Proposal for an EU Directive on ensuring a global minimum level of taxation (‘Pillar 2’)

On 22 December 2021, the European Commission published its proposal for a Council Directive to introduce a global minimum effective tax rate for large multinational groups and large-scale domestic groups operating in the European Union. This is intended to implement the OECD Pillar 2 rules (‘Model Rules’) in the EU Member States. The OECD Model Rules were published on 20 December 2021 and envisage an effective tax rate of 15% for multinational companies. When compared with the OECD Model Rules, the proposed EU Directive contains few adjustments, which mainly derive from (primary) European Union law.

Overview

In general, Pillar 2 aims at ensuring an effective minimum tax rate for large multinational groups and at putting a floor on excessive tax competition between jurisdictions.

Pillar 2 consists of two rules to be implemented under domestic law and a treaty based rule. The former comprise of the Income Inclusion Rule (IIR) and the Undertaxed Payments Rule (UTPR), which are collectively referred to as the Global Anti-Base Erosion Rules (GloBE) and are part of the proposed EU Directive. In accordance with these rules, group entities and permanent establishments (‘constituent entities’) with an effective tax rate below 15% (‘low-taxed’) are to be taxed at a minimum tax rate of 15%. Similar to the effect of (Austrian) CFC rules, the IIR is intended to ensure taxation of low-taxed income at the level of the ultimate parent entity (‘top-up tax’). The nature of the low-taxed income (active or passive income) is not decisive. In the event that the IIR does not apply to a low-taxed group entity – e.g. in case no qualifying IIR in the jurisdiction of the ultimate parent entity is implemented – the UTPR would apply and the top-up tax would be allocated to the countries concerned, based on the number of employees and the carrying values of the tangible assets.

The Subject to Tax Rule (STTR) is a treaty based rule that allows source jurisdictions to impose limited source taxation on certain related party payments that are subject to tax below a minimum rate. The STTR is to be addressed in bilateral tax treaties and does not form part of the proposed EU Directive.

Key features of the proposed EU Directive: Income Inclusion Rule (IIR) and Undertaxed Payments Rule (UTPR)

Scope

  • The IIR and UTPR shall apply to constituent entities (group companies or permanent establishments) located in the EU that are members of a group which has an annual revenue of at least EUR 750m in its consolidated financial statements (this corresponds to the threshold for CbC reporting) in at least two of the last four consecutive fiscal years. Going beyond the OECD proposal, purely domestic groups with consolidated annual revenues of at least EUR 750m (‘large-scale domestic groups’) are also covered by the IIR and UTPR in order to ‘avoid any risk of discrimination in a Member State between cross-border and purely domestic situations.’ However, in accordance with a transitional rule for large-scale domestic groups, there shall be no additional tax burden resulting from the GloBE rules in the first five fiscal years, starting from the first day of the fiscal year in which the large-scale domestic group falls within the scope of this Directive for the first time.
  • Governmental entities, international organisations, non-profit organisations, and pension funds are excluded from the scope. Investment funds and real estate investment funds are excluded if they are at the top of the group structure.
  • Multinational groups shall be excluded from the GloBE rules in the first five years of the initial phase of their cross-border activities if i) they have constituent entities in no more than six countries and ii) the sum of the carrying values of the tangible assets of all constituent entities of the multinational group in the respective countries excluding the reference jurisdiction (the jurisdiction in which the constituent entities of the multinational group have the highest sum of carrying values of tangible assets) does not exceed EUR 50m. In contrast to the OECD Model Rules, this exception applies to both the UTPR and the IIR.

