Proposed amendment to IAS 12 Income Taxes – Pillar Two model rules

Tue 11 Apr 2023

Entities may be aware that in December 2021, the Organisation for Economic Co-operation and Development (OECD) published its Pillar Two model rules (“the rules”). The rules address the tax challenges arising from the digitalisation of the economy and were agreed by jurisdictions representing more than 90% of global GDP.  The rules aim to ensure that large multinational groups pay a minimum amount of tax on income arising in each jurisdiction in which they operate.  If there are group entities established in jurisdictions where the income tax rate is below 15%, then a top up tax will be paid by other entities in the control chain, provided that the jurisdictions of those controlling entities have also enacted the OCDE pillar 2 regulation.

As and when jurisdictions substantively enact local tax law to introduce the rules, so there are potentially deferred tax consequences to account for in financial statements.  However, following concern raised by stakeholders about these consequences, the International Accounting Standards Board (IASB) has published an exposure draft proposing to introduce an exception to the requirement in IAS 12 Income Taxes (IAs 12) to account for deferred tax on temporary differences as and when countries introduce the rules into law. The period for commenting on the exposure draft ended on 10 March 2023.

Where a multinational group does not operate in any jurisdiction that has tax rates less than 15%, then it’s global tax liability will not be affected by any amendment made to IAS 12.  However, for those multinational groups which are affected, the following should be borne in mind:

• As the amendment provides an exception to, not an exemption from, the requirements of IAS 12, entities would be prohibited from recognising deferred tax on the temporary differences created.
• Disclosures would be needed where legislation has been enacted or substantively enacted prior to that legislation taking effect.
• The exception is described in the exposure draft as being “temporary”.  Therefore, while many entities will be glad at not having to worry about the potentially complicated accounting for deferred tax in the short term, it is unclear how long the temporary exception will last.  Whether the temporary exception will become a permanent exception remains to be seen.

However, a particular challenge arises if (substantive) enactment of the rules occurs before an annual reporting date, with the amendment to IAS 12 not endorsed until sometime after the intended publication date of the financial statements.  This is because the proposed exception in the amendment could not be applied, with deferred tax having to be recognised accordingly in those financial statements.  The resulting deferred tax balances would then in turn have to be reversed in a subsequent period once the amendment has been endorsed.  It is hoped, therefore, that the IASB can progress the amendment in a timely fashion with the UK endorsement board ratifying any such amendment promptly thereafter. 

It would also be welcome if the Financial Reporting Council (FRC) in the UK would clarify (with reasoning) whether a proposed amendment to accounting standards can be applied in interim financial statements on the basis of its expected endorsement by the next annual reporting date.  Companies faced a similar challenge in 2020 regarding the then proposed amendment to IFRS 16 Leases dealing with Covid-related rent concessions, with different views being held as to whether the amendment could be applied in interim periods prior to its endorsement. Clearly an ability to apply the proposed IAS 12 amendment in interim financial statements in light of its likely eventual endorsement would make life a lot easier for preparers.