Understanding Pillar Two: Safe Harbor Guidance and Considerations

The discussion on Pillar two's Safe Harbor guidance impacts multinational companies' tax reporting and compliance outlook.

### OECD Pillar Two Safe Harbor Guidance: Key Considerations and Implications
* 🛡 The OECD introduced temporary Safe Harbors in December 2022, allowing multinational companies to **exclude low-risk jurisdictions** from the scope of the Global Anti-Base Erosion (GloBE) rules based on **revenue and income thresholds**.
* 📊 Multinational groups have been analyzing their Country-by-Country Reporting (CbCR) data to identify jurisdictions at risk of **falling out of the Safe Harbor** and taking measures to **mitigate the risks**.
* 🔄 The temporary Safe Harbors have led to a shift in the timeline for implementing technology solutions, with more focus on **advisory projects** and **updating existing reporting tools** to meet compliance requirements.
* 📑 The concept of "**qualified CbCR**" (QCbCR) has been introduced for the permanent Safe Harbors, allowing countries to use an acceptable accounting standard for the application of the **Qualified Derivative MNE Taxpayer Test (QDM TTS)**.
* 🌍 The use of different accounting standards across jurisdictions for Safe Harbor calculations has raised challenges related to **consistent treatment and validation of CbCR data**.
* Companies are now required to consider how **intercompany transactions** and the booking of income and expenses within the consolidation will impact the financial accounting **net income** used for Safe Harbor calculations.
* 🔒 The permanent Safe Harbors provide greater certainty to taxpayers by treating the **QDM TTS as a local tax**, simplifying the assessment process and allowing for **confirmation of rule interpretations in jurisdictions**.
* 🇺🇸 For US-based multinationals, the absence of a QDM TTS means that there is still uncertainty regarding the application of the Under-Taxed Profits Rule (UTPR) to US earnings, leading to a **one-year delay in its implementation**.

[Music] From Deoe Tax, welcome to Tax News and Views podcast. In this series, we talk to specialists from Deoe about the latest business issues and developments. I'm Krie Falcon Han, your host for Tax News and Views. Today's discussion is part of our Global series focused on Pillar two. Some of our listeners may be familiar with our US series, also focused on Pillar 2, but more specifically focused on the issues US multinationals are facing. This series is focused much more broadly. Today's topic is on the Safe Harbor guidance that global multinational companies need to understand and consider. Today, I'm joined by two leaders in Del's Pillar two efforts, Daniel Stutzman, who is a Swiss partner, and Jim Petri from the US. So, thank you both for joining me today, and maybe we can talk about some of the new guidance that's coming out and how the temporary Safe Harbors changed how companies prioritize as they look at Pillar two. Yeah, thanks for the introduction. It's a very interesting

question you have raised, and had clearly an impact of the approach our clients are taking in relation to pillar two. So, essentially, the temporary safe harbors have been approved in December 2022, and they have been designed as a short-term measure that would effectively exclude multi Internationals operations in certain lower-risk jurisdictions from the scope of globe in the initial years. Thereby, the safe harbor would allow a multinational to avoid undertaking the detailed globe calculations in respect of that jurisdiction if it can demonstrate, based on its qualifying cbcr and financial accounting data, that in that jurisdiction it has revenue and income below the Minimus threshold or ET that equals or exceeds an agreed rate of 15% for 2024, 16% for 2025, 17% for 2026, or no excess profits after excluding the routine profits. The transitional cbcr safe harbor uses revenue and profit loss before income tax from a cbcr report and income tax expenses from the financial accounting data after eliminating taxes which are not covered.

taxes and uncertain tax positions. So here we already see the first deviation between the normal cbcr and qualified cbcr. And then essentially you use this data to determine whether the multinationals operations in the jurisdiction meet these tests. And if you do not meet one of these tests, then essentially you're required to do the full calculation. I have to say that you cannot use the cbcr for the routine profit test, but you would have to do the full substance-based income exclusion calculation. But on the other hand side, that is not too complicated. On that basis, multinationals groups in scope have started analyzing the cbcr to assess the jurisdictions that are at risk of failing one of these free tests. So we essentially see them categorizing them in low-risk jurisdictions, high, and middle where potentially you have to look at whether they have certain measures to be taken in order to mitigate the exposure of falling out of the safe har. The risk of falling out of the safe harbor is essentially that once you're out, you are

