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The realisation principle election

Applies
FY2024 onwards
Reviewed
Rule
P2-REAL-2024.1
By

Can fair value gains be ignored under Pillar Two?

Yes, by five-year election: fair value and impairment movements are excluded, and gains or losses count only when realised, across the jurisdiction.

Per GloBE Model Rules (Pillar Two), December 2021, Article 3.2.5, election to use the realisation principle

With respect to assets and liabilities that are subject to fair value or impairment accounting in the Consolidated Financial Statements, a Filing Constituent Entity may elect to determine gains and losses using the realisation principle for purposes of computing GloBE Income. The election is a Five-Year Election and applies to all Constituent Entities located in the jurisdiction, and to all their assets and liabilities unless the Filing Constituent Entity chooses to limit it to tangible assets of such Constituent Entities or to Constituent Entities that are Investment Entities. Under the election, all gains or losses attributable to fair value or impairment accounting with respect to an asset or liability are excluded from the computation of GloBE Income or Loss; the carrying value of an asset or liability for purposes of determining gain or loss is its carrying value at the later of the first day of the election year or the date the asset was acquired or liability was incurred; and if the election is revoked, GloBE Income or Loss is adjusted by the difference at the beginning of the revocation year between the fair value of the asset or liability and its carrying value determined pursuant to the election.

It removes volatility that tax does not follow. A write-down that tax does not allow, later reversed by a sale at cost, would otherwise produce a GloBE gain with no tax on it — and Top-up Tax on a profit nobody made.

Three computations, by what happened in the year

(a) While the asset is held

Every fair value or impairment gain or loss on an item within the election is left out of GloBE Income or Loss: a gain in the accounts is taken out, a loss or impairment is added back.

(b) On disposal

Gain or loss is the proceeds less the carrying value at the later of the first day of the election year and the date the item was acquired or incurred. That figure replaces the gain or loss in the accounts, which was measured from a fair-valued or impaired amount.

(c) On revocation

GloBE Income or Loss is adjusted by the difference, at the beginning of the revocation year, between fair value and the carrying value under the election. That recaptures the net movement left out while the election ran.

The Commentary's example

A Constituent Entity holds convertible debt in a start-up that does badly, and records a fair value loss. The start-up is then bought and the debt is disposed of for what it originally cost. The accounts show a gain on the sale that is no economic gain at all; with no tax on it, it could attract Top-up Tax. Under the election the loss was never deducted and the gain on sale, measured from original cost, is nil.

A Five-Year Election, by jurisdiction

It binds every Constituent Entity located in the jurisdiction and cannot be revoked within five Fiscal Years of the election year; after a revocation it cannot be made again for five. It may be made for assets already held, taking their carrying value at the start of the election year. It may be limited to tangible assets, or to Investment Entities.

Deferred tax follows the GloBE carrying value

Deferred tax expense on the items is worked out by reference to the carrying value under the election. Movements in accounting deferred tax that relate to fair value changes excluded by the election are disregarded; deferred tax on an item held when the election was made reverses when, and to the extent that, the carrying value comes into GloBE Income or Loss.

With other rules

An election limited to tangible assets defers an Included Revaluation Method Gain or Loss on the property it covers, and can be combined with the election to spread a gain on local property.

Order of testing

  1. 1

    Inputs requiring your determination

    Which event is being computed, whether the election is in force and reaches the item, and then that event's own figures.

  2. 2

    The Five-Year Election

    Without it fair value and impairment movements stay in.

  3. 3

    The scope of the election

    All items, tangible assets only, or Investment Entities only.

  4. 4

    Fair value and impairment gains and losses

    Article 3.2.5(a) — reversed.

  5. 5

    Gain or loss on disposal

    Article 3.2.5(b) — proceeds less the carrying value under the election, in place of the accounting figure.

  6. 6

    Revocation of the election

    Article 3.2.5(c) — fair value less the carrying value under the election, at the start of the revocation year.

Examples

Illustrative scenarios — ours, not the authority’s — each computed live by this rule. Change any fact and the outcome is the rule’s, not a hand-written answer.

A write-down on a start-up investment

Convertible debt bought for EUR 10 million is written down by EUR 4 million. With the election in force the loss is left out: EUR 4 million is added back.

Computed

Financial Accounting Net Income or Loss is increased by EUR 4,000,000 for FY2026 as computed: under Article 3.2.5(a) the fair value or impairment loss of EUR 4,000,000 is excluded from the computation of GloBE Income or Loss. It is brought in on disposal, measured from the carrying value under the election. Deferred tax on the movement is left out of Adjusted Covered Taxes with it. Based on the figures you supplied.

