Pillar Two, the global minimum tax framework led by the Organization for Economic Cooperation and Development, was recently introduced and will impose significant new compliance obligations on midsized multinational enterprises.
It's essential to act now as the Global Anti-Base Erosion, or GloBE, model rules are set to take effect for tax years beginning on or after Jan. 1, 2024, in over 140 countries for multinationals with consolidated annual revenues exceeding €750 million (approximately U.S. $800 million). Assessing readiness, identifying pain points and leveraging technology will be pivotal for smooth implementation.
While larger multinationals may have more resources to devote, midsized companies will face proportional challenges in meeting the extensive reporting and compliance requirements. Preparing the mandatory GloBE Information Return will require collaboration across departments, extending beyond the traditional scope of tax departments. This process is intricate and calls for a detailed understanding and presentation of data, coming from various sources and potentially from multiple jurisdictions, which many tax departments may not be equipped to review or prepare.
Each jurisdiction will determine noncompliance penalties, and the OECD recommends enacting a 5% revenue penalty for multinational enterprises not implementing Pillar Two within 15 months after each entity's fiscal year-end — making thorough preparation essential. With undisclosed penalties looming and complex standards for multinational entities to adopt, examining compliance strategies now is imperative.
Compliance with Pillar Two
Before implementing any new processes for compliance, midsized multinationals must thoroughly assess their preparedness for these new obligations, and review their current tax and transfer pricing policies and any cash tax liabilities. This involves evaluating the existing information, systems and processes of their tax departments against the requirements of the model rules and understanding the rules' application in each operating jurisdiction. Further, analyzing key factors such as corporate footprint, tax and transfer pricing profile, effective tax rate, data availability, and operational issues, and identifying data gaps and insufficiencies early on will significantly ease future compliance burdens.
For midsized companies that have to stretch their limited operational and compliance resources, Pillar Two's expansive data and systems access demands will naturally create pain points. For example, the GloBE Return includes extensive information reporting and definitional differences from traditional finance, not typically present on a tax return or financial statement, such as:
- Revaluation of depreciation;
- Foreign currency gains or losses;
- Qualified refundable tax credits;
- Increases and decreases in equity;
- Arm's-length adjustments to intercompany transactions;
- Eligible payroll costs;
- Eligible tangible assets;
- Deferred tax items;
- Ownership interests across the legal entity organization chart; and,
- Changes in accounting principles.
With many requirements typically spread across local legal, tax, accounting and controllership systems, which are not structured for Pillar Two's granular reporting, centralizing all this information can be a great challenge for midsize companies.
Technology and software alignment is critical for multinationals to meet Pillar Two compliance. It's essential to ascertain whether the required data points exist in accessible formats and sufficient detail levels for the mandated calculations.
Leveraging technology will help bridge the necessary components of compliance, including assessing data strategy and operational readiness, streamlining and automating processes, creating workflows that allow different systems to connect and speak to each other, and applying the technical expertise to design a maintainable process.
Silver linings
While compliance poses challenges, effective international tax and transfer pricing strategies provide midsized multinationals opportunities to reduce overall tax burden by aligning transfer pricing policies and legal entity structures with business functions, assets and risks.
When conducting business between two or more subsidiaries, transfer pricing aligns the profit attributable to a jurisdiction with the functions, assets and risks utilized in the business operations. Proper transfer pricing planning and review can ensure that the profit existing in a jurisdiction continues to align over time.
When considering strategies to offset the tax burdens associated with Pillar Two rules, consider asking questions such as:
- Are there certain companies with employees, functions or risks that have expanded over time?
- Have you reviewed the overall profitability in your supply chain and how that profit is allocated among the entities involved?
- Have the dynamics of your business or market changed, increasing the risks associated with business operations?
- Are there legal or regulatory requirements that have changed the way your business operates in a jurisdiction?
- Have you centralized or outsourced any functions?
Pillar Two is more than a compliance challenge; it's an opportunity to rethink and realign an organization's tax and transfer pricing strategies. In the evolving tax and transfer pricing environment, proactive adaptation and strategic planning are key to turning compliance into opportunity.
