Pillar 2 and accounting standard adjustments – what if companies within a group have different tax years?

Pillar 2 tax, which forms part of the Global Anti-Base Erosion (GloBE) rules, is intended to ensure a minimum level of taxation of the income of companies belonging to multinational and domestic groups whose revenues exceed EUR 750 million. Under the regulations, where organisations exceed this threshold, each business entity within the group (each constituent entity) is required to pay tax globally at a rate of at least 15% of its profits. Unfortunately, the experience of tax advisers specialising in complex business structures shows that adapting existing procedures and solutions to the Pillar 2 framework involves numerous challenges, including accounting standard adjustments and the alignment of tax years within multinational groups.

Introduction to the calculation of the tax introduced under Pillar 2

At the outset, it should be recalled that, in order to perform a calculation of the Income Inclusion Rule (IIR) top-up tax, it is essential to carry out an Effective Tax Rate (ETR) test at the level of a given jurisdiction.

To calculate the effective tax rate for a jurisdiction, two key elements must be determined: 

• adjusted covered taxes, 
• net GloBE income (or net GloBE loss) of the constituent entities located in that jurisdiction. 

The starting point for calculating the qualified income or loss of a constituent entity belonging to a domestic or multinational group is, in turn, the determination of the net profit or loss of that entity (as recognised for the purposes of preparing the consolidated financial statements of the group subject to the GloBE Rules and determined in accordance with the accounting standard applied in those financial statements). The use of the accounting standards adopted for the consolidated financial statements is motivated by the fact that this approach may ensure greater consistency of accounting data than the application of local accounting standards by individual constituent entities within the group.

The calculation of the Qualified Domestic Minimum Top-Up Tax (QDMTT) follows a similar approach. In this case, however, the first step is to determine which accounting standard the entity should apply for calculation purposes.

Accepted and authorised accounting standards – how do they differ under Pillar 2?

Rules applicable to the global minimum top-up tax

As a general rule, the determination of the qualified income (or loss) of a constituent entity for the purposes of calculating the effective tax rate (ETR) is based on the data included in the group's consolidated financial statements, prepared in accordance with the accounting standard adopted by the Ultimate Parent Entity (UPE). This means that the starting point for entities required to calculate the global minimum top-up tax is the financial result determined under the accounting standard applied for consolidation purposes (e.g. IFRS or US GAAP), followed by the adjustments provided for under the GloBE Rules.

The GloBE Model Rules, however, provide for situations in which the effective tax rate may be calculated on the basis of a constituent entity's local accounting standard, provided that specific requirements are met and data comparability is ensured.

Rules applicable to the Qualified Domestic Minimum Top-Up Tax

The provisions of Chapter III concerning the Qualified Domestic Minimum Top-Up Tax (QDMTT) indicate that, in certain cases, it is also possible to calculate the qualified income (or loss) of a constituent entity based on an authorised or accepted accounting standard. 

• Authorised accounting standard – a broad concept encompassing applicable accounting regulations or other generally accepted accounting principles authorised by a body with the legal authority to issue, establish or adopt accounting standards for financial reporting purposes within the jurisdiction where the entity is located,
• Accepted accounting standard – an accounting standard consisting of International Accounting Standards (IAS) and International Financial Reporting Standards (IFRS), as well as the applicable accounting regulations of European Union Member States, other states belonging to the European Economic Area (EEA), or other countries indicated in the Accounting Act.

This means that, for Pillar 2 purposes, it is possible to determine the income (or loss) of a constituent entity based on, for example, the Polish Accounting Act or similar legislation in other EEA countries, as well as Australia, China, the United States, the United Kingdom, Switzerland and other jurisdictions. The application of these standards does not require additional adjustments beyond the standard GloBE adjustments.

However, where the income (or loss) of a constituent entity is determined on the basis of an authorised accounting standard that is not an accepted accounting standard, it is necessary to adjust the accounting net profit (or loss) in order to eliminate so-called significant accounting differences. This is intended to ensure comparability and compliance of the resulting net profit (or loss) with Pillar 2 requirements. 

Taking the above into account, it can be noted that for entities subject to the Qualified Domestic Minimum Top-Up Tax and located in Poland, it is possible to apply domestic accounting standards, International Accounting Standards or International Financial Reporting Standards. 

Importantly, where local accounting standards are applied, all constituent entities within a given jurisdiction must use the same accounting standard (i.e. a uniform accounting standard).

In addition, for the purposes of the Qualified Domestic Minimum Top-Up Tax, Polish companies should have the same financial year as their Ultimate Parent Entity. What happens if the financial years of the parent company and its subsidiary are not aligned?

Different tax years of the parent company and subsidiaries

Under the GloBE Model Rules, the reference period for calculating Pillar 2 tax is the financial year adopted for preparing the consolidated financial statements of the Ultimate Parent Entity. However, the GloBE provisions provide very limited detailed guidance on how to proceed where there are differences between the tax years of the parent company and its subsidiaries.

In practice, this means that the entity's financial data must be appropriately adjusted so that the ETR and qualified income calculations are performed for a uniform group reporting period.

A separate issue concerns the Qualified Domestic Minimum Top-Up Tax, regulated in Chapter III of the Act. This mechanism allows a jurisdiction to retain the top-up tax within its own tax system instead of allowing it to be collected by other jurisdictions under the IIR or the Undertaxed Profits Rule (UTPR).

QDMTT therefore enables a country to collect the additional tax required to bring the effective tax rate on entities located within its territory up to 15%.

Chapter III of the Act introduces further clarification. As a rule, constituent entities located within a jurisdiction should, for GloBE purposes:

• apply the same accounting standard as their Ultimate Parent Entity,
• adopt the tax year of their Ultimate Parent Entity as their own tax year. 

This means that even if a local company has a different financial year for accounting or corporate income tax (CIT) purposes, it may still be required to prepare financial data corresponding to the period adopted by the UPE for top-up tax calculation purposes. Where such alignment of the tax year is not possible, taxpayers should use either an accepted accounting standard or the authorised accounting standard applied by the group for preparation of its consolidated financial statements when calculating the Qualified Domestic Minimum Top-Up Tax. 

Making adjustments in line with the requirements of the Pillar 2 Directive is a major challenge 

Determining qualified income (or loss) and making the necessary accounting standard adjustments is a complex process requiring detailed analysis. Differences in tax years between the parent entity and its subsidiaries – as well as the use of different accounting standards – may give rise to significant difficulties. It is therefore advisable to review the group's financial statements in advance in order to appropriately align accounting standards and tax years with GloBE requirements. 

It should be emphasised that the requirement for constituent entities to align their tax years with that of the parent company is regarded by some practitioners and experts as potentially controversial. Entities with different tax years may be forced to prepare separate reports or adjusted statements in order to obtain the information necessary for GloBE calculations, resulting in additional administrative effort and costs.

Accordingly, appropriate tax planning and a careful assessment of the consequences arising from any change in tax year or accounting standards are essential not only for ensuring compliance, but also for mitigating potential risks.

If you have any doubts, we encourage you to contact our tax advisers specialising in Pillar 2 top-up tax compliance. Our experts remain at your disposal and will be pleased to answer any questions relating to the global minimum tax.