Koninklijke Philips N.V. – Annual report – 31 December 2023
Industry: manufacturing
6 Risk management (extract)
6.5 Financial risks (extract)
Philips is exposed to tax risks which could have a significant adverse financial impact
Philips is exposed to tax risks that could result in double taxation, penalties and interest payments. The source of the risks could originate from local tax laws and regulations as well as international and EU regulatory frameworks. These include transfer pricing risks on internal cross-border deliveries of goods and services, as well as tax risks relating to changes in the transfer pricing model. Examples of initiatives that may result in changing tax rules include, but are not limited to, the plans adopted by the Dutch parliament to abolish the tax exemption for dividend withholding tax on share buy backs with effect from 2025 and the OECD/G20 Inclusive Framework to address the allocation of income to user markets (Pillar One) and a 15% minimum corporate income tax rate (Pillar Two). The formal adoption of Council Directive (EU) 2022/2523 (the Pillar Two Directive) in December 2022 aims to achieve a coordinated implementation of Pillar Two in EU member states. The Dutch government adopted the Minimum Tax Rate Act 2024 (MTR Act) in December 2023 and the Pillar Two legislation will be applicable in local law with effect from 2024. As for Pillar One, it is too early to assess the potential impact. Philips is closely following the developments of this initiative.
As Philips maintains substance in the form of relevant assets and personnel in the countries in which it operates, and with the recently provided transitional safe harbor rules (based on Country-by-Country report) enacted by OECD, Philips currently expects to have limited exposure to taxation under Pillar Two. Pillar Two may still impose an additional tax burden on a jurisdiction-by-jurisdiction basis (which do not meet the transitional safe harbor rules) and increase Philips’ tax compliance burden significantly.
Furthermore, Philips is exposed to tax risks related to acquisitions and divestments, permanent establishments, tax loss, interest and tax credits carried forward, and potential changes in tax law that could result in higher tax expenses and payments. The risks may have a significant impact on local financial tax results, which could adversely affect Philips’ financial condition and operating results. The value of the deferred tax assets, such as tax losses carried forward, is subject to the availability of sufficient taxable income within the tax loss-carry-forward period. The ultimate realization of the company’s deferred tax assets is uncertain. Accordingly, there can be no absolute assurance that all deferred tax assets, such as (net) tax losses and credits carried forward, will be realized.
Risk response: Philips has a globally organized and experienced tax function, which is accountable for the definition and execution of the tax strategy and for the tax position of Philips worldwide. It advises management on the tax implications of intended decisions, performs appropriate tax planning to support business goals, and ensures compliance with all local and international tax laws. Philips has a Tax Control Framework in place, which creates awareness of and ensures adherence to current tax policies.
Philips will be in full compliance with Pillar Two whereby we will be leveraging our existing digital tax systems to ensure an efficient and high-quality process to determine countries in scope, calculate the additional tax liability (if any) and enable timely filing.
Potential risks are carefully monitored and dealt with by tax specialists from relevant areas (e.g., corporate income tax, transfer pricing, indirect taxes, wage tax and tax accounting). There are extensive controls in place on processes and systems to address these risks, which are discussed in detail in the Country Activity and Tax Report and in the note Income taxes, starting on page 164.
10.6 Notes to the Consolidated financial statements (extract)
1 General information to the Consolidated financial statements (extract)
Accounting estimates and judgments
The preparation of financial statements requires management to make a number of estimates and judgments that affect the application of accounting policies and the reporting amounts of assets and liabilities, revenues and expenses, and the disclosure of contingent assets and liabilities. Amounts recognized are based on factors that are by default associated with uncertainty. Actual results may therefore differ from estimates. Estimates and underlying assumptions are reviewed on an ongoing basis. Revision to estimates are recognized prospectively. Where applicable, the estimates and judgments of specific financial statement items are described in the respective note to the consolidated financial statements.
