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Deferred Tax Recapture Rule

Pillar Two - Deferred Tax Recapture Rule

The Recapture Rule

Article 4.4.4 of the OECD Model Rules implements a recapture rule for deferred tax liabilities. This applies when the deferred tax liability has not reversed within five years of the fiscal year in which it was originally recognized.

When this recapture applies, the MNE group is required to recompute its ETR for the year the deferred tax liability was originally recognized. If there is then any top-up tax, this top-up is added to the top-up tax for the current year. See our interactive deferred tax recapture tool to simulate the application of this rule.

Certain deferred tax liabilities are excluded from the recapture rule, so they do not need to be adjusted for, even if they take more than five years for the deferred tax liability to release.

Deferred tax liabilities that are excluded from the recapture rule under Article 4.4.5 of the OECD Model Rules include:

• Accelerated depreciation on tangible assets (Note: it does not include timing differences relating to the amortization of intangibles or goodwill)

• Costs of a license or similar arrangement from the government for the use of immovable property or exploitation of natural resources that incurs significant investment in tangible assets;

• Research and development expenses;

• De-commissioning and remediation expenses;

• Movements arising from fair value accounting;

• Foreign currency exchange net gains;

• Insurance reserves and insurance policy deferred acquisition costs;

• Gains from the sale of tangible property located in the same jurisdiction as an entity that are reinvested in tangible property in the same jurisdiction; and

• Other amounts accrued as a result of accounting principle changes for the above.

Deferred Tax Recapture – Example

Company A is subject to the Pillar Two GloBE rules. It is resident in Country A which has a 15% corporate income tax rate.

Company A provided services to another company and charges 100,000 euros payable on an instalment basis over 5 years. It, therefore, receives 20,000 euros each year.

For financial accounting purposes and under the relevant GAAP the 100,000 euros income is recognized in year 1 under the accruals basis.

However, for local tax purposes, the income is recognized when it is received. This results in a deferred tax liability in year 1 of 12,000 euros (80,000 euros * 15%). This would be:

Dr Deferred tax expense (P&L) 12,000
Cr Deferred tax liability (balance sheet) 12,000

If we assume Company A had other taxable income of 250,000 euros, its current tax in Year 1 would be 37,500 euros on the other income and 3,000 euros on the service income received. Therefore, total tax payable is 40,500 euros.

For accounting purposes, it would have income of 350,000 euros in year 1. The current tax expense is 40,500 euros ie an ETR of 11.5%.

The deferred tax expense in the P&L is 12,000 euros.

For Pillar Two purposes, adjusted covered taxes would be 52,500 euros and Pillar Two GloBE income would be 350,000 euros. The Pillar Two GloBE ETR is therefore 15% and no top-up tax is due.

If in year 6, the deferred tax liability has not reversed (eg the income has not been received), this is treated as a recaptured deferred tax liability. The year 1 ETR and top-up tax calculation have to be recalculated with the deferred tax liability in year 1 removed.

Therefore, the ETR would be 11.5% and top-up tax may be due.

FAQs

Article 4.4.4 of the OECD Model Rules implements a recapture rule for deferred tax liabilities. This applies when the deferred tax liability has not reversed within five years of the fiscal year in which it was originally recognized.

When this recapture applies, the MNE group is required to recompute its ETR for the year the deferred tax liability was originally recognized.

Yes, there are a number of exemptions, the main one being accelerated depreciation on tangible assets. Note: this does not include timing differences relating to the amortization of intangibles or goodwill.

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