Episode Transcript
[00:00:00] Foreign.
[00:00:05] 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.
[00:00:17] This is Ed Raza. I'm a Senior Director in the Tax practice of A and M based out of Hong Kong.
[00:00:23] By way of background, I have been a US Cap and IFRS Tax Reporting Specialist for over the past 19 years with experience of working across New York and Hong Kong serving clients in global markets, experience as an external auditor of US SEC, FTSE 100 and Hong Kong exchange listed companies in prior Big Four capacity and currently at A and M serving clients across transactions, regulatory accounting changes, tax law changes, bankruptcies, restructuring and transformation of the tax reporting function for those looking for an optimal sourcing model in the prior podcast you heard from my colleague Bruno Da Silva speak through an overview of the OECD side by side reforms that were released a few weeks ago.
[00:01:16] This is a continuation of that and our objective is to speak through the reforms in simple Weekly podcast outlining the reforms, objectives and a pragmatic solution for you to consider bearing the knowns and the unknowns of the rule.
[00:01:31] 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 new OECD guidance which will bring the new guidance into law in those jurisdictions today.
[00:01:51] Other jurisdictions will require amended legislation or other procedures to adopt the new guidance into local law.
[00:02:00] Companies should assess carefully their jurisdictional footprints to determine when and how the new guidance will impact their organizations.
[00:02:10] Another thing to bear in mind is that the foundation for Pillar two is your group and local statutory tax accounting starting off at the legal entity basis.
[00:02:21] Secondly, consolidation tax accounting adjustments continue to be a component of your Pillar 2 adjustments in the Simplified ETR safe harbor provision.
[00:02:33] In summary, in pre pillar 2 world ATR interfered taxes were primarily a function of financial disclosures.
[00:02:41] Now and beyond, they are used for actual tax calculations which continues to be transformational.
[00:02:51] Now let's get into the provisions and go through the mechanics of what it is if a multinational group simplified ETR in a jurisdiction is 15% or higher. The new safe harbor deems that no top up taxes to you for that jurisdiction.
[00:03:08] In simpler terms, simplified ETR streamlined effective tax rate calculation using a jurisdiction's financial accounting, income and tax expense with minimal adjustments instead of doing the full pillar 2 math.
[00:03:23] This safe harbor is intended to permanently simplify the pillar to compliance for companies in low risk jurisdictions.
[00:03:31] It becomes mandatory for all jurisdictions from 2027 onwards with optional early use in 2026 if the local law allows it.
[00:03:42] This is intended to replace the transitional CBCR safe harbor and reshape the approach to GLOBI compliance and moving Pillar two towards a more predictable system, one that relies far more on existing reporting structures and far less on the exhaustive adjustments required under the full globe E computation.
[00:04:05] Secondly, the safe harbor applies on a jurisdictional basis, meaning that the focus shifts from entity level calculations to the combined position of all constituent entities within a single jurisdiction.
[00:04:19] If that jurisdiction achieves a simplified effective tax rate of at least 15%, the top of for that entire jurisdiction is deemed to be zero for the year.
[00:04:30] We'll go through some of the mechanics in further detail, but I do want to point that we have observed that the simplified ATR safe harbor still feels very close to a full pillar 2 calculation than a light shortcut.
[00:04:46] So while I should reduce the compliance effort in jurisdictions that clearly have a high tax rate, if it does not eliminate the heavy lifting in all the cases.
[00:04:59] Let's go into further details on the mechanics Simplified Income and Simplified Taxes are two streamlined concepts that have been introduced.
[00:05:11] Simplified income that starts off from the jurisdictional profit before tax, just as reported in the Group's financial reporting package, and then applies only a limited number of adjustments.
[00:05:24] These include the removal of excluded dividends and excluded equity gains and losses, as well as the addition of certain non deductible items that are above a defined threshold.
[00:05:35] Beyond these adjustments, there are targeted industry specific adjustments for groups operating in financial services or the international shipping industry.
[00:05:46] We also have conditional adjustments which are only required in specific circumstances, such as when income is reported directly in equity or where purchase price allocation adjustments impact both the income and deferred taxes in the accounts.
[00:06:03] And finally, there are a set of optional adjustments essentially mirroring certain elective features under the standard full global calculations, some of which require a five year binding election.
