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Pillar Two GloBE Adjustments

Pillar Two GloBE Adjustments

Contents

Summary

Once the financial accounting income or loss is determined this is then adjusted to arrive at the Pillar Two GloBE income or loss.

The broad intention here is to arrive at a substituted, standardized measure of taxable income. As such many of the Pillar Two GloBE adjustments are typical adjustments that would be made for tax purposes in domestic jurisdictions.

However, the big difference between the Pillar Two GloBE rules and domestic tax systems is the inclusion of deferred tax. There will be many differences between financial accounting income, and taxable income. Differences can either be temporary (if they reverse) or permanent.

For more information on deferred tax, see Deferred Tax.

Net Tax Expense

Given the financial accounting income or loss figure is a below the line (ie after-tax) figure, Article 3.2.1(a) of the OECD Model Rules provides that the net tax expense needs to be added back (ie it will increase Pillar Two GloBE income assuming it is a positive figure).

The net tax expense is made up of:

• Any covered taxes accrued as an expense or included in the income tax figure in the accounts as current or deferred tax, including covered taxes on income that is excluded from the Pillar Two GloBE rules. For more information on covered taxes, see Covered Taxes.

Note that withholding taxes are not classed as covered taxes for this purpose and there is no adjustment to Pillar Two GloBE income.

• A deferred tax asset attributable to a loss for the fiscal year. In this case (unlike the other adjustments), this will result in a negative adjustment (ie reducing Pillar Two GloBE income/increasing the loss).

This is because, in the case of a loss, the deferred tax asset would have been created:

Dr Deferred Tax Asset (Balance Sheet)

Cr Deferred Tax Expense (P&L)

This would be a negative tax expense.

• A qualified domestic minimum top-up tax accrued as an expense. For more information, see Qualifying Domestic Minimum Top-Up Taxes

• Any taxes under the Pillar Two GloBE rules that are included as an expense

• Any disqualified refundable imputation tax included as an expense. These are generally taxes that are refundable on the distribution of a dividend or creditable against other taxes.

Excluded Dividends

As the financial accounting income or loss figure is a below-the-line figure, dividends are generally included in this amount. However, for tax purposes, many countries have some form of participation exemption for intra-group dividends (with differing requirements in terms of shareholdings and length of ownership).

Article 3.2.1(b) of the OECD Model Rules applies a standard exemption for certain dividends similar to a participation exemption.

Dividends excluded are generally dividends (or other distributions on shares) where the MNE group holds 10% or more of the ownership or had held full ownership for more than 12 months.

Dividends on short-term portfolio shareholdings and from investment entities that have made a taxable distribution method election are excluded aside from portfolio shareholdings (defined as less than 10% of ownership) held for at least one year.

For more information on the Taxable Distribution Method Election, see Investment Funds and Pillar Two.

Excluded Equity Gains or Losses

This includes:

• Changes in the fair value of an ownership interest. This relates to accounting policies that apply to financial instruments which revalue assets and liabilities at their current market value.

These are excluded from Pillar Two GloBE income under Article 3.2.1(c) of the OECD Model Rules if they were taken through the profit and loss account. If the fair value gains or losses were included in Other Comprehensive Income they would have been excluded anyway.

• Profits or losses from an ownership interest under an equity method of accounting.

The equity method of accounting is a method of accounting for holdings in entities that are not subject to consolidation. Generally, this applies when the equity interest is less than 50%. These entities aren’t generally controlled by the MNE group and therefore aren’t constituent entities (aside from certain Joint Ventures).

As the equity method of accounting brings in the proportionate share of the entity’s income or loss into the parent company’s financial accounts, this needs to be excluded.

• Gains and losses from the sale of an ownership interest (except a shareholding with ownership of less than 10%) are excluded under Article 3.2.1(e) of the OECD Model Rules. Similar to the treatment of excluded dividends (above), many jurisdictions have a participation exemption for gains on group shareholdings.

The Pillar Two GloBE rules seek to replicate this by excluding such gains and losses from Pillar Two GloBE income. However, unlike the rule for excluded dividends, the ownership period is irrelevant.

Included Revaluation Gains or Losses

Where an entity values assets under a revaluation method for accounting purposes, its value in the balance sheet is revalued to the current market value (less accumulated depreciation and impairment losses).

Revaluation gains are generally included in Other Comprehensive Income whereas revaluation losses are taken through the profit and loss account.

This would mean that revaluation gains (as they are reflected in Other Comprehensive Income and not the Profit and Loss account) would generally not be taken into account for the purposes of Pillar Two GloBE income (thus potentially increasing the Pillar Two GloBE ETR).

As such, under Article 3.2.1(d) of the OECD Model Rules, all revaluation gains or losses that are included in Other Comprehensive Income and aren’t taken through the P&L are required to be included in the Pillar Two GloBE income or loss.

An election is available so that the revaluation gains or losses reflected in Other Comprehensive Income aren’t included in Pillar Two GloBE income and would only be reflected when the asset is sold.

Asymmetric Foreign Currency Gains or Losses

These are generally currency conversion differences that arise due to differences in the currency used for accounting and tax purposes.

Generally, foreign currency gains and losses in the constituent entity’s financial accounts are included in Pillar Two GloBE income.

