EU publishes minimum corporate tax rate directive

The draft directive follows the publication by the Organisation for Economic Cooperation and Development (OECD) of model rules for pillar two of the proposed two-pillar solution to address the tax challenges of the digitalisation of the economy, as agreed by 136 countries in October.

Pillar two is the so-called ‘Global Anti-Base Erosion’ (GloBE) rule, which is designed to ensure that large multinational enterprises pay a minimum level of tax of 15% on the income arising in each jurisdiction where they operate.

Countries signing up to the OECD deal are not obliged to introduce the pillar two rules, but if they do so, they must follow the approach taken in the OECD model rules.

“If the EU directive is approved, it will ensure that all EU member states introduce the rules and do so in a broadly consistent way,” said Eloise Walker, a corporate tax expert at Pinsent Masons. “However, the directive will need to be transposed into the national laws of each member state so differences in implementation may still arise”.

The proposed directive will apply to any group with annual consolidated revenue of at least €750 million with a parent company or a subsidiary situated in an EU Member State. It will apply to both purely domestic groups as well as those operating internationally.

The effective tax rate is established per jurisdiction by dividing taxes paid by the entities in that jurisdiction by their income. If the 15% minimum effective rate is not imposed by the country where a low-taxed company is based, the member state of the parent company can apply a ‘top-up’ tax. This top-up tax is known as the ‘income inclusion rule'.

Where the parent company is situated outside the EU in a low-tax country which does not apply equivalent rules, the undertaxed payments rule will allocate any residual amount of top-up tax to group entities in the EU. The amount of top-up tax that a member state will collect from the entities of the group in its territory will be determined by a formula based on employees and assets.

Although the proposed directive follows the OECD model rules closely, some adjustments have been made to make it compatible with EU law. In particular, the proposed directive will include purely domestic groups. In contrast, the OECD’s Pillar 2 applies to multinational groups so that a parent entity subjects only its foreign subsidiaries to the income inclusion rule. This adjustment is required so that domestic arrangements are not treated more favourably than cross-border ones so as to comply with the freedom of establishment, one of the EU’s fundamental freedoms.

The OECD model rules allow jurisdictions the option to apply a qualifying domestic minimum tax. The draft directive allows EU member states to opt to apply a domestic top-up tax to low taxed domestic subsidiaries. This option will allow the top-up tax due from the subsidiaries of the multinational group to be charged within the relevant EU country, and not in the jurisdiction of the parent company.

“EU member states which do not increase their tax rates to at least 15% are likely to want to apply the domestic top-up, as otherwise they will see the tax revenues going elsewhere,” Eloise Walker said.

The Commission proposes that EU member states transpose the directive into their national laws by 31 December 2022 for the rules to come into effect from 1 January 2023. The introduction of the undertaxed payment rule will be deferred to 1 January 2024, as envisaged by the OECD.

The EU had pledged to move swiftly and be among the first to implement the OECD global tax reform agreement. However, the directive will need to be unanimously agreed by EU member states.

“Although all EU countries have signed up to the OECD deal, or in the case of Cyprus said they agree to it, they may not want to agree the directive introducing the pillar two rules until it is clearer that the US will get pillar one through its legislative process,” Walker said.

Pillar one allocates 25% of the residual profit of the largest multinationals to market countries where sales are made or users are located. Pillar one applies to groups with turnover of €20 billion and a profit margin of at least 10%.

“The main beneficiaries of pillar one are likely to be countries in Europe such as France and the UK. Pillar one will mean tax revenues moving to these jurisdictions from the US where many of the tech giants are based. In contrast pillar two is likely to be a significant revenue raiser for the US as the taxing rights go first to the country where the ultimate parent company is based,” Walker said.

The European Commission has proposed that some of the shortfall in the EU budget should be funded by pillar one additional tax revenues. It has proposed that 15% of the pillar one additional revenues should be transferred to the EU budget. Other revenue sources proposed by the Commission are the revenues from emissions trading and revenue generated by the proposed EU carbon border adjustment mechanism.