BEPS Pillar Two Rules: Background, Accounting, Tax and Other Key Considerations
1. Prelude and Overview
At the outset, it may be recalled that the Organisation for Economic Co-operation and Development’s (OECD) Inclusive Framework on Base Erosion and Profit Shifting (BEPS) has been continuously evolving, with a view to developing an agreement on a two-pillar approach to help address key international tax issues like (a) tax avoidance and (b) ensuring coherence of international tax rules—eventually leading to a more transparent tax environment.[1]
Accordingly, in December 2021, the OECD / G20 Inclusive Framework (IF) on BEPS released Model Global Anti-Base Erosion (GloBE) rules (hereinafter called Model Rules or GloBE Rules) under Pillar Two. These Model Rules stipulate a “common approach” for a Global Minimum Tax (GMT) @ 15% on a country-by-country basis for multinational enterprises (MNEs) with a turnover of more than Euro 750 million in the Consolidated Financial Statements of the Ultimate Parent Entity (UPE) in at least two of the four Fiscal Years immediately preceding the tested Fiscal Year.
The underlying objective is to have coordinated global rules that ensure that large MNEs pay an effective tax rate of at least 15% in every jurisdiction in which they operate. This was followed by additional guidance on the Model Rules (including Commentary, an Implementation Framework, and Administrative Guidance). The GloBE Rules are designed to ensure that large multinational companies pay a minimum level of tax on the income arising in each jurisdiction where they operate, irrespective of where they are headquartered. The rules are relatively very complex and will require substantial new forms of financial data that tax departments may not currently have access to (and one school of thought indicates that it may require up to 200+ new data points for each legal entity to comply with the Rules).
2. Key Features of the Model GloBE Rules
- Turnover Scope: The GloBE rules apply to multinational groups (MNE Groups) that have revenue of Euro 750 million or more in at least two out of the last four years. "Revenue" means the revenue reported in the Consolidated Financial Statements of the Group prepared in accordance with an Acceptable Financial Accounting Standard and after adjustments required by GloBE Rules (not limited to revenue recognized in accordance with IFRS 15).
- Jurisdictional Blending: In-scope MNE groups must calculate their GloBE effective tax rate (ETR) for each jurisdiction where they operate.
- Top-Up Tax Liability: If the blended GloBE effective tax rate for all companies in a specific jurisdiction is below the 15% minimum, they will be liable to pay a top-up tax for the difference between the 15% minimum rate and their jurisdictional GloBE ETR. However, if the domestic GloBE ETR is 15% or more, no GloBE top-up tax will be payable.
- Primary Liability on Ultimate Parent: It is the Ultimate Parent Entity (UPE) that is primarily liable for the GloBE top-up tax in its jurisdiction. Accordingly, the group company liable for the top-up tax (e.g., the UPE) will often differ from the group company that triggered it (e.g., a low-tax subsidiary).
- Subject to Tax Rule (STTR): Apart from the above, GloBE Rules also introduce the Subject to Tax Rule (STTR). The STTR is a tax treaty-based rule that allows source jurisdictions to impose limited source taxation on certain cross-border intercompany transactions not subject to a minimum 9% rate of tax. STTR is a creditable tax under the GloBE Rules.
3. Key Components & Operational Hierarchy
The Model GloBE Rules contain two main interlocking components—the Income Inclusion Rule (IIR) and the Undertaxed Payment Rule (UTPR)—and collection operates across three sequential mechanisms:
1st Preference: QDMTT
'Local' Country Measure: Qualified Domestic Minimum Top-Up Tax incorporated into domestic law. Allows the host jurisdiction to collect top-up tax locally on profits earned within its borders, preventing tax leakage to foreign parent jurisdictions.
