Like many CFOs at midsized multinational companies below the €750 million (about $815 million) threshold for compliance with Pillar Two global tax reforms, finance chief Mark Partin at accounting solution provider BlackLine is planning for the impact of Pillar Two.
With $590 million in consolidated annual revenue in 2023, BlackLine, which operates in 12 countries, is below the requirement for now, but “we may be subject to Pillar Two in time to come,” says Partin. “We want to be ready well before it.”
At other burgeoning businesses below the compliance cap, CFOs are gauging the impact of Pillar Two on their global structures, financial operating models and tax strategies.
“All it takes is one or two mergers, and we’re over the limit,” says Anthony Rose, CFO of small business lender Kapitus. “It’s super complicated. I need to be in front of this now.”
Getting in front of what many tax and audit professionals consider the most sweeping and exacting global tax regulation in the last 30 years makes sense. Pillar Two’s overarching objective is to impede profit shifting from high-tax countries to low-tax countries to reduce a company’s overall tax burden. Given the loss of previously favorable tax treatment, the rules will pull the rug out from many multinational operating structures.
An Onerous Task
One consideration, for example, is the location of a company’s intellectual property (IP), as the present income retained by shifting IP to an offshore tax haven will be subject to the framework’s global minimum effective corporate tax. That rate is 15 percent. Companies with a lower effective tax in any jurisdiction must pay a “top-up” tax to make up the shortfall.
“CFOs may need to unwind or relocate IP structures and cost-sharing arrangements to mitigate Pillar Two taxes, including consolidating IP in certain countries or moving IP to another jurisdiction,” says Dean Peterson, a partner and member of the International Tax Services Group at Eisner.
The tax rate calculations required by the new framework on a jurisdiction-by-jurisdiction basis are not for the fainthearted. Separate books, records and recurring financial reports are required for each operating jurisdiction. The reports must include transfer-pricing charges on a jurisdictional basis, something previously not required or at least overlooked by companies. The need to collect data backing up the reports is the framework’s most onerous administrative demand. Companies must assemble and disclose data from more than 200 sources per entity across multiple countries.
“Assuming 20 foreign jurisdictions, at least 4,000 new data points must be extracted from ERP systems, core accounting systems, forecasting systems and functions like HR legal, IT and other data repositories,” says Partin. “Data on items like the changing number of employees in each entity and whether the business has immovable property [land and buildings, for example]. We’re reviewing these rules and figuring out how to mine this data to develop our own solutions to encompass these needs.”
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Last but far from least, CFOs of multinationals will have to understand the potential tax impact of Pillar Two on so-called “controlled foreign corporations,” which are considered permanent establishments in certain countries.
If the entity is located in a country that has not adopted the framework, and its effective tax rate falls below the 15 percent minimum, Pillar Two’s Undertaxed Profits Rule (UTPR) comes into play, beginning in 2025.
“UTPRs are where all the controversy lies, as they upend the international tax consensus by allowing the jurisdiction of any member of a multinational group to tax any other member of the group that isn’t already topped up to 15 percent,” says Chad Hungerford, partner and global Pillar Two leader at audit and advisory firm Deloitte.
Since so many different jurisdictions are allowed to potentially tax the same entity, the OECD has provided in Pillar Two a “mechanical rule” to apportion the tax between the jurisdictions, based on their relative number of employees and the amount of their assets placed in service, he says.
The complex, sweeping framework, especially for a midsized multinational, requires consultative tax advice, and the sooner, the better.
“Every multinational with more than €750 million in revenue has to comply with this regime—filing returns, asking questions of their financial auditors, and undergoing audits around the world to defend their position,” says Hungerford. “For most companies, that’s a lot of effort and activity to prove a negative. The vast majority of multinational companies will not owe anything under Pillar Two but will spend hundreds of thousands to millions of dollars to comply. That’s a hard pill to swallow.”
Possible Approaches
The global minimum tax framework has 140 countries as signatories; they represent more than 90 percent of global economic activity. The Organization for Economic Cooperation and Development (OECD) estimates Pillar Two could raise corporate taxes globally by $220 billion annually. Although the United States is not among the signatories, the U.S. has applied its own 15 percent minimum tax rate for U.S. multinationals globally. President Joe Biden has said he supports implementing Pillar Two in the U.S. and worldwide.
As CFOs ready the corporate ship for compliance, international tax experts suggest the following approaches:
- Compare the status of Pillar Two enactment and implementation worldwide to the corporation’s multinational global footprint. EMEA is well underway, with countries in the European Union now collecting the additional taxes.
- Determine the impact on global structures, financial operating models and tax strategies, particularly in low- or no-tax jurisdictions. Operating in those jurisdictions may result in significant top-up taxes. Assess the location of IP to reduce this impact.
- Review transfer-pricing practices and amounts paid in intercompany transactions. Transfer pricing represents the price for goods and services that one entity in a company charges another. Smaller companies often neglect transfer pricing; however, it can become a significant tax risk as revenues grow.
- Assess current data collection methods, models, technology and systems, given the need to assemble and disclose data from more than 200 sources per entity across multiple countries.
- Consider Pillar Two in expansion plans since a foreign government’s current tax incentive package may be irrelevant if the company is going to cross the threshold.
