Episode Transcript
[00:00:00] Speaker A: Foreign.
[00:00:05] Speaker B: And welcome to our podcast series A and M Tax Talks Tax Policy Updates, where we bring you insights into the latest developments in global tax policy and controversy space.
This is Ed Raza. I am a Senior Director in the Tax practice of A and M, based out of Hong Kong and I am joined by Jay Thompson, International Tax Managing Director from our Melbourne office.
In a prior podcast you have heard from our colleagues speak through an overview of the OECD side by side forms that were released in early January.
This is a continuation of that and our objective is to speak through the reforms in a simple weekly podcast outlining the reforms objective and a pragmatic solution for you to consider bearing the knowns and the unknowns of the rule. I do want to highlight that the OECD Guidance is not enacted law. Having said that, there are a few jurisdictions whose enacted Pillar 2 legislation provides for automatic adoption of the no of the new OECD Pillar 2 guidance, which will bring the new guidance into law in those jurisdictions today.
Other jurisdictions will require amended legislation or other procedures to adopt the new guidance into local law. Therefore, for all of us on the line, we should assess carefully the jurisdictional footprints where we operate to determine when and how the new guidance will impact the organization.
So this is where we are now. And now moving into fiscal year 26 and beyond.
You have heard us say this many times to undertake a risk based review in updating your Pillar two assessment and unboxing these side by side reforms.
Today we're going to provide you a viewpoint on how best to unpack this problem statement based on defined risk parameters. And that should hopefully help you unlock the hidden unknowns and ideally help you develop a game plan to address these through interim fiscal year 26 and moving on to fiscal year 27 and fiscal year 28.
So Jade, the question that I get from clients is that I don't want to overkill the process, Ed, and I don't want to do the assessment again. And I think there needs to be a fine balance between materiality and precision of the data on a specific process based upon a company's profile. I'd love to get your thoughts on that.
[00:02:45] Speaker A: Yeah. Thanks Head Hi everyone.
I think as a starting point, one of the biggest questions with Pillar two is exactly that. It's how precise does our data actually need to be?
And I think the answer here really depends on your pillar 2 exposure and what you're using the data for.
There isn't one materiality threshold anymore and you have to sort of think about it in layers.
So at the compliance end, you have the globe information return, where materiality is at its lowest and precision is at its highest.
And why is that? It's really because pillar two is formula driven and it's jurisdictional.
So a relatively small adjustment in a low profit jurisdiction can push your effective tax rate below 15% and trigger top up tax.
So here this isn't just traditional tax materiality, it's a mechanical position and clean jurisdictional data. Robust tracking of globe adjustments and tight reconciliation to financial accounts is necessary.
And then we kind of move one step back to the statutory accounts and group provisioning.
And here the precision is really driven by things like auditor expectations and how close you are to the 15% line.
So if you're comfortably above 15% or you're relying on safe harbors, modeling that you do may be lighter. But if you're sitting at 15 to 16% in key jurisdictions, the scrutiny increases and your practical materiality thresholds drop.
So precision becomes exposure driven and risk adjusted. And the closer you are to the line, the lower your practical materiality threshold becomes.
And then the third kind of layer to this is around the globe adjustments and elections. So if we think about equity gains exclusions, deferred tax recast, substance based exclusions, if one of those adjustments is the reason you're above 15%, then it needs to be highly precise and well documented.
If it's not ETR driving, then you may apply a more pragmatic approach to the thresholds.
So here the materiality isn't just about size, but it's about whether the adjustment is structurally important to your pillar 2 outcome.
And then the fourth layer is for transactions, you don't necessarily need compliance level detail everywhere.
You need decision grade precision. So think about things like does the deal push a jurisdiction below 15%?
Does it change blending outcomes?
Does it affect deferred taxes? If it moves the effective tax rate in a meaningful way, it matters. But if it doesn't, then you don't really need to over engineer it.
And then the final layer here is around governance, which is really important.
But even a small adjustment needs traceability if they relate to key elections or recurring globe positions.
And tax authorities will expect a clear bridge from the financial accounts to the globe income.