[00:06:17] Simplified Taxes follows a similar philosophy. You'll start off with the jurisdiction's income tax expense as recognized in the financial statements referred to as the jurisdictional income tax expense, adjusted to remove any amounts that don't qualify as covered taxes under the GLOBI rules.
[00:06:36] The rules then outline how deferred taxes are handled, and they introduced a simplified mechanism for dealing with situations where the jurisdiction experiences a loss and generates a negative tax.
[00:06:50] Any negative amount that exceeds a defined threshold must be carried forward as a negative tax attribute, similar to the excess negative tax concept under the main GLOBI framework, during transition, groups can apply a loss DTA adjustment instead of the negative tax mechanism.
[00:07:12] Another adjustment to mention are true ups that don't require amendments to simplified income or simplified taxes.
[00:07:19] Instead, any differences flow through to the year in which they are recognized in the accounts.
[00:07:27] Transit Pricing under the default full GLOBI rule, any transit pricing adjustments made after year end must be reflected in the year in which it is recognized, both for income and the related tax effects.
[00:07:41] But the Safe harbor rules offers a five year election allowing groups to reassign the adjustment to the original transaction year provided that the adjustments finalized within 12 months of year end.
[00:07:57] Entry into the safe harbor is further governed by simple test.
[00:08:03] The group must have had no top up tax in that jurisdiction for any fiscal year beginning in the previous 24 months.
[00:08:11] This can occur either because the full Globe B computations are produced no top up tax, or because the group relief on the transitional CBCR safe harbor or because the jurisdiction simply wasn't subject to GLOBI or a QDMDT in that year.
[00:08:30] Once inside the safe harbor, the group can continue to apply it after year end, but if it drops out for a year, it must again satisfy the 24 month no top up tax test before reentering.
[00:08:45] Safeguarding the integrity of the system is another top priority of the simplified ETR safe Harbor.
[00:08:52] To prevent mismatches, double counting, or artificial shifting of income taxes, the Safe harbor incorporates four foundational principles.
[00:09:02] Income must be matched with the corresponding tax expense in the same year.
[00:09:07] All profit and loss must be allocated to exactly one tested jurisdiction.
[00:09:12] Expenses and losses can only be deducted once, and taxes must only be recorded once.
[00:09:19] If the group's accounting does not naturally satisfy these principles, it must make appropriate adjustments.
[00:09:26] Finally, the Safe harbor interacts with local QDMTTs, especially in jurisdictions that apply local financial accounting standards.
[00:09:38] While these jurisdictions may require GLOBI and Safe harbor calculations to be performed based on the local standard, the OECD encourages them to allow groups to use the same accounting standard as their consolidated financial statements to maximize simplification.
[00:10:00] So how does this compare to the transitional CB CFR birth that we have in place now?
[00:10:06] If you think about that, the CBCR safe harbor was meant to be temporary in nature and act as a bridge while everyone geared up for the full Pillar 2 calculations?
[00:10:18] Initially it was set to expire after 2026, but with the new SPS package it got extended one more year covering 2027. To ease the trans the new simplified ETR regime, the computation used data that companies already produced, provided that the CPCR data is qualified with almost no additional computations. If you qualified.
[00:10:47] One case to be mindful of is that the transitional Safe harbor had a once out always out rule, meaning that if a company failed to qualify in a jurisdiction once, it couldn't use the CPCR Safe harbor for that jurisdiction in later years.
[00:11:02] In contrast, the new simplified ETR Safe harbor is more flexible.
[00:11:07] Companies can generally opt in or out each year by jurisdiction as long as they meet the criteria without the strict lockout provision.
[00:11:21] In comparison, the full GLOBI calculation is a comprehensive method.
[00:11:27] You take each entity's financials, adjust them per the GLOBI rules, which involves, if you think about it, a long list of inclusions and exclusions, timing, alignment and treatment of taxes and credits.
[00:11:42] Then you aggregate by jurisdiction, then compute whether the effective tax rate is below 15% and if so, apply the top up tax.
[00:11:54] There's also numerous adjustments, elections around currency gains or pension cost, and also tracking of other temporary differences such as a special five year deferred tax recapture provisions.
[00:12:07] In short, that is a massive compliance effort.
