IFRS Staff Paper – Pillar Two Model Rules and IAS 12

On 11 November 2022, the staff of the IFRS Foundation issued an IFRS Staff Paper on the accounting of the Pillar Two Model Rules for discussion at a public meeting of the International Accounting Standards Board (IASB) to be held on 22 November 2022.

The Staff Paper includes several recommendations made by the staff to the IASB to amend IAS 12 Accounting for Income Taxes.

If the IASB agrees with the staff recommendations, the staff will begin the balloting process for the proposed amendments to IAS 12. In the Staff Paper it is mentioned that it would be possible to publish an Exposure Draft (i.e., consultation document) in January 2023 and, subject to the comments received, issue final amendments to IAS 12 during the second quarter of 2023.

What does this mean for your organization?

The main purpose of the Staff Paper is to address the potential tax accounting implications of the Pillar Two Model Rules and to ask the IASB whether it agrees with the recommended amendments to initiate a potential standard-setting project.

If adopted, the amendments will impact the financial statements of companies that are in scope of Pillar Two. As the Pillar Two Model Rules are in itself complex and given the pace at which Pillar Two is expected to be implemented in various jurisdictions, it would be helpful to already consider the potential impact of the proposed amendments so that when consensus is reached, you are prepared.

Overview of the recommended amendments

The Staff Paper includes several recommendations to amend IAS 12, by introducing the following:

(a) a temporary exception from accounting for deferred taxes arising from legislation enacted to implement the OECD’s Pillar Two Model Rules, including any qualified domestic minimum top-up tax (the exception). The exception would apply until such time that the IASB decides to either remove the exception or make it permanent.
(b) a requirement for reporting entities to disclose:

(i) whether it is in the scope of the Pillar Two Model Rules and whether it operates in low-tax jurisdictions¹;

(ii) the fact that it has applied the exception as mentioned under (a); and

(iii) its current tax expense related to Pillar Two top-up tax.

(c) a requirement for reporting entities to apply the amendments to IAS 12 as set forth under (a) and (b):

(i) immediately upon their issuance; and

(ii) retrospectively in accordance with IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors.

_{1. The Staff Paper defines low-tax jurisdictions as jurisdictions in which the entity reasonably expects the effective tax rate to be lower than the minimum rate of 15%. This could include jurisdictions in which (a) tax rates are lower than the minimum rate or (b) tax incentives, tax exemptions or additional tax deductions an entity receives might result in an effective tax rate lower than the minimum rate.}

Reason for the recommended amendments

Since the Pillar Two Model Rules were published in December 2021, one of the relevant questions is how to account for top-up taxes (resulting from the application of these rules) in the financial statements of a reporting entity. Up to this moment, there is no guidance nor consensus on how the accounting standards apply to Pillar Two.

Although it is still uncertain when jurisdictions will implement Pillar Two into national law, it is expected that many will do so during 2023, and possibly as early as the first half of 2023, with entry into force date 31 December 2023 (we also refer to our recent Pillar Two update in this PwC tax accounting article).

Given this (tight) timeline and the absence of consensus on how to deal with Pillar Two top-up taxes for financial reporting purposes, concerns have been raised about the implications of the imminent implementation of the Pillar Two Model Rules on the accounting for income taxes. These implications relate to, inter alia, whether Pillar Two top-up taxes qualify as an income tax, whether the Pillar Two Model Rules could create additional temporary differences, whether an entity is required to remeasure deferred taxes recognised for existing temporary differences bearing in mind any Pillar Two impact and if so, at what rate. Furthermore, concerns were raised in relation to the timing of providing clarity on these implications.

The Staff Paper intends to start up a narrow-scope standard-setting project by addressing these implications from an IFRS point of view and includes recommendations to the IASB to amend IAS 12.

Our observations

The Staff Paper includes an overview of the Pillar Two Model Rules and an overview of the general tax accounting provisions within IAS 12 that are relevant for understanding the accounting implications of the Pillar Two Model Rules.

More interestingly in our view, the staff also considers the usefulness of including Pillar Two related information in the financial statements for investors. In this respect, the Staff Paper mentions that further work is required to determine how IAS 12 can be applied to Pillar Two top-up taxes and that such work could require some considerable time. Given the pace at which Pillar Two is expected to be implemented in different jurisdictions, the staff mentions that in their view it would not be feasible to complete such work before new tax laws are expected to be (substantively) enacted and, consequently, before entities are required to reflect the new laws in accounting for income taxes.

Consequently, the staff recommends that the IASB should introduce a temporary exception from accounting for deferred taxes with respect to Pillar Two top-up taxes. The staff admits that introducing such a temporary exception would result in a potential loss of the information that would otherwise be provided by recognising deferred taxes. However, in their view, the possible inconsistent application of the requirements in IAS 12 would result in less useful information than consistent application of the temporary exception.

The staff has also proposed several disclosure requirements on Pillar Two, as mentioned above. One worth further deep-diving is the proposed requirement for reporting entities to separately disclose the current tax expense related to Pillar Two top-up tax. This would allow investors to understand the impact of Pillar Two relative to a reporting entity’s overall tax expense. According to the staff, disclosing such information would not be costly for reporting entities, as the calculation of the top-up tax amount has to be performed in any event, irrespective of whether the Pillar Two top-up tax is considered an income tax or not.

Next steps

The comments in the Staff Paper do not purport to set out what would be an acceptable or unacceptable application of the IFRS Accounting Standards. Therefore, we will have to wait and see how the IASB will respond to the recommendations made in the Staff Paper during the board meeting on 22 November 2022 and whether an Exposure Draft will be published.

At PwC, we closely monitor these developments and provide you with updates on Pillar Two on a regular basis. If you want to receive our tax news insights and publications going forward, please click on the link below to subscribe.

For further details and advice on the content (including Pillar Two technical content) in this publication, please contact one of the below members of our Tax Accounting team or your PwC advisor.