“The biggest blunder a CFO might make is to think Pillar Two won’t apply to them,” says Peterson. He’s far from alone in this view.
“The CFO of a $100 million multinational company might look at Pillar Two and not worry, thinking they’re a long way from compliance and it may never hit them,” says Christopher Migliaccio, partner at PKF O’Connor Davies Advisory. “Failure to deal with these issues can produce significant liabilities. A startup can accelerate very quickly.”
Helios, a human capital management platform provider set to launch in September, is a case in point. Helios has 42 employees and offices in Chicago, Dublin and Shanghai. “A CFO has to have the vision of becoming a billion-dollar company; if you don’t, then why even try?” says Michael Bercovich, the company’s CFO.
In planning Helios’s multinational operations, Bercovich has heeded Pillar Two’s permanent establishment, transfer pricing and IP location rules. “I’ve learned to beware a `permanent establishment,’ either to move forward or not in a country [based on] its litigation history on taxing multinational corporations. I’m also mindful of transfer pricing policies and our IP in relation to the purpose of the legal entity overseas and what it provides the parent company. I’m constantly reviewing where to position the legal entities facing our customers and [reviewing] the intercompany withholding taxes between the different entities.”
Similar assessments are absorbing Rose’s attention at Kapitus. “When something revolutionary like Pillar Two comes along, it touches every area of your business. Where you have subsidiaries, your corporate hierarchy and the value of your different profit chains worldwide all have to be reevaluated,” he says.
Expansion Effects
Since the U.S. is not a signatory to Pillar Two, the tax calculations required for compliance must be performed by a U.S. multinational company’s next-largest entity in its ownership chain outside the U.S. “If the next largest entity is Germany, that entity’s tax staff has to do the tax rate calculations for Germany and all the other operating entities and then bring it all together in one consolidated number,” Peterson says.
CFOs are also wrestling with Pillar Two’s emphasis on eliminating the profit shift from low tax or no-tax jurisdictions to jurisdictions where revenue might be considered earned, says Migliaccio, citing the shifting of IP profit as the most prominent example. “When valuable assets like IP profits are held in a low-tax or no-tax jurisdiction, payments from affiliates in taxable jurisdictions to access the IP are deductible, thus depriving those countries of tax revenue,” he explains. “Pillar Two essentially reverses that deduction by requiring taxation of the profits in the low tax or no-tax jurisdiction.”
At BlackLine, Partin is analyzing the location of the publicly traded company’s IP. He says that IP resides in the U.S., the UK and the Netherlands to ensure that the company achieves or minimizes its effective tax rate. “Since the location of the IP drives the effective tax rate, does it make sense for our business to continue to have three locations? Are these the right locations?” he says. “Maybe, it makes more sense to have a single person in charge of sales in EMEA and the rest of the world, and someone in charge of sales in the U.S. for regions in North America and South America.”
Finance chiefs must also review a company’s plans for future global expansion. Tax incentives offered multinational companies to relocate parts of the business may lose most or all of their value once a company surpasses the €750 million threshold. Previously, operations outside a headquarters company might have invited “business hassles,” but the tax savings made it worthwhile. “If there’s a piece of the structure that is tax-driven, it needs to be reviewed to determine if it will continue to provide significant benefits,” says Migliaccio. “These implications now need to be reweighed, especially if the company is at or near the threshold for Pillar Two.”
Hungerford concurs that future compliance with the new tax regime affects today’s decisions on where to locate operations. “Companies typically decide where to put a new factory or delivery center after assessing the cost of capital, prevailing wage rates, utility costs, culture and taxes,” he says. “Since Pillar Two will significantly change the tax cost of locating in certain countries, the company could get stuck at a competitive disadvantage.”
To avoid this fate, Migliaccio advises finance chiefs to undertake a comprehensive assessment of their transfer pricing policies, starting with an identification of any intercompany transactions.
“Track where the company sales are made and products consumed. Does your company have a transfer pricing policy? Are agreements in place for the key transactions? If not, it may be a good time to invest in a transfer pricing study to make sure you’re using the most appropriate method,” he says. “While transfer pricing can foster tax savings, tax authorities may contest the filing, reducing the benefit of operating in certain jurisdictions.”
Kapitus CFO Rose is cognizant of the impact of transfer pricing on a global business’ operating structure. “How you operate as a business for advantageous tax purposes may no longer make sense,” he says. “If I don’t get the same efficiencies I had tax-wise, if I have to do a top-up, do I really need far-flung subsidiaries? Do I need to have this super-complex structure to avail [of] tax savings that may no longer exist?”
Partin is reevaluating BlackLine’s transfer pricing policies and models to better determine the amounts paid in intercompany transactions on a jurisdiction-by-jurisdiction basis. “We’re also looking at other indirect taxes, like whether a royalty stream from one company to another in the affiliated group might result in additional taxes,” he says.
“It’s not uncommon for tens of millions of intercompany transactions in multiple currencies to be recorded monthly by a midsized and larger multinational,” the veteran CFO says. “We’re fortunate in that we introduced an AI-enabled solution for clients to process their intercompany transactions and are in the process of implementing it ourselves.”
Other companies are not so lucky. To be ready to comply with the wide breadth of the Pillar Two global tax reforms, there’s no time like the present to start thinking strategy.
