns and tax positions. Tools for tax provisioning are absent, i.e., local finance teams prepare their estimates individually and without supporting audit trails. - Hybrid Tax Accounting
These are organisations where the tax reporting positions are managed by HQ and group accounting together. Local finance teams (or local external advisors/accounting firms) are responsible for preparing local and/or regional tax reporting packs (“tax packs”) annually, semi-annually, quarterly, or monthly for one or more reporting units. The review of and tax consolidation of tax packs is done at HQ level by group tax in close collaboration with the group consolidation manager. This setup is seen with organisations that have established a robust tax reporting process and have the appropriate tools. Tax accounting knowledge and support are present at HQ level. Tools used for tax provisioning range from full-fledged tax provisioning software solutions to high-quality Excels with proper audit trails and a robust return-to-provision process.
What is the current state of tax accounting processes in Multinationals?
Most multinational groups have a tax accounting process with a decentralised character. Over the past months, we have seen many multinationals starting their Pillar Two journey and have taken the following steps:
- Initiate a Pillar Two project
- Set up a project team including, e.g., the head of group tax, in-house tax (accounting) experts, the director/manager of group consolidation & reporting, group accounting
- Identify Pillar Two data points and source systems. This has appeared to be complex, especially due to weaknesses in the current tax reporting, such as, e.g.:
- Entities reporting on current taxes only (with limited permanent differences) and do not report on (or do not recognize) deferred taxes. As a consequence, the consolidated financials only show limited levels of deferred tax assets/liabilities (“DTAs”/” DTLs”) on the balance sheet and/or deferred tax effects in the P&L tax charge
- Effective tax rates for the group are reported without an audit trail and are vulnerable to manipulation due to a lack of controls
- No or very limited knowledge/experience on tax (accounting) within group accounting centrally or locally
- No return to provision process (i.e., a comparison of tax returns filed and the tax provision) to determine prior year adjustments
- No content review of tax positions reported by local entities
- Absence of documentation and audit trails of tax positions reported
- Tax consolidation is done manually and without content review
- Short reporting deadline post-close does not leave sufficient time to review
- Group auditors (both central and local audit teams) do not challenge or ask for information about the tax position
- Tax returns and local statutory tax positions are outsourced to external accounting firms/tax advisors
- Absence of group-wide process around the (non)-recognition of DTAs and uncertain tax positions (“UTPs”).
What is the future state of tax accounting and Pillar Two process?
If your multinational group is in the start-up phase of its Pillar Two journey and is uncertain about its tax accounting process, the following steps are advised:
- Prepare a Pillar Two Impact Analysis
- Set up a project team
- Set up a project team with the appropriate tax accounting experts, e.g., the head of group tax, in-house tax (accounting) experts, the director/manager of group consolidation & reporting, group accounting
- Commitment from all actors/stakeholders. Fine-tune the collaboration between group tax and group accounting with the support from the ultimate sponsors (CFO/Board)
- Clear assignment of roles and responsibilities around tax reporting and Pillar Two between group tax, HQ, group accounting, local finance teams, and external professionals
- Get sponsorship from the group’s board to deal with the Pillar Two challenges
- Implement an automated tax provisioning solution
Replace insufficient, complex, and/or unenforceable Excel-based tax packs with a tax provisioning software solution (such as TaxProof). Ensure this to avoid the risk that the new tax reporting process is only partially implemented, including:- Data integrity – new tax packs should function as the single point of truth for the tax disclosures in the consolidated (IFRS) financials. To further strengthen the data integrity, a further (semi-)automated integration between your group’s (financial accounting) systems and a tax provisioning/Pillar Two solution should be established
- Training – Training of local finance teams on the preparation of the new tax packs
- Shadow close – Perform an FY23 shadow close of the group’s reporting / legal entities
- Review tax positions – Analyse/reconcile tax positions for material reporting/legal entities
- Embed Pillar Two reporting into the tax reporting process
As soon as the tax reporting process stands, the next step is to integrate tax reporting with Pillar Two reporting in 3 phases:- FY23 YE Close / Q1 2024: IFRS reporting Pillar Two (current tax effects Pillar Two)
- FY24 YE Close / Q1 2025:
- FY24 transitional safe harbor / full Top-up-Tax calculation
- FY24 IFRS reporting around Pillar Two (current tax effects of Pillar Two)
- H1 FY25 – Determine the offset and allocation of Top-up-Tax for FY24
- FY25 YE Close / Q1 2026:
- FY25 transitional safe harbor / full Top-up-Tax calculation
- FY25 IFRS reporting around Pillar Two (current tax effects of Pillar Two)
- H1 FY26 – Determine the offset and allocation of Top-up-Tax for FY25
- July FY26 – GloBE Information Return and Domestic Top-up-Tax Return filings for FY24
How can Tax Systems assist in achieving your Pillar Two milestones?
Below is an overview of where we believe Tax Systems can assist you in achieving your Pillar Two milestones.
Pillar Two Impact Analysis
Tax System’s Pillar2 solution assists multinational groups in meeting the FY23 IFRS disclosure requirements. The solution helps deliver content for the IFRS / IAS12 disclosures for your FY23 year-end close.
It is carefully designed based on the reviews and validations by our clients and their advisors, as well as our understanding of the latest publications by the OECD Pillar Two GloBE Regulations, the GloBE Information Return, Transitional Safe Harbour rules, and the Administrative Guidance.
Pillar2 covers the core flow of the Transitional Safe Harbour Tests and the Top-Up Tax Calculations to meet the first IFRS Pillar 2 reporting requirement concerning FY23.
Embed Pillar Two reporting into the tax reporting process
TaxProof offers a solution for easing tax accounting-related workflows for companies ranging from small to large-cap, while reducing the operational costs and risks. Replace complex Excel-based spreadsheets and manual labor with smart data collection, assessment, reporting and analytics features.
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Manage your FY23 IFRS reporting obligations and remain compliant!