In January 2023 the International Accounting Standards Board (IASB) issued an Exposure Draft with proposed amendments to IAS 12 (Income Taxes). The amendments relate to tax and accounting implications of the implementation of the global minimum corporate tax under Pillar Two of the OECD’s two-pillar approach to international tax reform. The proposed amendments introduce a temporary exception to accounting for deferred taxes resulting from the Pillar Two rules and some targeted disclosure requirements.

When the Pillar Two model rules were published, they gave rise to concerns about the implications for income tax accounting when the rules were implemented. There were concerns about how to account for top-up tax; how useful it would be to account for the deferred taxes related to top-up tax; and the need to quickly obtain clarity about the accounting treatment, given that some jurisdictions were already considering changing their tax law to implement the rules.

The top-up tax would be an income tax for purposes of the consolidated financial statements of a group and would therefore be within the scope of IAS 12. The position is however less clear when a subsidiary must pay tax in relation to the profits of another company such as a fellow subsidiary which is not part of its own reporting group.

It was also unclear as to how an entity would account for the deferred tax in relation to top-up tax. It was not clear if the Pillar Two rules would create additional temporary differences to be dealt with under deferred tax or if the deferred tax calculated under national tax rules would need to be remeasured to reflect the potential top-up tax payable. There was also a need for clarification on the tax rate to be used to measure deferred taxes related to top-up tax. Under IAS 12 the tax rate to be used would be the rate that is expected to apply when the asset is realised or the liability is settled; however the rate that would apply to excess profit (under Pillar Two) in future periods would depend on a number of factors that are difficult to reliably forecast.

The costs of calculating the deferred tax relating to top-up tax could therefore outweigh the benefits. Given the complexity of the calculation and the uncertainty surrounding the tax rate to be used, there was a view that the information produced in relation to deferred tax would not be useful enough to users of the accounts.

Under IAS 12 the calculation of deferred tax must take into account the tax rates and laws enacted before the end of the relevant accounting period. As a number of jurisdictions intend to pass laws in relation to Pillar Two during the first half of 2023, there is not much time in which to resolve the uncertainties for deferred tax relating to top-up tax. In the absence of further clarity there could be inconsistency in the approach to deferred tax by different entities and the resulting information would not be useful to the users of the accounts.

To give more time to the IASB and the entities affected by Pillar Two to resolve the difficulties of interpretation, including through consultation with stakeholders, the IASB has proposed the temporary exception to IAS 12 in relation to recognition of deferred tax assets and liabilities relating to Pillar Two taxes. The exception would be mandatory for the affected entities.

Under the IASB proposals an entity would however be required to disclose information for the current period on Pillar Two legislation enacted (or substantively enacted) in the jurisdictions where it operates. The entity would also need to disclose the jurisdictions where its average effective tax rate for the current period is below 15%, together with the aggregate tax expense and accounting profit in those jurisdictions and the weighted average effective tax rate. The IASB also proposes a requirement for the entity to disclose if its compliance work on Pillar Two has indicated any additional jurisdictions (or fewer jurisdictions) where it may be exposed to paying Pillar Two taxes.

For periods when Pillar Two legislation is in effect an entity would be required to separately disclose the liability to Pillar Two taxes.

The exception from accounting for deferred taxes arising from the Pillar Two rules would apply retrospectively. The disclosure requirements when finalised would apply to periods beginning on or after 1 January 2023. The IASB is inviting comments on the Exposure Draft by 10 March 2023.