Workings

Fair value or impairment gain or (loss) in the accountsAs supplied
(EUR 4,000,000)
Adjustment to Financial Accounting Net Income or LossArticle 3.2.5(a) — the movement reversed
EUR 4,000,000

Decided by the fair value and impairment gains and losses

The same investment sold for what it cost

Two years later it is sold for EUR 10 million. The accounts show a gain of EUR 4 million over the written-down value; measured from the carrying value under the election there is none, so the EUR 4 million is taken out.

Computed

The gain on the disposal for GloBE purposes is EUR 0 for FY2028 as computed: proceeds of EUR 10,000,000 less the carrying value under the election of EUR 10,000,000 (Article 3.2.5(b)). The accounts show EUR 4,000,000, so Financial Accounting Net Income or Loss is reduced by EUR 4,000,000. The difference is the fair value and impairment movements left out while the election was in force. Based on the figures you supplied.

Workings

Disposal proceedsAs supplied
EUR 10,000,000
Carrying value under the electionArticle 3.2.5(b) — at the later of the first day of the election year and acquisition
(EUR 10,000,000)
Gain or (loss) on the realisation principleArticle 3.2.5(b)
EUR 0
Gain or (loss) on disposal in the accountsAs supplied — replaced
(EUR 4,000,000)
Adjustment to Financial Accounting Net Income or LossThe realisation gain or loss in place of the accounting one
(EUR 4,000,000)

Decided by the gain or loss on disposal

Investment property sold after years of fair value gains

A building carried at EUR 100 million when the election was made, fair-valued up to EUR 180 million in the accounts and sold for EUR 200 million. The accounts show a gain of EUR 20 million in the year of sale; the GloBE gain is the whole EUR 100 million.

Computed

The gain on the disposal for GloBE purposes is EUR 100,000,000 for FY2030 as computed: proceeds of EUR 200,000,000 less the carrying value under the election of EUR 100,000,000 (Article 3.2.5(b)). The accounts show EUR 20,000,000, so Financial Accounting Net Income or Loss is increased by EUR 80,000,000. The difference is the fair value and impairment movements left out while the election was in force. Based on the figures you supplied.

Workings

Disposal proceedsAs supplied
EUR 200,000,000
Carrying value under the electionArticle 3.2.5(b) — at the later of the first day of the election year and acquisition
(EUR 100,000,000)
Gain or (loss) on the realisation principleArticle 3.2.5(b)
EUR 100,000,000
Gain or (loss) on disposal in the accountsAs supplied — replaced
(EUR 20,000,000)
Adjustment to Financial Accounting Net Income or LossThe realisation gain or loss in place of the accounting one
EUR 80,000,000

Decided by the gain or loss on disposal

Revoking the election

The same building still held when the election is revoked, with a fair value of EUR 180 million at the start of the revocation year: EUR 80 million comes in.

Computed

GloBE Income or Loss is increased by EUR 80,000,000 in the revocation year FY2032 as computed: the fair value at the beginning of the year of EUR 180,000,000 less the carrying value under the election of EUR 100,000,000 (Article 3.2.5(c)). This is for an asset; for a liability the direction is the opposite. The adjustment recaptures the net fair value gain or loss that arose while the election was in force. A new election cannot be made within five Fiscal Years of the revocation. Based on the figures you supplied.

Workings

Fair value at the beginning of the revocation yearAs supplied
EUR 180,000,000
Carrying value under the electionAs supplied
(EUR 100,000,000)
Adjustment to GloBE Income or LossArticle 3.2.5(c) — for an asset
EUR 80,000,000

Decided by the revocation of the election

Financial assets under an election limited to tangible assets

A fair value gain on listed securities where the election was limited to tangible assets: the item is outside it.

Computed

No adjustment is made under Article 3.2.5, as determined: the asset or liability is outside the election as made. Fair value and impairment gains and losses stay in GloBE Income or Loss as the accounts show them. Based on the determinations you supplied.

Decided by the scope of the election

Try it

Supply the facts and this rule computes the outcome in your browser, live. Leave a determination undecided and it blocks the result — it is never read as a no.

Not computed yet

1 input still need your determination:

  • Which is being computed: a fair value or impairment movement recorded in the year on an item within the election; a disposal of such an item in the year; or the adjustment on revoking the election?

Computed in your browser from the figures you supply. Nothing is sent anywhere, and the result is a computation against a rule — reference, not tax advice.

Sources

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Reference, not tax advice.

Pankaj Agarwal — Tax Technology Leader