Loyens & Loeff New York regularly posts 'Snippets' on a range of EU tax and legal topics. This Snippet describes the impact of book-to-tax differences ('B/T Differences') for Pillar Two ('P2') purposes.
P2 seeks to enforce a global minimum income tax at an effective rate ('ETR') of 15% for each country in which the MNE operates. The starting point for the ETR calculation is book income which is subsequently adjusted to - amongst others - eliminate certain B/T Differences.
An example of such an adjustment relates to dividends and capital gains. Dividends and capital gains derived from qualifying shareholdings are treated as tax exempt under the participation exemption in many countries, whereas they are included as income in the (standalone) financial statements. This would be an issue as the dividends and capital gains would be included in the P2 calculation without a corresponding tax charge. P2 recognizes that this is an undesirable outcome and adjusts this by excluding dividends and capital gains from qualifying shareholdings from the P2 computation. Dividends will be excluded for P2 purposes in case the taxpayer holds at least 10% of the vote and value in the subsidiary and/or after a 12-month holding period has been met. Capital gains will be excluded if at least 10% of the vote and value is held (irrespective of whether the 12-month holding period has been met).
Not all B/T Differences are adjusted under P2. The remaining B/T Differences can be split in (a) permanent differences and (b) temporary differences. It is important to distinguish between these two categories as permanent differences generally have a more substantial impact for P2 purposes than temporary differences.
Examples of permanent and B/T Differences that are not adjusted under P2 are:
- preferential IP regimes (e.g., FDII);
- depreciation of goodwill in the tax accounts but not in the financial accounts;
- debt / equity classification differences (financial accounting vs tax), such as preference shares that are treated as equity for tax purposes but as debt under financial accounting standards; and
- participation exemption systems that exempt income derived from shareholdings of less than 10% from local tax.
Temporary B/T Differences exist if the tax and financial accounts recognize the relevant income/expense but at different points in time. Temporary differences are addressed under P2 via deferred tax accounting. However, deferred taxes are capped at a 15% rate. An example of a temporary difference that generally should not have an impact for P2 purposes is accelerated tax depreciation on tangible assets.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.