[00:12:14] The simplified ETR Safe harbor sits somewhere in between.
[00:12:19] It uses readily available financial reporting numbers which in theory makes it more data friendly than full global and it's applied at a jurisdictional level than at a constituent entity level. But it still requires some careful adjustments and calculations within the Pillar 2 framework.
[00:12:40] Think of that as a slimmed down Pillar 2 calculation, simpler in shape but not weightless.
[00:12:49] I mean the full globe is now rolling out many jurisdiction rules took that into effect in 2024 or 2025.
[00:12:58] The transitional CBCR safe harbor covered the years 2024 through 2026, now extended through 2027.
[00:13:06] The simplified HR safe harbor becomes available for 2026 as an optional and fully enforced from 2027 onwards as a permanent fixture.
[00:13:19] So there is going to be that overlap from 2026 through 2027 where companies might be able to choose between using the last of the CBCR Safe harbor or the new simplified approach after that. The simplified ETR method should effectively replace the CBCR Safe harbor for the longer term.
[00:13:43] Now let's speak to the critical role of tax account into the overall process which is the core foundation for Pillar two.
[00:13:51] Your financial statement, tax reporting group GAP and Local STAT is the bedrock of all these Pillar two calculations.
[00:14:01] Why?
[00:14:02] Because both Pillar two rules and Safe harbor rely on bulk accounting and the tax figures as their starting point.
[00:14:11] The simplified ETR Safe harbor explicitly uses the consolidated financial statements profit before tax and tax expenses inputs.
[00:14:21] Even the Transitional CBCR Safe harbor requires that your CBC reports be qualified financials, essentially aligning with the audit accounts and for full globi. Of course that begins with financial pre tax book income and you go through a defined list of adjustments.
[00:14:41] What this means is that the quality and the nature of your tax accounting provisioning process deferred tax calculations directly affect your pillar 2 outcomes.
[00:14:56] Now given these issues, what are some of the practical steps that you can take now to navigate through the new Safe harbor provisions and solutions for you to consider?
[00:15:08] Number one, Leverage the Safe Harbors strategically.
[00:15:12] Use the Transitional CPCR Safe harbor while it lasts for you.
[00:15:17] This can significantly reduce the initial compliance burden.
[00:15:21] Identify which jurisdictions qualify under the test.
[00:15:25] This lets you focus your detailed Pillar 2 computations on the handful of jurisdictions that are likely low tax.
[00:15:32] At the same time, prepare for the switch to the Simplified ETR Safe harbor as the transitional rules phase out early on, you might even have a choice.
[00:15:43] Some jurisdictions may allow the new simplified ATR calculation early or you could use last year of the CBCR Safe Harbor Model both options to see which is easier and more beneficial to you.
[00:15:59] Be flexible and choose the optimal safe harbor on a jurisdiction by basis and on a per year basis. That is going to save you a lot of effort and potential top of tax exposure based upon your profile.
[00:16:16] Number two, take a risk oriented approach and update your pillar two assessment for fiscal year 26 now utilizing fiscal year 25 data as a baseline.
[00:16:28] Define your risk parameters and update your pillar to impact assessment across defined parameters and if you do that, the hidden unknowns will pop out and you will have a game plan to address through interim fiscal year 26 provision timeline.
[00:16:51] In summary, the Simplified ETR Safe harbor is a welcome development along with the Transitional CBCR Safe harbor which aims to make the Pillar to Compliance more manageable by using the numbers the company already has in place within their financial statements.
[00:17:09] It concentrates the complexity where it truly matters.
[00:17:15] By understanding how it compares with the full Pillar 2 rules and its predecessor, and by recognizing the crucial interplay with tax reporting, companies can chart a clear path forward success. Over here is part tax strategy, part robust tax accounting and data.
[00:17:36] Use the relief while you can.
[00:17:38] Prepare for the detailed work where you must and above all build on your financial reporting foundation for this new layer of global tax compliance reporting under the new side by side reforms.
[00:17:52] Well, thanks for listening. We hope that this breakdown helps you approach your Pillar 2 in the new simplified ETRC with more confidence and clarity.
[00:18:02] Stay tuned for our next episode where we'll explore another piece of the side by side package puzzle.
[00:18:09] Until then, Happy Compliance and Happy reporting. I'll talk to you soon.