2nd Preference: IIR
'Parent' Country Measure: Income Inclusion Rule imposes top-up tax at the parent entity level on an ownership interest in a low-taxed foreign subsidiary where the local jurisdiction has not enacted a QDMTT.[2]
3rd Preference: UTPR
'Backstop' Measure: Undertaxed Payment Rule operates if low-taxed income is not brought into charge under QDMTT or IIR. Operates by denying domestic tax deductions or requiring equivalent adjustments allocated via a substance key.[3],[4]
4. Step-by-Step Methodology for Computing Top-Up Tax
| Step | Computational Stage | Substantive Explanation & Methodological Rules |
|---|---|---|
| Step 1 | Calculate GloBE Income (or Loss) | Determined from the financial accounting net profit or loss as per the Consolidated Financial Statements of the UPE, adjusted for required GloBE additions/exclusions (excluded dividends, equity gains, stock-based compensation, and PE allocations). Intra-group items must be added back (not eliminated). |
| Step 2 | Calculate Adjusted Covered Taxes | Sum of current income tax expenses of all constituent entities in the jurisdiction. Non-income taxes (property tax, payroll tax, VAT) are excluded. Adjusted for deferred tax movements and qualified refundable tax credits. |
| Step 3 | Calculate Jurisdictional ETR | Dividing Adjusted Covered Taxes (Step 2) by Net GloBE Income (Step 1). All constituent entities in the jurisdiction are blended together. |
| Step 4 | Calculate Top-Up Tax % | Top-Up Tax % = 15% (Minimum Rate) − Jurisdictional ETR % (if ETR < 15%). |
| Step 5 | Calculate Excess Profit via SBIE | Top-Up Tax % is applied to Excess Profit. Excess Profit = GloBE Income less Substance-Based Income Exclusion (SBIE). SBIE = 10% of eligible payroll expenses + 8% of carrying amount of eligible tangible assets (phased down to 5% each over 10 years). |
| Step 6 | Calculate Top-Up Tax Liability | Excess Profit × Top-Up Tax %, reduced by any applicable domestic QDMTT paid. Allocate to liable entities under IIR or UTPR. |
5. Detailed Numerical Case Study: S1 Limited & S2 Limited
Consider an MNE group operating two constituent entities (S1 Limited and S2 Limited) in a single tested jurisdiction. The following inputs and sequential calculations demonstrate how jurisdictional blending and substance carve-outs determine the net Pillar Two top-up tax liability:[5]
| Input Details & Financial Items | S1 Limited | S2 Limited | Jurisdictional Total |
|---|---|---|---|
| 1. Profit for the Year (GloBE Income) | ₹20,000 | ₹20,00,000 | ₹20,20,000 |
| 2. Current Income Tax Expense | ₹4,000 | ₹76,800 | ₹80,800 |
| 3. Carrying Amount of Eligible Tangible Assets | ₹16,00,000 | ₹3,00,000 | ₹19,00,000 |
| 4. Eligible Payroll Expenses | ₹10,00,000 | ₹10,000 | ₹10,10,000 |
| Calculation Step | Derivation Formula | Quantified Outcome |
|---|---|---|
| 5. Covered Taxes | Total of Item #2 above | ₹80,800 |
| 6. Total GloBE Income | Total of Item #1 above | ₹20,20,000 |
| 7. Blended Jurisdictional ETR | (Covered Taxes / GloBE Income) = (80,800 / 20,20,000) | 4.00% |
| 8. Top-Up Tax Percentage | 15.00% (Minimum Rate) − 4.00% (Blended ETR) | 11.00% |
| 9. Substance-Based Income Exclusion (SBIE): | ||
| • Payroll Carve-out (Article 5.3.3) | 10% of Eligible Payroll Expenses (10% of ₹10,10,000) | ₹1,01,000 |
| • Tangible Assets Carve-out (Article 5.3.4) | 8% of Carrying Amount of Tangible Assets (8% of ₹19,00,000) | ₹1,52,000 |
| 10. Total Excess Profit Base | GloBE Income (₹20,20,000) − Total SBIE (₹2,53,000) | ₹17,67,000 |
| 11. Final Top-Up Tax Liability | Excess Profit × Top-Up Tax % = (₹17,67,000 × 11.00%) | ₹1,94,370 |
6. Accounting Dilemmas & The IAS 12 Amendment
As jurisdictions began enacting GloBE legislation, profound accounting challenges arose under IFRS / Ind AS. Stakeholders questioned whether top-up taxes fell within the scope of IAS 12 Income Taxes, whether deferred taxes had to be recognized on future top-up liabilities, and whether existing deferred tax balances required remeasurement.