So precision here is about defensibility and repeatability, not just around the numbers.
So I think to sort of wrap all of that up together, I think pillar two changes how we think about materiality. It's no longer just a financial statement concept, but it's jurisdictional, it's mechanical, and it's risk based. And the closer you are to your exposure, the lower your effective materiality threshold becomes. And the precision should really be calibrated to the risk not applied uniformly across the group.
[00:06:33] Speaker B: Thanks, Jade. And I love the way that you said that just now. If it doesn't matter materially, do not over engineer it.
And that really comes down to the risk profile or the risk drivers for the organization.
And let's unpack that a little bit as well. Right.
And think through some of the action items that we would have to consider from a commercial policy and from an operational standpoint, really from a CFO or a business strategy lens as well.
So when we think about the risk drivers that's applicable to a company, I really think of it across I would say seven distinct pillars. Right.
Number one, it would be essentially as you're redoing the impact assessment is assess the jurisdictions where you are at that 15% ETR threshold.
[00:07:30] Speaker A: Right.
[00:07:30] Speaker B: That would be one item to focus on.
Number two would be based on materiality. You might want to focus on your material global adjustments that might drive you potentially being potentially drives your cash tax outlay as well as globi adjustments that from a data and from a technology perspective as well, there are some pain points around that. The common ones that we normally see within the context of financial services as an example would be items such as excluded dividends or excluded equity gains and losses.
Why is that? That is a material adjustment in your globi calculations within the context of financial services.
And if you think of it at the precision and precision level of the data that you need, you really have to go down to the underlying investment reporting system, preview the time period of the securities that you're holding onto as well as the application of the exclusion rules.
So within the context of a client profile, that might be material, that's a material risk driver. On the other hand, for other clients that do not fit that profile, that might be a low risk profile. So you have to think of it that way.
Then we talked about data governance and technology stack as well.
Depending on where you are from a local statutory reporting perspective and legal entity group gap reporting, as well as your overall profile, that's going to determine whether or not data and your tax technology infrastructure, how high is that on your risk profile and a driver of the risk for yourself.
And then last but not the least, I would say it would be the technical interpretation and the application of the Globey rules. Because as we can all attest to, the rules are complex.
They are subject to judgmental interpretations and the application.
And you don't have to over engineer the term that Jade used just now and when overkill the process, but maybe focusing on your material globey adjustments, maybe spend a little bit more time on that and go through a view in terms of what the appropriate technical interpretation is that drives the appropriate outcome for you to think through that. So think of that as some of those risk drivers to really take a step back and assess. And that Jade, I would say is going to drive out what the action items might be as you go through the impact assessment. Fiscal year 26, right?
[00:10:12] Speaker A: Yeah, absolutely.
It's really critical when you think about Pillar 2 readiness to frame it around your risk parameters and translate those into the actionable plans for not just FY26, but sort of FY26 and beyond.
And I think when you're doing those impact assessments it's important to look at it, you know, firstly from a commercial assessment perspective. So evaluating your safe harbour eligibility, look at new safe harbours and transitional provisions, including the interaction between the country by country reporting transitional safe harbour and the simplified ETR safe harbour for FY26 and FY27. And at the same time assess any qualified tax incentives to see if they meaningfully reduce your pillar two exposure. So this is really about identifying where your structural relief might lie before running those detailed calculations.
I think the next step on that impact assessment is around data and technology architecture.
So assessing whether you can aggregate jurisdictional data consistently on both group GAAP and local statutory basis and also revisit side by side mapping for globe adjustments and ensure that your tax provision and compliance processes are integrated.
And I think without a clean auditable data flow, even minor adjustments can sometimes create some unnecessary risk. So you just want to think about that.
The third part of the assessment is considering your policy interactions. So how do domestic regimes and worldwide tax systems interact with your qualified side by side regimes?
Are your positions aligned between the net CFC tested income and the globe rules? Net CFC tested income being the new Gilti rules in the US or for QDMTT jurisdictions. Compare the outcomes under local accounting standards vers group gap to identify any potential mismatches or other gaps. So this is really where you turn compliance mechanics into strategic policy insight.
