A recent “Mid-year 2023 Budget Performance Report” of the Finance Ministry indicated that Malaysia could implement Pillar Two in 2025.
MANY countries will begin implementing Pillar Two of the Organisation for Economic Co-operation and Development’s or OECD’s Base Erosion and Profit Shifting (BEPS) 2.0 project, also known as the Global Minimum Tax project, in 2024.
Other countries such as Singapore, Hong Kong and Thailand have announced that they will implement it in 2025.
A recent “Mid-year 2023 Budget Performance Report” of the Finance Ministry indicated that Malaysia could also implement Pillar Two in 2025.
Once Pillar Two is implemented, multinational enterprise (MNE) groups with group turnover of over 750mil euros (around RM3.7bil) and which are not subject to an effective tax rate (ETR) of at least 15% in each country in which they operate, will be subject to a top-up tax.
This article seeks to address some of the common misconceptions about Pillar Two.
> Misconception 1: There is plenty of time to prepare
The Pillar Two GloBE Information Return is due for filing 15 months from the close of the financial year (extended to 18 months in the first year of implementation of Pillar Two).
As such, an MNE Group with a Dec 31, 2024 financial year-end and which is operating in countries which implement Pillar Two in 2024, will only need to file its first return by June 30, 2026.
The deferral of implementation in some countries to 2025, has also led companies to think they have plenty of time to act.
However, MNE Groups need to start preparing for Pillar Two immediately for various reasons, including the following:
> If the MNE Group operates in a country which has enacted or substantially enacted Pillar Two legislation in 2023, it will need to make certain financial statement disclosures on its Pillar Two exposures.
For example, if an MNE Group with a Dec 31, 2023 year-end operates in the United Kingdom (which has already introduced Pillar Two legislation), it must make relevant disclosures in its Dec 31, 2023 financial statements.
> Listed groups will need to begin providing for Pillar Two exposures (where relevant) in their quarterly reporting, starting as early as the first quarter of 2024.
> Pillar Two calculations are complex and up to 200 data points are required to accurately prepare these calculations.
MNE Groups must assess where the relevant data sits in the organisation and how the collection of the data and the Pillar Two calculations can be automated.
Challenges arise when consolidating data across subsidiaries in different business units or if tax provisioning is performed manually. Preparations must inevitably involve changes to systems, processes and governance protocols.
> MNE Groups may need to re-negotiate tax incentives to ensure that they continue to provide the intended benefits.
> Misconception 2: Pillar Two only impacts tax departmentsPillar Two will, in fact, impact almost the whole organisation. For example:
> The C-suite needs to understand and stay updated on the impact of Pillar Two on the group,
> IT departments need to plan for and execute the relevant changes to new or existing systems,
> Finance teams need to understand the Pillar Two rules in detail to retrieve relevant information, recalculate carrying values of certain assets and reliably prepare Pillar Two tax provisions,
> Merger and acquisition teams will need to consider Pillar Two implications when evaluating deals,
> Internal audit teams will need to assess whether the MNE Group has adequate processes and governance protocols to properly comply with Pillar Two, and
> Treasury teams will need to ensure that funds are available in the right jurisdiction, to pay any top-up taxes.
> Misconception 3: If an MNE Group has a tax incentive, it will always be subject to a top-up tax
Pillar Two operates under a jurisdictional blending concept.
If an MNE Group has multiple entities in a country, the financial results of these entities will all be blended to arrive at the Pillar Two ETR.
As such, even if an MNE Group has an entity with a full tax holiday, the group may still not have any top-up tax exposure where its other entities in the same country have high ETRs.
If an MNE Group has only a single entity in a country and that entity has a tax holiday, the top-up tax risk could still be mitigated, by way of something known as a “substance-based income exclusion” (SBIE).
The SBIE allows the entity to deduct a percentage of the carrying value of its tangible assets and payroll costs, from the amount of the “Pillar Two profit” which is subject to a top-up tax.
That said, incentives should be a key focus area in Pillar Two impact assessments.
Where an MNE Group’s larger subsidiaries have tax incentives and limited SBIE, there could be a significant top-up tax exposure.
Impacted groups will need to immediately consider next steps, which may include the renegotiation of tax incentives.
> Misconception 4: If a group operates in a country with a statutory tax rate of above 15%, it will not be subject to top-up taxes
The Pillar Two ETR calculations are complex and take into account deferred tax movements and other adjustments which do not impact corporate income tax calculations under normal tax laws.
Further, tax incentives may reduce the ETR significantly.
Hence, a high corporate income tax rate or a high tax payable based on the statutory tax computation does not automatically mean that the Pillar Two ETR will be above 15%.
> Misconception 5: Top-up taxes will always be payable in the jurisdiction where the ultimate parent entity (UPE) is located, and there will be no top-up taxes if the UPE jurisdiction has not implemented Pillar Two.
Many countries will implement a Qualified Domestic Minimum Top-up Tax.
This will result in Pillar Two top-up taxes being collected in the countries with low ETR, instead of in the UPE jurisdiction.
This also means that an MNE Group could be subject to top-up taxes if any country in which the group has a presence has implemented Pillar Two, even if the UPE jurisdiction has not.
I hope the above provides some food for thought.
It is clear that Pillar Two is far more complex than many people have anticipated, and MNE Groups must immediately start undertaking a Pillar Two impact assessment, and planning and executing next steps.
Anil Kumar Puri is an International Tax and Transaction Services Partner at Ernst & Young Tax Consultants Sdn Bhd. The views expressed here are the writer’s own.