Narrow-Scope Amendment to IAS 12 (May 2023)
To address these acute complexities, the International Accounting Standards Board (IASB) issued an urgent, narrow-scope amendment introducing a mandatory temporary exception:
- Paragraph 4A (Mandatory Exception): Entities are mandatorily exempted from providing for and disclosing deferred tax assets or liabilities related to Pillar Two income taxes. Entities will neither recognize nor disclose deferred tax balances arising from GloBE rules.
- Paragraph 88A (Application Disclosure): Entities must explicitly disclose in their notes to accounts that they have applied this mandatory exception.
- Retrospective & No Sunset Date: The amendment applies immediately and retrospectively under IAS 8. The IASB did not include a sunset date; the relief will remain active until standard-setters decide whether to modify or make it permanent.
7. Staged Financial Statement Disclosure Mandates
| Statutory Stage | Mandatory Notes to Accounts Disclosure under Amended IAS 12 |
|---|---|
| Stage 1: Domestic Law Enacted or Substantively Enacted, but Not Yet Effective | Disclose known or reasonably estimable information helping users understand Pillar Two exposure at the reporting date (Paras 88C & 88D): • Qualitative Information: How the company is affected and the specific jurisdictions where exposure arises. • Quantitative Information: Indicative percentage of profits potentially subject to top-up tax and the average applicable ETR, or how the average ETR would have changed. If information is not known or reasonably estimable, disclose a statement to that effect along with progress made in assessing exposure. |
| Stage 2: After Top-Up Tax Legislation is Fully Effective | Under Paragraph 88B, disclose separately in the income tax note: • Current tax expense (or income) related to Pillar Two top-up taxes. • Continue disclosure regarding application of the mandatory deferred tax accounting exception. |
8. Key Takeaways & Enterprise Action Plan
With major economies implementing Pillar Two starting in 2024, corporate finance and tax departments must mobilize immediately:
- Current Tax Expense Impact: While deferred tax accounting is temporarily frozen, current tax expenses in 2024 will be directly impacted by GloBE top-up taxes and QDMTT payments.
- Jurisdiction-by-Jurisdiction Tracking: MNEs must closely monitor legislative enactment timelines across all operating countries to determine when disclosure and payment liabilities trigger.
- IT & ERP Architecture Upgrades: Collecting over 200 required data points—including non-IFRS 15 revenue adjustments, local tax credits, and granular payroll/tangible asset allocations—demands substantial upgrades to enterprise reporting systems.
- Resource Allocation: Companies must allocate expanded budgets, advisory bandwidth, and internal audit controls to manage year-end reporting complexities under the amended IAS 12.
Footnotes & Regulatory References
- The Inclusive Framework on Base Erosion and Profit Shifting (BEPS) was established in 2016 by the OECD and G20, and currently has over 140 participating countries and jurisdictions.
- Under the IIR, the effective tax rate of each jurisdiction is calculated based on all consolidated companies/branches in that jurisdiction and compared against the 15% minimum rate. Top-up tax is charged to the head office.
- If the UPE is in a jurisdiction that has not implemented a Qualified IIR, GloBE rules provide that top-up tax is levied on the next highest entity in the ownership chain located in a jurisdiction with a Qualified IIR.
- Where IIR cannot be applied, top-up tax is collected by all jurisdictions implementing UTPR via a substance-based allocation key, applied as a denial of deduction or equivalent mechanism.
- In the numerical illustration, although S1 Limited has a standalone ETR of 20%, jurisdictional blending blends its profits and taxes with S2 Limited (3.84%), producing a blended ETR of 4.00% and triggering top-up tax across the jurisdiction.