And then the fourth element of the impact assessment is around cash and transaction planning. So updating FY26 and beyond analysis for new substance based tax incentives that Qualify under Pillar 2 Model Deferred Tax adjustments and plan for anticipated transactions through scenario plan planning. So this ensures that your operational decisions from M and A to restructuring are informed by the pillar 2 lens and don't necessarily create unexpected top up tax.
So you really kind of want to look at it from a, you know, a holistic perspective.
[00:13:08] Speaker B: Yeah, thanks Jade. And I think it's interesting how we're thinking about the assessment across commercial policy and operational.
I'd love to get your perspective because you, me and some of our other team members have been traveling across the region in Asia Pacific as well as across in US and emea. And the sense that I get is that clients are on different spectrums.
Whether it is right now they're focused on just the pure compliance versus others that are a little bit more sophisticated and they're focused on more strategic planning.
Are they both in completely different boot camps, Jade, or do you have a view that more broadly it differs by region, differs by client? What's your view on that?
[00:14:01] Speaker A: Yeah, it's really fascinating, Ed, I think, and we've spoken about this previously, there seems to be two sort of camps of people.
There is the glass half empty camp of folk who are really focused on getting the compliance basics right, globe reporting effective tax rate calculations, top up tax exposures, et cetera. And then you have the glass half full camp who's really looking at pillar two from a strategic lens and really looking at, you know, their M and A and other transactions, tax incentives, safe harbors, and also doing early scenario planning for FY26 and beyond. And it, it sort of goes beyond a pure pillar 2 lens and looking at business models and operating models are, you know, is what is in place today is that fit for purpose? As companies are kind of transitioning into the new world where we have this new global tax framework, we have a lot of changes around tariffs and customs and royalties, post Pepsi, PepsiCo and other things that are happening around the globe. And really looking at this as that trigger point for a refresh and a rethink around their existing structures, their existing models and is it fit for purpose going forward? So I don't necessarily think that it's jurisdictional specific. I think it really depends on the footprint and the profile of multinationals. But I think what's been really fascinating is this is a really consistent theme that's coming through in a lot of the conversations that we've been having.
[00:15:42] Speaker B: Thanks, Jade. And I think the one thing that I do want to highlight is when we've been speaking with clients jointly, there are some significant opportunities for us to take advantage of as well as a result of the assessment because this is, yes, I know that this is a bit of a pain from a compliance perspective and essentially reconfiguring what we might have done previously for the SPS reforms. But Jay, there's some significant opportunities that clients can take a step back and assess on this. That's really going to derive the appropriate commercial outcomes from the CFO's perspective as well, right?
[00:16:22] Speaker A: Absolutely. And sometimes it doesn't necessarily mean wholesale change.
It can simply be just looking at what is currently in place and whether that needs free documentation or do you need to look at your flows and so forth. So it's not necessarily, it can mean a holistic change or it cannot mean a holistic change.
[00:16:46] Speaker B: Thank you, Jake.
No, that's, that's helpful. Thank you.
Well, I hope you all found this helpful. So let's take a step back and let me just speak through some of the key takeaways that I've taken from this.
Number one is as you're unboxing the side by side reform, let's not overkill, let's not over engineer your assessment. Take a practical and a pragmatic approach to the problem statement based on the risk parameters that need to be defined based upon your profile so you can focus on areas that really matter.
As you focus on the areas that you have identified, apply the appropriate materiality and the risk based approach as well as the precision of data so that we are managing the process effectively.
The outcome of the assessment hopefully is going to position you forward in terms of how best to tackle this from a technology perspective, data, strategic tax planning, as well as what your future state operating model might be for fiscal year 26 and beyond.
That's the way to think of it in a very practical and a pragmatic fashion for you to undertake this assessment as a result of the side by side reforms.
So that is it from us. I hope you found that helpful.
And for those of you listening in from the Pan Asia region celebrating the Lunar New Year festivities, I hope you all have a wonderful break for the families and we'll talk to you soon. Thank you.
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