Navigating BEPS Pillar Two Accounting Standards

Principally, the GloBE Rules apply to Constituent Entities (“CE”) that are members of an MNE Group that has an annual revenue of EUR 750 million or more in the Consolidated Financial Statements (“CFS”) of the Ultimate Parent Entity (UPE) in at least two of the four Fiscal Years immediately preceding the audited Fiscal Year. 

Further, Financial Accounting Net Income or Loss i.e. the starting point to calculate GloBE Income is the net income or loss determined for a CE in preparing the CFS of the UPE.

So it’s clear that both the definition of the scope (Article 1.1.1) as well as the calculation mechanism in the MRs reference to the CFS and these are then also defined in Article 10 as:

a. the financial statements prepared by an Entity in accordance with an Acceptable Financial Accounting Standard […]

b. […]

c. where the UPE has financial statements described in paragraph (a) or (b) that are not prepared in accordance with an Acceptable Financial Accounting Standard, the financial statements are those that have been prepared subject to adjustments to prevent any Material Competitive Distortions; and

d. […]

Paragraphs b. and d. of the definition relate to groups with permanent establishments and where deemed consolidation rules apply, which are separate topics and not the focus of this blog.

Material Competitive Distortion is defined as an aggregate variation greater than EUR 75 million in a Fiscal Year comparing the application of authorized (but not acceptable) accounting standard principles/procedures as compared to the amount that would have been determined by applying the corresponding IFRS principle/procedure. 

The CbCR Safe Harbor rules introduced in December 2022 on the other hand refer to Qualified Financial Statements and defines these as:

a. the accounts used to prepare the CFS of the UPE […]

b. separate financial statements of each Constituent Entity provided they are prepared in accordance with either an Acceptable Financial Accounting Standard or an Authorised Financial Accounting Standard if the information contained in such statements is maintained based on that accounting standard and it is reliable; or

c. […]

And finally, the QDMTT safe harbor rule introduced in the July Administrative Guidance requires the QDMTT to be computed based on the UPE’s Financial Accounting Standard or, in certain circumstances, a Local Financial Accounting Standard (refer to our separate blog in this regard).

The MR defines Swiss GAAP FER as an Acceptable Financial Accounting Standard. Swiss Code of Obligations (“CO”), however, only qualifies as an Authorised Financial Accounting Standard. Other international accounting standards commonly applied in Switzerland such as IFRS and US GAAP are clearly also Acceptable Accounting Standards. 

So, considering the above rules it seems clear that as long as a group prepares its CFS using Swiss GAAP FER or IFRS/US GAAP, this would also be the basis for the GloBE considerations and calculations.

However, in practice, various questions and challenges result in uncertainty and discussion:

What if a Swiss MNE group has not “fully implemented” IFRS or Swiss GAAP FER?

In principle, this would be a case of (a) of the definition CFS as CFS are in this case prepared in accordance with an Acceptable Financial Standard. Further, the commentary provides some tolerance/flexibility to ignore minor or inconsequential deviations in applying UPE’s accounting standards. 

While there is little guidance around this concept, the commentary specifically states that if an auditor accepts such a deviation without a note or qualification, this would constitute ‘evidence’, although it would not be conclusive.

If a group only consolidates using Swiss CO, when can they rely on the material competitive distortion concept?

In principle, this would be a case of (c) of the definition of CFS. Hence, if the group can prove that applying Swiss CO does not – in aggregate – result in differences to IFRS of EUR75m or more the MR calculations can be done based on these accounts. 

There is, however, also little guidance on how this concept will be applied in practice e.g. if aggregation is done using absolute and/or gross numbers. Further, as a pre-requisite to establish if the threshold is met, IFRS accounts would need to be prepared as well and if this is the case, the question would be whether the group doesn’t already have a set of IFRS CFS which it should then use for the MR calculations?

Can different accounting standards be applied for CbCR safe harbour, QDMTT safe harbors and/or GlobE MR calculations?

Considering the different principles in the different accounting standards commonly applied in Switzerland, it is clear that results from a GlobE MR and safe-harbor perspective can be significantly different depending on the accounting standard applied. 

CbCR safe harbors principally permit the application of both Acceptable and Authorised Accounting Standards. So to the extent that reliable CbCR are prepared based on Swiss CO, these may in principal be considered. Uncertainty remains, however, reains as to whether these will ultimately be accepted internationally (for additional considerations with respect to the CbCR basis refer to our separate blog).

The QDMTT safe harbors on the other hand would in principal only permit the use of a local accounting standard if this is stipulated in the (domestic) QDMTT law. Currently, this is not foreseen in the Swiss draft ordinance, although it may still be included before the ordinance comes into force. 

Finally, it remains to be seen whether the application of different standards for different purposes within the same MNE group will be accepted in practice, taking into account evolving practice.

Obtaining insights on guidance and interpretation as well as understanding best practice approaches and technology solutions are key and Swiss MNE groups should therefore consider:

• Obtain a clear picture of the accounting standards currently applied in the MNE group
• Analyze any deviations from principles/procedures in Acceptable Accounting Standards 
• Analyze the impact of potentially applying different accounting standards for different purposes (e.g. safe-harbor considerations) 
• Monitor how guidance and practice develop, particularly with respect to the acceptable standards for CbCR and QDMTT safe harbors and with respect to applying different standards within the group
• Review the existing CbCR processes and the resulting data to make sure they are considered appropriately accurate for Pillar Two purposes as this clearly is a paradigm shift in terms of what the CbCR was originally designed to do and what it was used for.