Deferred tax judgments could increase business compliance burden

The UK introduced Pillar Two global minimum tax rules for accounting periods commencing on or after 31 December 2023. So, for groups with a 31 December 2024 year end, we are approaching the end of the first year in which the Pillar Two rules may apply.

Broadly, these rules apply for multinational businesses with revenue of at least €750m. The minimum tax rate is currently set at 15% and the resultant Pillar Two ‘top-up tax’ will be payable either by the ultimate parent entity or an intermediate parent in the group structure. Some territories, including the UK, collect any top-up tax locally through a domestic minimum tax.

These rules are one of the key outputs of the Global Anti-Base Erosion (GloBE) project undertaken by the Organisation for Economic Cooperation and Development over the past decade.

Transitional safe harbours are available to multinational groups for periods starting no later than 31 December 2026 and ending no later than 30 June 2028. Entities falling within these safe harbours will not need to perform full Pillar Two calculations or pay top-up tax.

One of the Pillar Two transitional safe harbour rules is the simplified effective tax rate (‘simplified ETR’) test. If met, the test means the jurisdiction is deemed to have a nil top-up tax position and significantly reduces the data gathering requirements and, therefore, reporting requirements.

The simplified ETR test is calculated by reference to Country-by-Country Reporting (CbCR) data, plus deferred taxes in financial statements (less taxes relating to uncertain tax positions), as shown here:

Simplified ETR test

The jurisdiction has an effective tax rate of at least the transition rate in the fiscal year, where:

• Simplified ETR is the simplified current taxes (income tax accrued in CbCR report plus deferred taxes in financial statements less taxes relating to uncertain tax positions) divided by CbCR profit before taxes
• Transition rate is:
  1. 15% for fiscal years beginning in 2023 and 2024
  2. 16% for fiscal years beginning in 2025
  3. 17% for fiscal years beginning in 2026

If, for example, an entity or jurisdiction in the group recognises deferred tax assets in the current year that were not previously recognised, this would give rise to a deferred tax credit in the financial statements, reducing the overall simplified ETR. If this credit is sufficient to bring the overall simplified ETR below 15% (or the transition rate for the relevant year per the bullet points above), the simplified ETR test could be failed.

There are other transitional safe harbour tests that can be considered (the ‘de miminis test’ and ‘routine profits test’), however these will not be available to all entities.

There is a ‘once you’re out, you’re out’ rule for transitional safe harbours, meaning once the transitional safe harbour tests are failed once, it is not possible to apply the tests again the following year and the full Pillar Two data gathering and reporting requirements will continue to apply. This therefore needs to be considered carefully in each relevant year.

It is important that groups are fully aware of the potential impacts of their year-end tax accounting and reporting judgments, as they could have implications beyond the immediate requirements of the financial statements.