The areas involving a higher degree of judgment and complexity in applying accounting principles and for which changes in the assumptions and estimates could result in significantly different results than those recorded in the consolidated financial statements are the following:
- Assessment of control (below paragraph Basis of consolidation and Interests in entities, starting on page 158)
- Revenue recognition (Income from operations, starting on page 159)
- For acquisitions, the identification and valuation of acquired assets and liabilities including contingent considerations provisions (Acquisitions and divestments, starting on page 156, Provisions, starting on page 188)
- Determination of deferred tax assets for losses carried forward and uncertain tax positions (Income taxes, starting on page 164)
- Assumptions used for impairment testing (Goodwill, starting on page 173, Intangible assets excluding goodwill, starting on page 176)
- Assessments of exposure to credit risk of financial instruments (Other financial assets, starting on page 178, Receivables, starting on page 181, Debt, starting on page 186, Fair value of financial assets and liabilities, starting on page 208, Details of treasury and other financial risks, starting on page 213)
- Assumptions used to determine the net realizable value of inventories (Inventories, starting on page 180)
- Actuarial assumptions of future events that are used in calculating post-employment benefit expenses and liabilities (Post-employment benefits, starting on page 192)
- Estimates and assumptions regarding the timing and the amount of outflow of resources, as well as estimating the likelihood of a potential outflow of resources and the ability to make a reliable estimate of the obligation relating to provisions and contingent liabilities (Provisions, starting on page 188, Contingencies, starting on page 198)
The company regularly updates its significant assumptions and estimates to support the reported amounts of assets, liabilities, income and expenses.
In preparing the consolidated financial statements management has considered the impact of climate change, specifically the financial impact of Philips meeting its internal and external climate related aims, the potential impact of climate related risks and the costs incurred to pro-actively manage such risks. These considerations did not have a material impact on the financial reporting judgments, estimates or assumptions. The specific financial impacts considered include, for example: specific climate mitigation measures, such as the use of lower carbon energy sources, the costs of developing more sustainable product offerings and expenses incurred to mitigate against the impact of extreme weather conditions. Philips uses 100% electricity from renewable sources, mainly through long-term Power Purchase Agreements thereby mitigating the impact of carbon taxes. The development of more sustainable products are covered through our EcoDesign program and already included in our R&D expenses. The physical risk related to climate change on our sites resulting from our TCFD-assessment is currently considered limited.
8 Income taxes (extract)
Tax risks
Philips is exposed to tax risks and uncertainty over tax treatments. For particular tax treatments that are not expected to be accepted by tax authorities, Philips either recognizes a liability or reflects the uncertainty in the recognition and measurement of its current and deferred tax assets and tax attributes. For the measurement of the uncertainty, Philips uses the most likely amount or the expected value of the tax treatment. The expected liabilities resulting from the uncertain tax treatments are included in non-current tax liabilities (2023: EUR 390 million, 2022: EUR 435 million, decrease due to release of liabilities, in combination with higher tax losses or similar tax carryforwards that can be used if uncertain tax treatments were settled for the presumed amount at balance sheet date). The positions include, among others, the following:
Transfer pricing risks
Philips has issued transfer pricing directives, which are in accordance with international guidelines such as those of the Organization of Economic Co-operation and Development. In order to reduce the transfer pricing uncertainties, monitoring procedures are carried out by Group Tax to safeguard the correct implementation of the transfer pricing directives. However, tax disputes can arise due to inconsistent transfer pricing regimes and different views on “at arm’s length” pricing.
Tax risks on general and specific service agreements and licensing agreements
Due to the centralization of certain activities (such as research and development, IT and group functions), costs are also centralized. As a consequence, these costs and/or revenues must be allocated to the beneficiaries, i.e. the various Philips entities. For that purpose, service contracts such as intra-group service agreements and licensing agreements are signed with a large number of group entities. Tax authorities review these intra-group service and licensing agreements, and may reject the implemented intra-group charges. Furthermore, buy in/out situations in the case of (de)mergers could affect the cost allocation resulting from the intragroup service agreements between countries. The same applies to the specific service agreements.
Tax risks due to disentanglements and acquisitions
When a subsidiary of Philips is disentangled, or a new company is acquired, tax risks may arise. Philips creates merger and acquisition (M&A) teams for these disentanglements or acquisitions. In addition to representatives from the involved business, these teams consist of specialists from various group functions and are formed, among other things, to identify tax risks and to reduce potential tax claims.
Tax risks due to permanent establishments
A permanent establishment may arise when a Philips entity has activities in another country, tax claims could arise in both countries on the same income.
Accounts examples 