In this article, we’ll explain how close and consolidation must change to accommodate Pillar Two’s new requirements.
When exploring the ramifications of BEPS Pillar Two, the tendency is to categorize its requirements as your tax department’s challenge to solve. But the reality is that Pillar Two concerns finance departments in equal parts to tax. Core financial processes, specifically close and consolidation, are an oft overlooked but critical part of Pillar Two reporting.
In this article, we’ll unpack the connection between BEPS Pillar Two, tax, and finance, and explain how close and consolidation must change to accommodate Pillar Two’s new requirements.
What you’ll learn:
- Dissecting the connection between BEPS Pillar Two and Financial Consolidation process
- Ways to leverage finance technology to overcome BEPS Pillar Two challenges
- How CCH Tagetik software can help
Dissecting the connection between BEPS Pillar Two and Financial Consolidation process
BEPS Pillar Two brings tax into statutory financial statements, individual financial statements and group consolidated financial statements. To do this, taxation concepts must be integrated into financial close and consolidation processes.
Let’s dive into how tax and finance intersect around BEPS Pillar Two.
Financial consolidation is one of the starting points of BEPS Pillar Two implementation
Pillar Two begins and ends with consolidation. Even answering the question, “Does Pillar Two apply to us?” requires undo effort on behalf finance teams, who are then tasked with defining which entities are in its scope.
To do this, you must look to your consolidation system. Financial consolidation systems have the power to reveal:
- Data that determines the scope of Pillar Two. Consolidation systems contain valuable information about entities and ownership interests. Importantly, they also contain data about the entities’ attributes. For example, PE (permanent establishment),CFC (controlled foreign corporations), and flow-through entities are eligible for Safe Harbors or the GloBE full process.
- Which entities qualify for safe harbor eligibility on a jurisdictional level. Consolidation systems contain important information regarding entity attributes, which is imperative to have on hand in order to qualify for safe harbor status.
- Which entities are liable for the top-up tax. You can identify which entities are liable for the top-up tax via the group structures and ownership interests that link companies together. To find this information, you have to rely on your consolidation system. Intermediate parent-entity information is based on the ownership interest.
Accounting policies, close processes, and consolidated results drive BEPS Pillar Two results
Pillar Two calculations are derived from consolidated financial statements because IFRS/US GAAP results and adjustments make up GloBE income. It should be noted that financial consolidation and Pillar Two share many of the same data points. Consolidation systems can retrieve 40-60% of the data points to proceed with BEPS Pillar Two top-up tax calculations.
These include consolidated revenues, financial net income/loss, net tangible assets, fair value adjustments, foreign currency exchange rates, and more. You can see the full list of overlapping datapoints here: Global Minimum Taxation 101: Exploring the ins, outs, and material impacts of BEPS Pillar Two.
These new calculations and reporting obligations present MNEs with two options: 1. Adopt new systems or 2. Appropriate existing systems to identify, gather, and process the required data.
Tax teams will rely on finance teams to orchestrate BEPS Pillar Two process
Pillar Two involves three key activities, each of which involves finance and tax cooperation:
- Determining what data is material
- Assessing availability and controls around material data
- Supporting the close process at an interim and year-end level
To complete these activities and to successfully perform Pillar Two calculations, consolidated data will need to be cut in a new way. This reformatting will require a nuanced understanding of accounting policies, like GAAP and IFRS, and how they’re applied at the entity, jurisdictional, and consolidated levels.
What’s more, tax will rely on finance to understand how to make adjustments in entity consolidation and roll-up jurisdictional financial data to the group level in the context of Pillar Two.
And then, of course, there’s the matter of data governance, workflows, security, and control. Tax teams likely don’t have this knowledge upfront and will need to collaborate with finance teams to level-set on data needs and adjustments to the close and consolidation system.
The consolidation process itself will permanently change going forward
Finance will have to embed Pillar Two’s new ETR calculations into the financial consolidation process between legal and constituent entities. What’s more, since Pillar Two moves tax onto the balance sheet, tax must be considered during the accounting period.
Local charts of accounts will require adjustments. Subsidiary accounting will have to be prepared using the same standards as the ultimate parent entity. As a result, parent company accounting policies and entries will have to be pushed down to the local subsidiary charts of accounts.
How to leverage financial tech to bring finance and tech together around BEPS Pillar Two
Of all the processes impacted by Pillar Two, including the general ledger, tax provisioning, tax packs, and compliance, close and consolidation are arguably the hardest hit. Many of the challenges I touched on can be solved by leveraging modernized financial close and consolidation technology. Financial consolidation technology can help MNEs determine consolidated revenue, group structures, ownership interests, and entities in scope.
Consolidation tech enables finance to:
- Map out organizational hierarchies
- Determine eligibility for safe harbors
- Determine entities subject to the top-up-tax
- Consolidate tax data
- Foster tax-finance collaboration
- Produce financial statements that include BEPS Pillar Two tax burden
- Provide the executive team with insight into the complete tax position