However, adjustments are made under Article 3.2.1(f) of the OECD Model Rules where foreign currency gains and losses arise due to differences in the currencies used to calculate taxable income or loss and a constituent entity’s financial accounting net income or loss:

• Where transactions in the accounting currency give rise to a taxable gain because the tax currency is different, the foreign currency gain or loss is included in the financial accounting net income or loss.

• Where transactions in the tax currency give rise to an accounting gain or loss due to the accounting currency being different, the accounting foreign currency gain or loss is excluded from the financial accounting net income or loss.

• Where transactions in a third currency give rise to a foreign currency gain or loss in the accounting currency they are excluded from the financial accounting net income or loss.

• Similarly, where transactions in a third currency give rise to a foreign currency gain or loss in the tax currency they are included in the financial accounting net income in the case of a gain (and excluded in the case of a loss).

Foreign Currency – Example

Company 1 is subject to the Pillar Two GloBE rules. It uses euros as its tax currency and yen as its accounting currency.

At the beginning of the tax year, it has a bond with a value of 15,000,000 yen. The exchange rate is 1(euro):150 (yen). For tax purposes, the bond is therefore valued at 100,000 euros.

At the end of the year, the exchange rate is 1:180.

In the accounts, the value of the bond is still 15,000,000 yen. However, for tax purposes, the value of the bond is 83,333 euros. The foreign exchange loss of 16,667 euros is taken as a tax-deductible expense by Company 1.

Assume other income of 50,000 euros (or 9,000,000 yen).

If the tax rate was 20%, the tax in euros would be:

Income = 50,000 euros

Foreign currency loss = (16,667)

Taxable Income = 33,333 euros

Tax would be 6,667 euros

The ETR would therefore be 20%.

However, for accounting purposes there is no deduction for the forex loss as the currency used to prepare the accounts is the yen. Therefore, the ETR would be:

Income = 9,000,000 yen

Tax (6,667*180) = 1,200,060 yen

ETR = 13.33%

This, therefore, has the potential to affect the Pillar Two GloBE ETR, given the Pillar Two GloBE income calculation begins from the financial accounting net income figure. As such, an adjustment is required for Pillar Two GloBE purposes.

The amount of the forex loss for tax purposes is converted to yen at 1:180 and included as a reduction in financing accounting income for Pillar Two GloBE purposes (3,000,060 yen). The ETR then becomes 5,999,940/1,200,060 = 20%, the same as in the tax functional currency.

Policy Disallowed Expenses

Illegal payments, including bribes and kickbacks, are added back in the Pillar Two GloBE income calculation under Article 3.2.1(g) of the OECD Model Rules, just as they generally would be under a country’s domestic tax law. A payment is illegal if it is illegal under the domestic law of the country of the constituent entity or the UPE.

Fines and penalties are only added back if they are 50,000 euros or more (or an equivalent amount in local currency). Note that interest on late payment of tax is not considered a fine or penalty.

It’s worthwhile noting that given the 50,000 euros materiality threshold can be applied based on local currency this could impact on the Pillar Two GloBE tax base (and therefore the Pillar Two GloBE ETR) if the local currency rose or fell compared to the euro.

For instance, if the local currency fell, this could result in the actual threshold in euros being less than 50,000 euros. This may then lead to an additional increase in the Pillar Two GloBE tax base (and a reduction in the Pillar Two GloBE ETR).

The OECD recommends in its Commentary to the Pillar Two Model Rules that countries that apply the threshold in local currency also implement measures in their domestic legislation to ensure this does not happen.

Prior Period Errors

If there was an error in the accounts (or a change in accounting policy) in a previous year that impacts on the Pillar Two GloBE income or loss, Article 3.2.1(h) of the OECD Model Rules provides that this must be adjusted in the Pillar Two GloBE income calculation.

For accounting purposes, the adjustment would generally be by way of an amendment to the opening equity in the balance sheet.

For Pillar Two GloBE purposes, the Pillar Two GloBE income calculation is adjusted. For instance, if deductible expenses were not included, this would be represented as a decrease in opening equity and a decrease in Pillar Two GloBE income.

Note, given Pillar Two GloBE income isn’t based on the consolidated financial statements, but on the accounts of the Group entity, even if errors were between group members and therefore didn’t affect the consolidated accounts, they would still need to be taken into account for Pillar Two GloBE income.

Errors that relate to a decrease in covered taxes of 1 million euros or more are treated differently. For more information, see Post-Filing Adjustments.

Errors that relate to periods before the implementation of the Pillar Two GloBE rules are not taken into account.

Accrued Pension Expenses

Again, this adjustment looks to try and replicate the domestic law tax treatment in many jurisdictions.

Generally, pension contributions are tax-deductible when paid, as opposed to the amount accrued in the financial accounts.

Article 3.2.1(i) of the OECD Model Rules follows this treatment.

Therefore, if the amount paid is different from the amount accrued in the income or loss in the financial accounts, the difference is adjusted in the calculation of Pillar Two GloBE income.

FAQs

GloBE income is the financial accounting income after a number of Pillar Two adjustments. This is then used along with adjusted covered taxes to calculate the jurisdictional effective tax rate and whether any top-up tax is due.

These are generally currency conversion differences that arise due to differences in the currency used for accounting and tax purposes.