Pillar 2 GloBE rules technical series: using elections to align and simplify GloBE computations 

The seventh session of our 10-part series on Pillar 2 GloBE model rules focuses on how elections can help align GloBE income to mirror local tax treatment and iron out issues that could skew the effective tax rate (ETR). There are also elections that recognise the difficulty of obtaining the numerous data points needed to calculate GloBE income, particularly in the transition years.

There are various elections that can be used to make adjustments to, for example, arrive at GloBE base or take into consideration temporary tax differences. Such elections can be considered in a number of situations, including GloBE income or loss (Article 3), adjusted covered taxes (Article 4) as well as some less common situations (Articles 1, 5, 6 and 7). There are also transitional, permanent and qualified domestic minimum top-up tax (QDMTT) safe harbour elections to consider.

A common theme with many of the elections available is how they align GloBE income to ensure there is no mismatch between GloBE income and local tax treatment. This can arise where, for example, stock-based compensation differs substantially year on year, uneven top-up tax exposure in a particular jurisdiction for a specific fiscal year, or when there are lots of intra-group transactions in a jurisdiction, especially if transactions are not arm’s length. There are seven elections under Article 3, five of them having five year periods of application and two being annual elections. 

One of the article 3 elections is a stock-based compensation election. It allows substituting any accounting stock-based compensation deduction with the actual deduction available for tax purposes in a controlling entity’s (CE’s) jurisdiction. It’s limited to compensation expenditures and applies to stock-based compensation for employees and non-employees. The impact here is that you can take a deduction based on the stock value at the exercise date versus the stock-based compensation allowed in the computation of FANIL. It’s a five-year election that must be made by the filing CE and applies to the jurisdiction for which it is made, where it will apply to all CEs in that jurisdiction. It’s a valuable election when significant tax deductions differ from those made in financial accounting net income or loss FANIL, which could impact the ETR in certain years. 

Article 4 Adjusted covered tax elections 

Several elections relating to adjusted covered taxes can be used in various situations, such as the ability to exclude certain deferred tax liability (DTL) accruals in determining adjusted covered taxes or to effectively create and carry GloBE losses forward with a deemed deferred tax asset (DTA). Article 4 elections also take account of GloBE losses, apply an immaterial decrease in covered taxes of a prior period to the current period, excess negative tax carry-forward situations which can be carried forward to future periods reducing the ind=cadence of earlier top-up taxes, and the treatment of FX hedge gains and losses to avoid mismatches in accounting impacting Pillar 2 tax. 

Let’s take the unclaimed accrual election as an example. The GloBE model rules require an increase in adjusted covered taxes by the amount of any disallowed accruals (accruals in respect of amounts excuded from the GloBE calculation) or unclaimed accruals (accruals for amounts not expected to reverse within a five year period)paid during the fiscal year. However, by using the unclaimed accrual election, an MNE group can exclude any DTL in respect of these amounts in determining adjusted covered taxes. It provides the opportunity to simplify GloBE compliance in jurisdictions where the GloBE ETR exceeds 15% removing the need to take into account the DTL. It simplifies the deferred tax adjustment amount (DTAA) computation for DTLs, as there is no need to determine when the DTLs reverse.

Additional elections to consider

There are a number of other elections outside of Articles 3 and 4 that are equally important but cover a more varied set of situations. These include elections relating to excluded entities, fair value basis adjustment on the sale of an asset, as well as an election to treat an investment entity (IE) or insurance investment entity (IIE) as tax transparent.

A non-excluded entity election can apply when, for example, an MNE group has excluded entities such as pension schemes or government agencies that, in some locations, are subject to tax. If an MNE group is subject to a top-up tax, then electing for the excluded entities to come into the scope of GloBE calculations can drive up the ETR to above 15%, so no top-up tax is due. However, this is not a cherry-picking election, as it falls into the five-year election bucket. A further consideration is whether electing under Pillar 2 income inclusion rule (IIR) would be more effective than the undertaxed profits rule (UTPR).

There is also a substance-based income exclusion (SBIE) election. SBIE is complicated to calculate as it needs a high number of data points. It involves apportioning staff costs between jurisdictions using information that is not easily accessible or even available. So if this calculation is not needed to, for example, reduce the ETR below 15%, then there is no benefit in spending time on SBIE calculations. If no SBIE calculation is performed, it is taken that an election has been made to exclude SBIE.

Simplifying GloBE computations

Several safe harbour elections are available that simplify GloBE computations. These elections include transitional, permanent and QDMTT safe harbours. Many companies are now beginning to examined the use of the transitional safe harbour election as it simplifies computations in the early years of applying the GloBE model rules by using readily available country-by-country reporting (CbCr) data. This election exists for fiscal years beginning on or before 31 December 2026, but not including a fiscal year that ends after 30 June 2028. It’s worth noting that for MNE groups that are eligible for the transitional safe harbour election, the principle of “once out, always out” applies when the MNE group doesn’t qualify in subsequent years, or doesn’t make an election when it could have done.

Similarly, the permanent safe harbour election also offers a simplified computation mechanism based on more detailed data than CbCr information. The idea of permanent safe harbours was outlined in the November 2022 OECD guidance. However, the final details are awaited. There’s also the QDMTT safe harbour, which, under Article 8.2, excludes the application of the GloBE rules in other jurisdictions by deeming the top-up tax payable to zero. This election can only be used where a jurisdiction has implemented QDMTT and allows MNE groups to undertake one computation under the QDMTT, avoiding the need to undertake further Pillar 2 calculations under IIR or UTPR.

It’s essential that MNE groups take time to understand the scope, impact, procedure and how to use elections so that they can fully benefit from adjustments that level up or simplify compliance with the GloBE model rules.

For a recap of previous topics covered, please refer to previous articles:

1. Pillar 2 GloBE rules technical series: unpacking and applying GloBE model rule adjustments
2. Pillar 2 GloBE rules technical series: getting to know top-up taxes and safe harbours
3. Pillar 2 GloBE rules technical series: understanding MNE group structures through the lens of the GloBE rules
4. Pillar 2 GloBE rules technical series: addressing MNE group complexities under Pillar 2 GloBE
5. Pillar 2 GloBE rules technical series: understanding how Pillar 2 GloBE impacts tax accounting
6. Pillar 2 GloBE rules technical series: navigating adjusted covered taxes

You can also contact us directly to discuss the above topics or other GloBE issues.