out that means you have to do the detail calculations even if in the next year you would again meet the Safe Harbor test for that jurisdiction. So what we see with our clients is they have used their cbcr filings for previous years, typically 21 and 22, to assess the jurisdictions at risk. And quite surprisingly, there were jurisdictions in scope that would have failed that test that you would not have expected. So we saw a lot of clients that had Spain highlighted as at risk, occasionally also Germany and other known higher tax jurisdictions. Why was that? On the one hand, we saw that there were a lot of government-driven covid relief measures that still did drive rate and financial data for 21 and also still 22. Also, the recognition of the third tax assets can be a big driver in essentially driving the ET for that jurisdiction. And also, we should not forget about incentives and grants that potentially could benefit some of these groups in these jurisdictions. And what clients are then essentially doing

is identifying a trend, because obviously you cannot rely on the 2122 data for 24. But you can identify a trend and also use the opportunity. So, for example, in 23, to ensure that you can recognize any deferred tax assets that you may have not yet recognized before. And here I'm referring to IFRS standards where it's saying more likely or more probable that you can use it. Obviously for Gap, it's slightly different. It would have to be treated from a valuation allowance perspective. But so we saw a lot of clients first taking here um first steps on analyzing potential measures to be taken. But then on the other hand side, we also saw that this has impacted their approach in relation to reporting and compliance outlook, because a lot of clients are essentially now relying on the temporary safe harbors for managing their reporting and compliance obligations. So we saw a shift in saying, well, wait a moment. I'm not yet going ahead with a full-blown technology solution implementation project, but I have identified a small hand of

jurisdictions. Switzerland is typically one of them that is in scope of the calculations, and I apply a more pragmatic approach in essentially saying I use my existing reporting tool. I update that to reflect the pillar two requirements for 24, and then essentially man my reporting obligation for that, and essentially gain some time and assess the market in development of Technology Solutions that will help them Drive their compliance going forward. So I think that is quite an important aspect because it shifted the timeline quite a lot in relation to implementation project. So momentarily what we see, it's way more advisory related projects and also helping them with regard to the validation of their country by count reporting. Yeah, Danielle and what we see in the US, you know, there's a couple of different nuances that are perhaps more focused around US Gap, but one of them is for folks that are thinking about transactions close to this calendar year, perhaps looking at doing them ahead of year end. So things like moving assets between jurisdictions that may create a tax step up or perhaps you know

transactions that may release a valuation allowance against a deferred tax asset, and part of the reason for that is because you know from a US GAAP perspective that can create an effective tax rate benefit, right? And given these safe harbors, these temporary safe harbors, and the effective rate one is, in a lot of ways, just a metric of US GAAP effective tax rate as compared to 15%. And so, things like valuation allowances releasing or step-up and basis transactions can create an effective rate benefit, and so to do that ahead of the first year of Safe Harbor becomes very important. You know, the other thing that we're seeing from a US point of view, and perhaps you are as well, is it's brought to the show, if you will, the country-by-country reporting. This has been obviously a rule in many countries, including the US, to report out that information. You know, that in the US gets reported to the IRS, but I think for in a lot of cases companies can spend that much time.

validating and confirming the amount put in the country by report. And because of the Safe Harbor and because it likely will be used as support for financial statement Auditors, companies have spent more time validating that report during their compliance season this year to get ready for 1 one of 2024. Talk to us a little bit more about what that validation process looks like when an organization's looking at their country by country reporting to see if it will be qualified. So that's interesting again, the OECD has introduced a new term qualified CBCR. So essentially, qualified CBCR means that the country by count reporting needs to be prepared by an acceptable accounting standard as defined by the OECD in the model rules respectively by an authorized accounting standard that is considered reliable. And we had a lot of discussions, you know, normally clients can either apply a top down country by country reporting usually using the Consolidated accounts, usually using US GAAP, IFRS, or from Swiss perspective Swiss GAAP F or you can apply it using a bottom up approach using local accounts for.

Switzerland, and I also know that for many other European jurisdictions, that question of using a local accounting standard became quite interesting because yes, in Switzerland, for example, you file your Returns on the statutory accounts. However, our accounting standard for statutory purposes follows the principle of prudence, therefore not a true and Fair View principle, and consequently is not considered reliable. The same applies to other European jurisdictions where quite often you don't record for deferred taxes, and obviously as deferred taxes are Big Driver of your ETR, they need to be considered. So, our recommendation is to taxpayers' clients on the one hand side have a consistent approach, so best rely on the consolidation standard that you use for consolidation purposes atev of the ultimate parent entity, but only in other cases where data may not be available on the jurisdictional level, then potentially look at the local accounting standard. On the other hand side, we also realize that there could be the opportunity to have an acceptable authorized accounting standard that is usually not used for tax purposes because the treatment for cbcr reporting.

