In this blog, we take a closer look at Pillar Two and how it affects not only the tax function but also the Accounting, Reporting and Control capabilities within the organization, therefore requiring a multi-disciplinary approach to be adequately compliant within the coming three years.
The Pillar Two tax reform introduces a minimum income tax of 15% per jurisdiction
Over the last decade, tax avoidance strategies that exploit gaps and mismatches in tax rules have gained social and political interest. This has led The Organization for Economic Cooperation and Development (OECD) to develop and adopt the Inclusive Framework on Base Erosion and Profit Shifting (BEPS). BEPS represents a significant reform of the international tax system. Its biggest change is the implementation of the Pillar Two / Global Anti-Base Erosion (GloBE) rules, because it introduces a minimum income tax of 15% per jurisdiction for Multinational Enterprises (MNEs). If the GloBE Effective Tax Rate (ETR - the effective tax rate of each constituent entity) of a jurisdiction is below 15% (and thus below the minimum income tax), a top-up tax will be applied to achieve the internationally agreed 15%. This GloBE ETR is determined using the Covered tax as nominator and GloBE income as denominator. The data needed to assess this GloBE ETR is coming from different data sources, such as the financial data used to prepare the consolidated financials, local Accounting standard data and tax return information. This is a new paradigm in global taxation and requires a proactive approach from multinationals to evaluate and prepare for its impact.
The EU and several other countries, including The United Kingdom, Germany, Belgium, and The Netherlands, have introduced Pillar Two as of 2024, while other countries have indicated to introduce Pillar Two a year later (in 2025). Since the implementation date is now upon us, the new tax regime has gained interest and momentum within the global community and society in general.
As a transitional response, many organizations have opted for safe harbor exceptions, set out by the OECD, to initially simplify the complexity and compliance requirements. This conditional option is valid for a maximum of three years and allows for less extensive tax calculations. For example, calculations based on a smaller pool of data, which is typically more readily available within organizations. Ultimately, however, most MNEs will need to transform their current ways of working. We are already observing an increasing uprise in Pillar Two-related projects, and we expect that additional, more structural implementation initiatives, will increase significantly in the coming months and years.
Pillar Two is not just about Tax, it also impacts Accounting, Reporting and Control activities
Whilst tax directors and tax advisors are already focusing their efforts on understanding the implications of Pillar Two, the full end-to-end implications may still be overlooked by other finance professionals, in particular since the aforementioned safe harbors may have provided some implementation relief for the time being. However, Pillar Two may require new granular data elements to comply with the GloBE rules that are not readily available within the organization. Moreover, whereas defining the data points is one part of the puzzle, sourcing the actual data may be even more challenging, as sourcing new granular data points through existing (partially manual) Reporting chains can be time consuming. In addition, data gathering will likely affect multiple entities, regions, business units and require close collaboration between multiple departments (e.g., Tax, Finance, Operations, and IT). Those data points need to end-up in multiple (financial) reports, and therefore impact end-to-end data-to-report processes and related reconciliation and Control mechanisms.
In our view, Pillar Two calls for a multidisciplinary approach
Due to its wider organizational impact, Pillar Two will ultimately require a multidisciplinary approach, in order to structurally arrive at an adequately compliant GloBE income and Covered tax. We see leading companies implementing Pillar Two with a strong collaboration between the Tax, Accounting, and IT functions. The following leading practices are starting to emerge:
Identifying and addressing data gaps, including legal entity information and financial data that is complete and accurate in line with the OECD Model Rules and local QDMTT regulation.
Addressing existing ERP and IT systems to map potentially complex adjustments (e.g., accounts, interfacing, currency adjustments, purchase Accounting), and support the calculation of jurisdictional blending to arrive at the Covered tax and GloBE income, and potentially implement new tooling and interfaces to perform data transfers.
Assess whether additional GAAP conversions and Accounting policy alignments, to the materiality of the local jurisdiction, may be required as Covered tax and GloBE income is generally required to be presented under the current GAAP of the ultimate parent (which is typically U.S. GAAP or IFRS), while the local QDMTT may require a different (local) GAAP.
Developing new processes and automations, such as updating consolidation processes of financial statements at the jurisdictional level and calculating Covered tax and GloBE income; this may include integration updating or integration with tax Accounting technology solutions.
Redesigning consolidation and Reporting processes for ERP transactional data tables, data sourcing automation (e.g., payroll systems), fixed asset sub-ledgers, and further automation of spreadsheets in the Accounting and finance departments.
Creating new (Tax) disclosures to comply with Pillar Two and international Reporting mechanisms, and developing new KPIs to allow for monitoring and steering.
Revising the internal Control framework to comply with the new processes and new/adjusted internal controls ensuring the integrity of data for Pillar Two calculations but also ensuring that the top-up taxes are correctly reflected in the interim and/or year-end financials.
Improving collaboration between Tax, Legal, Finance, Accounting, and Control functions in each jurisdiction to make informed decisions.
Assessing and implementing revised corporate restructures (e.g., entities joining/leaving the group, transfer of assets/liabilities or simplifying the legal structure) as well as the treatment of e.g., joint ventures due to strategic decisions on positioning activities within jurisdictions.
Getting your organization ready for Pillar Two
While safe harbors may enable a better preparation for the full implementation of Pillar Two, MNEs will ultimately need to adopt the new tax regime more widely. Moreover, the end-to-end implications of Pillar Two can also be seen as an opportunity for change. Companies may need to step up their efforts related to the implementation of Pillar Two to make sure the entire end-to-end Reporting chain is adequately addressed. As Finance Leaders begin to oversee the broader impact of Pillar Two, companies may need to prepare their operating model sooner rather than later to yield positive outcomes in the long term. To take action, companies can:
conduct an inventory of potential data gaps, ensuring completeness and accuracy for the required calculations;
evaluate the implications on the end-to-end Target Operating Model and IT architecture to identify potential changes to the Accounting and Reporting operating model (e.g., tooling, interfaces, disclosures);
establish and roll out an implementation plan, including setting up a multidisciplinary team, addressing the changes needed to the finance-wide Target Operating Model, as well as integration into the existing tax framework.
