Pillar Two – how it works - BDO UK

Disclosures in financial statements

Now that the Pillar Two rules are in force, in-scope groups have both a disclosure obligation from a reporting perspective and any tax arising under Pillar Two will need to be quantified in the tax provision.

From a current tax perspective, tax arising under Pillar Two should generally be accounted for as an income tax.

The accounting framework requires disclosure of the expected impact of the Pillar Two rules in periods in which the rules are substantively enacted but not yet in force. Once the rules are in force, the requirement switches to disclosure of the top-up tax with potentially a reduced narrative/qualitative disclosure obligation. However, many multinational groups will now experience several periods of flux where some entities are fully in the scope of the rules, while others are in territories which are either yet to legislate or where the rules have been substantively enacted, but no tax can yet fall due. This patchwork brings with it both complexity in terms of where any additional tax will be levied in these ‘in between’ years and the need to still include disclosures for those territories yet to come ‘online’, as well as an estimate of any tax due for those already in force.

In estimating Pillar Two liabilities, groups need to expect a greater level of scrutiny from their auditors as amounts are being recognised in the accounts and not only disclosed. This also applies where groups are stating there is no liability to account for. The following are our observations in this respect:

Auditors will be as interested in the source of the data used in the estimates (and the processes used to gather that data), as the estimates themselves. Groups may find it difficult to obtain sufficiently granular data for the current period and therefore use the previous period’s data to arrive at the estimate. This is potentially acceptable, but auditors will want assurance and may test that no one off events or changes in the underlying business mean that the past position is not indicative of the current period. Technology can have an important role in accelerating the ability of a group to use current period data to derive Pillar Two outcomes (as well as to support from a process perspective) and is therefore likely to be an important feature in ensuring smooth audit processes and facilitating real-time planning.

Many groups are using Country-by-Country Reporting (CbCR) data to underpin their estimates through reliance on the transitional CBCR safe harbour, where such data exists or can be forecast. The TCSH provides for a much-simplified determination of whether top-up tax is due in a territory where the CbC Report is “qualifying” for a territory. It is a generally sensible approach to seek reliance on this safe harbour where possible, but in some cases, it has not been possible for a business to easily evaluate whether they are able to produce a CbC Report that is ‘qualifying’ under the relevant rules. To be ‘qualifying’ means to meet certain requirements on how the CbC Report is compiled and the data sources used. This will need to be tested, and assurance obtained, before reliance can be placed on the TCSH in any jurisdiction. In periods prior to the rules coming into force, many groups were able to state to their auditors an intent to ‘fix’ the process for the first reporting period where the rules apply. However, in periods where the rules are in effect and businesses are in scope, auditors will want to understand the work that groups have undertaken to satisfy themselves that their CbC Report is qualifying for each jurisdiction where they intend to rely upon it, what issues were identified and what remedial work is underway.

For the 2026 and 2027 periods, both the TCSH and the SESH are in principle available to groups. Businesses may wish to run parallel calculations to determine which safe harbour may apply in each jurisdiction, and where there is a choice of which to rely on, should take into account factors such as the different consequences of claiming each (for example, due to interaction with the transitional period).

The OECD has issued several sets of guidance to clarify, and in some cases amend or augment, the Pillar Two framework. Countries are then legislating and issuing guidance at different paces to reflect these OECD changes, or to remedy deficiencies and unintended consequences in their own drafting.

It is likely that there will continue to be significant practical divergence from what should be a ‘model’ set of rules due to the approach of different legislatures and competing domestic requirements.

For example, there has been divergence of certain territories from the OECD recommended timeline for registration and reporting for Pillar Two reporting processes, as well as certain countries requiring much more detailed local returns, in some cases including a significant amount of information on the global group, than was envisaged. In other cases, no return is required where no top-up tax is due. We expect to see more such deviations from the OECD suggested approach as time passes.

Find out more about the latest developments in the implementation of Pillar Two around the world

UK only groups are not fully exempt from the rules

One of the perhaps surprising outcomes from a set of rules that is prima facie designed to tax multinational groups is that UK-only groups are not exempt from the entire framework if they breach the turnover threshold. The DTT, which is designed to ensure that the UK retains the taxing rights over UK income, applies to such groups – and hence they also need to demonstrate they are paying an effective rate of more than 15% under the rules to avoid an additional charge, with the same disclosure obligations in the accounts.

Further, even a very small UK subsidiary of a large multinational group will be in scope of the DTT and must take action to comply.

Pillar Two is not just a compliance and reporting matter

While there are undoubtedly compliance and reporting challenges associated with Pillar Two, it must be remembered that it is a live tax. That means that the Pillar Two consequences of any transaction, restructuring or other event should be analysed in parallel to the Corporate Tax, VAT or stamp duty consequences prior to implementation. This will need to be built into group tax governance processes, and appropriate training (see here) provided to workers to be able to identify potential Pillar Two implications and to seek support where needed.