Author: Doug McHoney, International Tax Services Global Leader, Partner, PwC United States
Global compliance obligations, including tax provisions and local filings, are already exceptionally complicated and demanding for tax departments and administrators. Pillar Two’s complexity, novelty and associated uncertainty compound these challenges. Put simply, this overhaul of the international tax framework is a massive undertaking for tax, accounting and finance departments that are already spread thin.
In essence, Pillar Two discourages the shifting of profits by ensuring that MNEs pay a minimum effective tax rate of 15% of profits in all countries in which the MNE operates. The European Union has formally adopted Pillar Two as has South Korea and Japan, while other countries continue to propose and enact legislation throughout 2023. It’s anticipated that up to 140 countries will implement Pillar Two in the next several months.
Pillar Two is a change in tax law, just like any other tax law change: To lawfully operate in a country that has adopted Pillar Two, an MNE has to comply with the necessary tax filings and, more immediately, consider the implications on its tax provision. So, why is Pillar Two a disproportionately large undertaking compared to other changes in tax law that companies routinely absorb?
First, Pillar Two represents a significant additive layer of tax calculation and reporting to what is already an immensely complex tax compliance process for most MNEs. It will ultimately require a new global tax calculation in every jurisdiction in which an MNE operates. There will likely be divergence in rules as countries adopt slightly different versions in domestic legislation which will add to the complexity of these calculations.
Second, the tax base that Pillar Two is determined upon is entirely new and calculations will need to be based, in part, on data that companies currently don’t gather within their tax compliance processes. Pillar Two effectively requires keeping a new set of books and establishing all of the processes needed to maintain those books.
Third, there’s not long to prepare. New rules are effective January 1, 2024. Many governing bodies, such as the Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB), are expected to rule that Pillar Two can be accounted for on a period basis, which means that calendar year taxpayers would need to expose its implications in their 2024 first quarter reporting. The IASB has also proposed rules that could require disclosures in 2023 for International Financial Reporting Standards (IFRS) filers. Compliance with new annual tax filings will be necessary at year-end 2024 and some jurisdictions may require estimated payments throughout 2024. Hence, the runway to lay the data, technology and process foundation for global and statutory compliance is months not years.
Board members and MNE leaders should ensure their organizations are moving toward Pillar Two compliance with full recognition of the adoption effort required. A multi-functional team is needed from the outset to identify an implementation plan inclusive of operational readiness, data strategy, and quantitative analysis.
Pillar Two will likely require system and process transformation within the MNE to sustain the Pillar Two reporting and compliance requirements once enacted. Teams will need to include those not only from the tax function, but also systems, finance and accounting. The future state should include a comprehensive data strategy, technology-enabled processes to facilitate the efficient flow of information, new or enhanced technology, a calculation engine, resource model, connected compliance plan and effective governance.
To make required calculations to comply with Pillar Two, PwC has identified over 230 data points that an MNE needs to track for every legal entity or branch within the enterprise. See PwC’s Data Input Catalog for more on this. Based on early conversations with our clients, we believe that somewhere between 40% and 60% of this information resides within most companies’ enterprise resource planning (ERP) systems. The remaining 40% to 60% is in other systems or is data that’s not currently captured.
Identifying the data requirements and developing a comprehensive data strategy should be the first steps that taxpayers take to prepare for Pillar Two. An MNE will need to establish a cohesive, efficient and automated process to extract, cleanse, and organize the data from which the organization can mine real-time, actionable intelligence from data. The data model is arguably one of the most demanding and daunting aspects of ensuring readiness.
Generating the tax calculations for every entity within the MNE will be extremely complex since there will likely be disparate Pillar Two local rules and interpretations. MNEs will need to determine how they will do these calculations to anticipate risk and act with confidence in addressing the multiple jurisdiction global tax system. For most companies, it will require a global team with a depth of international tax expertise that does not typically reside within a company’s tax department or within the technology companies that enable the data strategy.
MNEs will need an iterative calculation capability that is configured to support the different country variations and interpretations of Pillar Two rules and that is flexible as those rules continue to evolve. Furthermore, the calculation engine should have the capacity to perform at volume, given the exhaustive data requirements, intra-data relationships and rules. See PwC’s Pillar Two Engine for more on this calculation engine and how it can help manage compliance risks with high reliability and efficiency.
International tax compliance has never been an easy task. It takes tremendous resources to navigate the complexity and to ensure local compliance across the globe. Because Pillar Two is totally new and, therefore, completely additive to existing work, it could have a pervasive impact on an organization’s financial operating model, and reasonably double an MNE’s tax compliance cost.
Board members and MNE leaders need to look at this tax law change differently than those they’ve effectively absorbed in the past. If they haven’t done so yet, it’s imperative to start now by identifying appropriate stakeholders, developing a data strategy and building a data model, choosing the best calculation engine to determine global and local tax responsibilities, and addressing the operating model changes needed to sustain compliance over time. This will likely require building a diverse community of solvers that brings expertise from inside and outside of the organization.
For more insight on Pillar Two and related topics, listen to PwC’s Cross Border Tax Talks podcast or visit PwC’s Pillar Two Readiness.
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