may be different so that could apply for an opportunity in managing your Safe Harbor. On the other hand, side here it has to be noted that the OCD is issuing guidance on the usage of accounting standards and consistency in their application for purposes of the safe harbor. Yeah, Daniel, and that's become a big discussion point because companies are, you know, perhaps historically they might have, like in the US, might have used US GAAP figures throughout their country by count rep 40 and the question they're asking themselves is whether there should be any deviation if you know because US GAAP eliminates the impact of a lot of intercompany transactions statutory financial statements in some instance might be a better reflection of what's happening economically in a jurisdiction. And so companies are looking at that right and analyzing whether or not they should change in particular jurisdictions to move away from a US GAAP standard. So that's one thing that we're observing and you hit on the head. The OECD is also having to contend when

you use different standards across the same group of entities. It can create a situation where you can have inconsistent treatment associated with the same transaction, right? Just the counterparties of the transaction. And so, that's created some pressure points that we're likely to see more guidance from the OECD in terms of validating the country by-count report. I think this has brought to light a couple of things that perhaps aren't all that relevant or haven't been all that relevant within the book of our clients, of our US-based clients. And part of the sea change here is that the recording of book income in the um, you know, profit before tax or financial accounting at income or loss is defined by the globals. It becomes very important where income and expense is booked within the consolidation. And it so it brings to light things that are booked perhaps topside within an organization that ultimately should get pushed down or will get pushed down. And so companies are spending time looking at those items that are that are booking topside historically and whether those should be

pushed and where they should be pushed within their organization to properly reflect the financial income. You know, in a jurisdiction, and and so these things were always relevant from deferred accounting perspective, but perhaps weren't all that relevant because most, you know, countries outside of the US used a statutory metric to calculate their taxable income. The other thing that has now become the norm, but is something that, you know, wasn't all that relevant before, is effectively the treatment of intercompany transactions. And what I mean by that is the US Gap treatment or IFRS treatment instruments like preferred shares between legal entities. And what it has brought to light is that, you know, thinking about the accounting treatment of those instruments, whether they're considered debt or equity for US Gap purposes, and whether there's any embedded derivative in those contracts, become very important because your Baseline for country bycount reporting for Safe Harbor, as well as for the pillar two rules, are rooted in, you know, the financial accounting net income or loss, which is based on you.

know either us Gap or local Accounting Standards. Thank you for that. And so we've been talking a lot about the temporary safe harbors, but we now have recent guidance from the oecd talking about permanent safe harbors, particularly around qdm TTS. So what are some initial thoughts on how this changes the reporting and compliance considerations our clients are going through? So in July, the oecd came out with their guidance on permanent safe harbors, essentially saying if a country has implemented qualifying QD MTT, that essentially then an i tion would not be allowed to Levy in a top-up Tex following the income inclusion rule. The interesting point about that is on on the one hand side to be considered as a qualified QD MTT, the um qualified QD MTT needs to be implemented in line with the model rules, and respective processes by the tax authorities need to be considered and adhere to ensure compliance with the model rules. On the other hand side, what's the rules here introduced was that jurisdictions could also use a local

accounting standard for the application of the QDM. And again, here then the question comes up that it either needs to be an authorized or an acceptable and reliable accounting standard. Just this morning, I had a conversation with a client asking about that and saying, Well, should we potentially switch then for the QDM safe harbor to essentially prepare data on Swiss GAAP F instead of IFRS, and whether that would provide a bit more flexibility? In the end, it outlined that the local accounting standard here in Switzerland with Swiss GAAP F was quite similar to IFRS and would not have provided for many differences. One difference could, for example, be the treatment of trademarks, whether they can be amortized or would have to be impaired, which is an interesting aspect to be looked at. On the other hand side, if you then apply that approach for a Swiss headquartered multinational or someone that would apply that approach in general in Switzerland, it would mean look on the one hand side you would have to do the statutory accounts for the

current tax calculation then you would have the Swiss Gap f F accounts to determine you QD MTT and potential top out TX and then still have the accounting standard used for normal tax reporting on the US Gap ORS so it would essentially mean introducing a a third standard and consequently add a lot of complexity just from an accounting and Reporting perspective why did the oecd introduce that. I think one of the main aspects there was to make the life of the tax inspector easier because they think they have a better understanding of essentially their local accounting standard compared to for example us Gap. Yeah that's right and that that's been the push and pull here and and maybe just to so the way that I frame this because I think the lens in the outside of the US versus inside the US UPS or ultimate parent entities in the US I think slightly different lens because I think the the US folks before this permanent Safe Harbor came out were thinking okay this is ultimately the endstate computation is going to be a you know