Income Inclusion Rule and Undertaxed Payments Rule

  • If group companies or permanent establishments are subject to an effective tax rate of less than 15%, these are considered to be low-taxed. In this case, under the IIR, the difference between the effective tax rate and the 15% minimum tax rate should be taxed in the state of the ultimate parent entity (top-up tax). In contrast to the OECD Model Rules, the proposed EU Directive extends the application of the IIR to low-taxed group companies and permanent establishments that are located in the same Member State as the ultimate parent entity.
  • If the IIR does not apply in the state of the ultimate parent entity, e.g. because no IIR has been implemented in this state, the IIR should be applied by group entities below the ultimate parent entity in the ownership chain and located in the European Union with regard to respective low-taxed subsidiaries or permanent establishments.
  • The effective tax rate will be calculated ‘on a jurisdictional level’, i.e. on a country-by-country basis: All constituent entities that are tax resident in a given jurisdiction will be assessed collectively with regard to the effective tax rate. The effective tax rate is calculated by dividing the covered (income) taxes of the constituent entities in a given jurisdiction by the adjusted net income of the constituent entities in that jurisdiction.
      • The basis for calculating the adjusted net income is the financial accounting net income or loss of the constituent entities before any consolidation adjustments for intra-group transactions, as determined under the accounting standard used for the consolidated financial statements of the ultimate parent entity (IFRS or equivalent). This result must subsequently be adjusted for specific items, e.g. net tax expenses, dividends received from shareholdings of 10% or more, or adjustments of fair value valuations. Furthermore, the proposed EU Directive includes specific rules regarding the treatment of temporary differences (e.g. for loss carryforwards).
      • The EU proposal contains a substance-based income exclusion, according to which the adjusted net income shall be reduced, for the purpose of calculating the top-up tax, by an amount equal to the sum of 8% of the carrying value of tangible assets and 10% of payroll costs. Within a 10-year transition phase, these percentages will be gradually be reduced to 5% by 2032.
      • The taxes to be taken into account in a given jurisdiction include, among others, income taxes and withholding taxes on dividend payments.
  • The proposed EU Directive contains a de-minimis exclusion from the GloBE-rules in case the profits of a group’s constituent entities in a jurisdiction are below EUR 1m and revenues are below EUR 10m.
  • If the ultimate parent entity is resident in a non-EU country that does not apply an equivalent IIR, or if the ultimate parent entity itself is low-taxed, the Undertaxed Payments Rule shall apply to the income of low-taxed constituent entities that are not fully covered by an IIR. The top-up tax on income of this kind shall be allocated to the countries that have introduced a UTPR on the basis of a two-factor formula (number of employees and carrying values of tangible assets).
  • The proposed EU Directive specifies under which circumstances a foreign IIR implemented by a third country jurisdiction can considered as equivalent to the EU IIR (e.g. ultimate parent entity shall compute and collect its allocable share of top-up tax in respect of low-taxed constituent entities of the group; minimum effective tax rate of at least 15%; blending of income of entities located within the same jurisdiction). The assessment of equivalence will be performed by the European Commission.

Domestic top-up tax

  • The draft directive provides for an option for Member States to introduce a domestic top-up tax for low-taxed constituent entities in their respective jurisdiction. If a domestic top-up tax is levied up to an effective tax rate of 15%, no (additional) top-up tax will apply at the level of the ultimate parent entity. The domestic top-up tax will enable Member States to participate in the additional tax revenue to be accrued from the low-taxed companies resident in their respective jurisdictions as a result of the GloBE rules.

Tax return obligations and penalties

  • Every constituent entity is obliged to submit a top-up tax information return with its tax administration, unless such a return has been filed by the ultimate parent entity or another group company in a jurisdiction that has an exchange of information agreement in place with the Member State of the constituent entity. The top-up tax information return must be submitted within 15 months of the end of the financial year to which it relates (in the first year after the new rules enter into force: within 18 months).
  • Member States shall introduce effective, proportionate and dissuasive penalties for breaches of the Pillar 2 rules. If a group company does not comply with the obligation to file a top-up tax information return in time, or if it submits an incorrect tax return, a penalty of 5% of its turnover in the relevant financial year must be imposed. However, this penalty shall not apply if the top-up tax information return is provided within six months of the request.

Conclusion and outlook

The envisaged implementation of the GloBE rules creates a new taxation regime with extremely complex and detailed rules that will apply to all large groups. The European Commission has set a very ambitious schedule for the implementation of the proposed EU Directive: It is envisaged that the Income Inclusion Rule shall be transposed into national law by Member States by 31 December 2022 and applied from 1 January 2023; the Undertaxed Payments Rule shall apply from 1 January 2024. Given the strong political commitment for the OECD Model Rules, it seems plausible that the unanimous approval of all 27 Member States, which is required for the adoption of the EU Directive, can be obtained. However, it remains to be seen whether the envisaged schedule can be met as, in our view, several highly complex questions about the application of the rules still remain unanswered.

From an Austrian perspective, the implementation of the proposed EU Directive would primarily affect groups with headquarters in Austria, consolidated annual revenues of EUR 750m or more, and subsidiaries or permanent establishments in low-taxed jurisdictions. Furthermore, Austrian subsidiaries or permanent establishments of a group with consolidated annual revenues of EUR 750m or more may also be affected if the GloBE rules are not (yet) applicable in the residence state of the ultimate parent entity. In addition, other Austrian group companies could also face high compliance costs due to the obligation to submit a top-up tax information return for each group company (provided no exception applies), or due to the required involvement of group companies in the collection of data for the application and calculation of the GloBE rules.

Link to the EU Directive proposal: https://ec.europa.eu/taxation_customs/system/files/2021-12/COM_2021_823_1_EN_ACT_part1_v11.pdf

Link to the OECD Model Rules: https://www.oecd.org/tax/beps/tax-challenges-arising-from-the-digitalisation-of-the-economy-global-anti-base-erosion-model-rules-pillar-two.pdf

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