As businesses navigate their first audit of a financial year subject to the Pillar Two rules, we consider the key pressure points businesses need to prepare for.

What are the Pillar Two rules?

The Pillar Two rules are a global minimum tax framework aimed at ensuring large multinational enterprises (MNEs) pay a minimum level of tax regardless of where they operate. As these rules begin to take effect across jurisdictions, this is the first time the financial statements of many MNEs are being audited in the context of the Pillar Two rules. The implications are far-reaching, from data collection and provisioning to disclosure and governance.

How do they tie into an audit process?

Increased scrutiny of management’s approach to Pillar Two

There is now greater emphasis on the robustness of management’s approach to Pillar Two compliance. Key areas of focus include:

• Compliance and governance strategy: Management should be able to provide detailed documentation of the group’s approach to Pillar Two for the relevant financial year. This includes how data was gathered, the compliance profile established, and the governance strategy adopted.
• Safe harbour analysis: Evidence supporting the application of safe harbour provisions is critical. This includes proof of the qualifying status of Country-by-Country Reporting (CbCR) and how the group meets the relevant thresholds.
• Complex positions and elections: Management should ensure they can support the rationale behind elections intended to be made under the rules, and assess the impact of material accounting positions such as purchase price allocations and impairments, as well as material transactions such as debt restructuring and divestments.

Complexity surrounding the provisioning process

The provisioning process for Pillar Two top-up tax introduces several layers of complexity:

• Recognition: Current tax must be recognised for top-up taxes expected to be payable in respect of the profits for the period, based on enacted (US GAAP) or substantively enacted (IFRS and UK GAAP) legislation. If there are uncertainties, management will need to consider how those are measured and whether any tax related contingencies should be disclosed. The G7 announcement earlier this year confirmed that US parented groups will be exempt from certain aspects of the Pillar Two rules. Where this exemption has not yet been enacted it should not be reflected in the financial statements of relevant entities.
• Phased jurisdictional implementation: With staggered implementation dates, such as Singapore, Hong Kong, Guernsey and Jersey from 1 January 2025, and optional implementation in Poland from 1 January 2024, provisioning may become a jurisdiction-by-jurisdiction exercise. The complexity increases when both the ultimate parent entity is in a territory that is not implementing the Pillar Two rules, and the group has more than one intermediate parent entity that becomes a responsible member for Pillar Two purposes.
• Domestic minimum departures from model rules: Many jurisdictions have implemented a domestic top-up tax (DTT), as this enables collection of any top-up tax due on profits arising in a particular jurisdiction to be collected in that jurisdiction. Some jurisdictions have introduced a DTT that deviates from the OECD’s model Pillar Two rules. These local departures mean that detailed knowledge of the rules in each relevant territory is required in order to ensure provisions are accurate.
• Deferred tax recognition: The deferred tax of entities that are immaterial for group reporting may not be calculated for the purposes of, or included in, the MNE’s consolidated financial statements. However, as the Pillar Two top-up tax calculations are based on the consolidated accounts, this unrecognised deferred tax may not be taken into account as part of the top-up tax calculations where there is no basis of deferred tax calculation recorded. In some circumstances, this may result in a different top-up tax liability than was initially expected. In these circumstances, MNEs may wish to reconsider their approach to the recognition of deferred tax of immaterial entities in their consolidated financial statements.

Additional disclosures of expected top-up tax profile

Under IFRS and UK GAAP, a mandatory temporary exception means that there is no requirement to account for deferred tax arising from the Pillar Two rules. However, accounting standards still require certain Pillar Two disclosures in financial statements, including:

• Confirmation of whether the MNE expects to fall within the scope of Pillar Two.
• Status of legislation implementing the Pillar Two rules in relevant jurisdictions.
• Expected financial impact, if reasonably estimable.
• A statement on the non-recognition of deferred tax under the temporary exemption. Disclosure exemptions may apply for entities included in consolidated financial statements.

How our Pillar Two team can help

The Pillar Two rules are reshaping the audit landscape for in scope MNEs. With increased scrutiny, complex provisioning requirements, and evolving disclosure expectations, businesses must be proactive in preparing for their audits.

If you would like support with your audit process or to discuss your Pillar Two approach more widely, get in touch with our Pillar Two team leads, Sarah Hall and Kaila Engelsman.

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