this is for the detail pillar two. So we're no longer in this temporary Safe Harbor World. We're past that. And the concept is that, okay, I'm going to be able to use my US Gap figures to do my computations for pillar two. So in other words, I'll be able to use the same data set and before this July guys. But for these permanent safe harbors, the way the mechanic worked is you had effectively duplicative computations. So the local country would do a QDM DT this local tax on their local income using the pillar 2 rules. And then you'd also do a computation using the globe rules using US Gap. And you paid the higher of the two is the way that that mechanic worked. And that cre complication, right, because you potentially have to do two separate computations. So this permanent Safe Harbor, what it does is it eliminates that additional computation. So now and Daniel's talking about like, okay, how's this going to roll out in each jurisdiction. But what they're eliminating is instead of doing the

local QD MDT computation plus the US gamp computation. You just do the local computation so that's helpful, right? Because you have one less computation to do. But the difficulty is, and this is to Daniel's last point, like how are authorities going to audit the computations if it's all based on US Gap in all these other jurisdictions, because they don't, presumably in a lot of jurisdictions, don't understand, you know, US Gap accounting principles. They know local statutory. And so the OECD came out with this permanent Safe Harbor, which allows countries to continue to use that local statutory IFRS, perhaps US Gap, but they choose in those jurisdictions what companies will use to do their local QDM DT computations. It's important because, right, you think about that from a process perspective within an organization, you know, oftentimes statutory financial statement data is not something that's done necessarily for your US Gap close. It might be done much later. Well, now that that data perhaps is going to be relevant. Now we're going to see in implementations.

here this rule came out in mid-July and so countries are starting to informally say which direction they're going and which accounting standard to use. But we will likely see it over the next three to four months. And so the pressure point will be for organizations is, you know, how to gather that data. You know, is it relevant for financial accounting reporting? And how are we going to do the compliance long term? And that's caused the same dynamic that I think we've been seeing, which is just this computation. It's a lot of data. It's a lot of reputational exercise. And there's perhaps still a need for centralization, you know, within organizations to process all this data to make sure there's consistent treatment amongst jurisdictions. But it's definitely a sea change. And I think it's important for us to all sit and see how this pans out in each jurisdiction, but also be prepared, you know, as organizations to react to it now. The helpful thing and where we started this conversation was the temporary safe harbors, you know, perhaps

are still going to delay the need to do all that that detailed computation. To you know post 2026, but that becomes even more important, right, that organizations meet that temporary Safe Harbor. Well, you both raised the issue of tax Authority and how they're going to look at these computations to share a little bit more. What do we think the permanent safe harbors are going to do to how the taxing authorities view the calculations? Yeah, krie, as you know, there's a high level of uncertainty still around the interpretation of certain of the rules and certainly also the interpretation can deviate from a country perspective. The benefit of a permanent safe harbor relying on the qdm and thereby on an assessment by local tax authorities essentially means that when you have received an assessment by the local tax authorities, that you should be certain that no other jurisdiction would be in a position to tax you. And I think that is from a reporting and just from a certainty perspective extremely helpful and important because you have certainty that no additional top up tax would be

due and that your position should be accepted. And consequently, also the expectation is that this would simplify overall the assessment process. Because imagine that you would otherwise have to wait for feedback from all the authorities that could potentially look at your calculation. Also, on the other hand side, it provides the benefit that in your jurisdictions where taxpayers are closer potentially to the tax authorities, that you can get confirmation on the interpretation of certain rules before you enter into reorganizations. So it simply really adds certainty. Yeah, yeah, the way I see it is that that permanent Safe Harbor, and you hit it on the head Daniel, is somewhat consistent with how we've gotten certainty in the past. Because it becomes a local tax right. The QD MDT is on if it's in Switzerland, it's on Swiss income. You know, as opposed to these Globe rules like the income inclusion rule, which it would be, you know, the tax collected by the parent entity for the Swiss income. And so it's a

little bit more difficult to get certainty in those instances. I think the US, you know, because the US was not on board with pillar two for US-based multinationals, there still is a layer of uncertainty because, you know, the US is on the US income, right? The US is not going to be, does not have a QD MDT, so they're not going to meet a permanent Safe Harbor, at least in our current state, and that means that the under tax profits rule applies or can apply to the US income, which means that in those instances, you'd still have a lot of jurisdictions, basically all the jurisdictions that implement pillar two, would all potentially have a say in the computation of, you know, the effective tax rate, the amount at the top of associated with the US earnings. And so, it was for that reason that as part of the July guidance, that, well, presumably that's the reason that the OECD provided an additional one-year delay associated with the application of the this under tax profits rule in.

other words, the tax on the US earnings for US-based multinational provided an additional one-year delay. So, there's already one delayed in the application of UTPR, the under-tax profits rule, or just the normal rules. So, instead of it being 2024, it's 2025. This would delay it to then 26. And so, perhaps the acknowledgment was that the administration of that from an authority perspective, from a certainty perspective, perhaps the OECD acknowledged that that's going to be a big pressure point with for organizations, especially for US-based multinationals because you're not going to have that certainty like you would associated with the QD MDT. Well, thank you Jim and Daniel for sharing that background on the safe harbors. Clearly, a number of benefits to organizations if they can qualify under the safe harbors but also a lot of complexity and new consideration. So, thank you for sharing that with us. As I mentioned at the beginning, this is part of a series Focus globally on pillar two issues. We also have an episode focused

specifically on compliance and Technology, as well as a separate episode focused on the accounting issues associated with these rules. So, hope our audience is able to tune into those. If you'd like more information from Jim or Daniel directly, you can reach out to them on LinkedIn. And we have a lot more information on pillar two, as well as a variety of Global Tax topics on the tax at hand app that you can get at any of your popular app stores. Thank you all for listening. I hope you continue to be well, and I hope you listen to our future episodes. Take [Music] care.

Pillar Two: A look at global safe harbor qualifications

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Deloitte US

Discussing Safe Harbor Guidance for Global Multinational Companies

The temporary Safe Harbor guidance, approved in December 2022, allows multinational companies to exclude operations in certain low-risk jurisdictions from the scope of global calculations.

The guidance uses revenue and income data to determine if companies meet the set thresholds, with the risk of having to do full calculations if the tests are not met.

Clients are using their previous cbcr filings to assess at-risk jurisdictions, with some unexpected countries, like Spain and Germany, highlighted as being at risk.

Government-driven COVID relief measures, recognition of deferred tax assets, and incentives/grants are identified as factors driving the risk in these jurisdictions.

Shifting Trends in Tax Asset Recognition and Reporting Compliance

Companies are now focusing on identifying trends and taking measures to recognize deferred tax assets, impacting their approach to reporting and compliance.

There is a significant shift towards using temporary safe harbors for managing reporting and compliance obligations, delaying full technology solution implementation projects.

The validation of country-by-country reporting has become a crucial focus, with the introduction of the term "qualified CBCR" by the OECD, leading to discussions on the preparation and reliable accounting standards for CBCR.

Impact of Accounting Standards on Tax Reporting in European Jurisdictions

Using local accounting standards for tax purposes in European jurisdictions is often considered unreliable due to the lack of true and fair view principle and the non-recording of deferred taxes.

Taxpayers are recommended to have a consistent approach by relying on the consolidation standard for the ultimate parent entity, with a potential consideration of local accounting standards when data is not available at the jurisdictional level.

The use of different accounting standards across the same group of entities has become a significant point of discussion, leading to potential pressure points and the need for more guidance from the OECD.

OECD's Guidance on Permanent Safe Harbors and its Impact on Reporting and Compliance

The OECD has released guidance on permanent safe harbors, affecting the reporting and compliance considerations for clients, particularly regarding QDM TTS.

The guidance introduces the use of local accounting standards for QDM application, raising questions about potential switches and adding complexity to accounting and reporting.

The permanent safe harbors eliminate duplicative computations, providing a single mechanism for tax calculation under pillar two, and aiming to simplify the process for ultimate parent entities in the US.

The Impact of Permanent Safe Harbors on QDM DT Computations

The OECD's permanent Safe Harbor allows countries to choose the accounting standard for local QDM DT computations, providing certainty and simplifying the assessment process.

This change will create a sea change in the way organizations gather and process data, requiring them to react and adapt to the new rules in the next three to four months.

The permanent Safe Harbor also allows for local tax certainty and confirmation of the interpretation of rules, simplifying the overall assessment process and providing clarity for taxpayers.

The Impact of the US's Position on Pillar Two

The US's lack of participation in pillar two creates uncertainty for US-based multinationals.

The one-year delay in the application of the under-tax profits rule acknowledges the pressure and lack of certainty for these organizations.

The OECD's additional guidance aims to address the complexity and provide more time for the administration of these rules.