Pillar Two – Commission publishes draft directive on global minimum tax rules in the EU

Draft directive is based closely on G20/OECD Inclusive Framework's model rules

23 December 2021

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On 22 December 2021, the European Commission published a ‘Proposal for a council directive on ensuring a global minimum level of taxation for multinational groups in the Union’ (‘draft Directive’).

The draft Directive is based on, and will implement in the EU, the global minimum tax model rules published by the G20/OECD Inclusive Framework on BEPS on 20 December 2021 (‘OECD Inclusive Framework model rules’). The OECD Inclusive Framework model rules are designed to ensure that large multinational groups pay corporate income taxes at a minimum level of 15% in every country in which they operate. They include a main rule generally applied at the parent company level (the ‘income inclusion rule’) and a backstop rule where the income inclusion rule is not applied (the ‘undertaxed payments rule’).

Deloitte Comments

The European Commission (‘EC’) draft Directive closely follows the OECD Inclusive Framework’s model rules for a global minimum tax. European Commissioner Paolo Gentiloni commented that the draft proposals are ‘fully consistent with the final version of the OECD's model rules which set out the details for the application of the new framework. That means no gold plating; no departure from the international agreement. We are maintaining the careful consensus that has been forged among EU member states and our international partners’.

The draft Directive’s proposed amendments to the OECD Inclusive Framework model rules are focussed on matters affecting EU parented groups. They include requiring the income inclusion rule to be applied to entities in the EU parent jurisdiction and requiring large domestic groups to also apply the income inclusion rules. The effect of these changes is that only the income inclusion rule (i.e. not the undertaxed payments rule) will apply to groups with an ultimate parent entity in the EU. Some businesses will want clarity that the draft Directive appropriately takes account of domestic top up taxes paid in countries outside the EU when applying the undertaxed payments rule for top up tax to be allocated to EU member states.

Businesses will want to understand the compliance and administration requirements for group companies in the EU, and how these compare to the OECD model rules. Whilst broadly similar, businesses will be keen for the ‘OECD standard template’ for global minimum tax return information to also be used within the EU, in order to minimise unnecessary compliance costs. There is also mention, in the accompanying notes, of potential safe harbours that might be considered by the OECD Inclusive Framework such as a ‘tax administrative guidance safe harbour’ or ‘country-by-country report ETR safe harbour’.

Businesses will be concerned that the timetable does not allow for a public consultation on the draft Directive, particularly since the OECD Inclusive Framework model rules had limited public consultation.

The draft Directive will require unanimity of the EU Council, and as such it is possible that there may be amendments, within the confines of needing to implement the OECD Inclusive Framework rules in a manner consistent with the global agreement. In particular, it remains to be seen whether all EU member states are prepared to approve the Pillar Two global minimum tax Directive before there is more certainty on the proposals for the implementation of Pillar One. 

The release of the draft Directive to implement the OECD Inclusive Framework’s Pillar Two global minimum tax in the European Union (‘EU’) is part of a collection of tax proposals published by the EC on 22 December 2021. These include a draft Directive dealing with the taxation of shell companies (following a public consultation) and proposals for new ‘own resources’ to fund the EU budget out of tax collected by member states. Notably, the Commission have proposed to the Council that some of the shortfall in ‘own resources’ at the EU level should be funded by tax on profits reallocated to EU member states under the OECD Inclusive Framework proposals for Amount A of Pillar One. The OECD Inclusive Framework proposals look to allocate 25% of the residual profit of the largest multinationals (with turnover of €20 billion and a profit margin of at least 10%) to market countries where sales are made or users are located. The EC has proposed that of the amount of profits reallocated to Member States, 15% should be transferred to the European Union budget.

The proposals are limited in detail, not least because the OECD Inclusive Framework is still working on the Pillar One Amount A rules. A draft Directive is planned for 2022 to implement the OECD Inclusive Framework’s Pillar One Amount A rules once finalised.

Income inclusion rule and undertaxed payments rule

The OECD Inclusive Framework model rules, on which the draft Directive is based, apply to large multinational groups with annual consolidated group revenue of at least EUR 750 million:

  • The income inclusion rule applies on a top down basis such that in most cases any tax due is calculated and paid by the ultimate parent company to the tax authority in its country. The tax due is the ‘top up’ amount needed to bring the overall tax on the profits in each country where the group operates up to the minimum effective tax rate of 15%.
  • The undertaxed payments rule applies as a secondary (backstop) rule in cases where the effective tax rate in a country is below the minimum rate of 15%, but the income inclusion rule has not been fully applied. The top up tax is allocated to countries which have adopted the undertaxed payments rule based on a formula, and is implemented either by denial of a deduction for payments or by making an equivalent adjustment.

See the Deloitte Alert of 20 December 2021 for more details and comments on the OECD Inclusive Framework model rules.

EU draft Directive

The draft Directive is based closely on the OECD Inclusive Framework’s model rules with some adjustments designed to guarantee conformity with EU law. The draft Directive consists of detailed chapters on:

  • scope, definitions, and location of group companies (‘constituent entities’);
  • income inclusion rule, domestic top up tax and undertaxed payments rule;
  • calculation of the ‘qualifying income or loss’ (tax base);
  • computation of ‘adjusted covered taxes’;
  • calculation of effective tax rates and top up tax;
  • corporate restructurings and holding structures;
  • tax neutrality and distribution regimes;
  • administration;
  • transition rules;
  • application of the income inclusion rule to large-scale domestic groups; and
  • assessment of equivalent rules outside the EU and commencement provisions.

Large scale domestic businesses

The scope of the OECD Inclusive Framework model rules includes only large multinational businesses (i.e. businesses with entities or permanent establishments in more than one country). The draft Directive will also apply the income inclusion rule to large scale domestic businesses in the EU i.e. groups with annual consolidated group revenue of at least EUR 750 million where all entities are located in the same EU member state.

Large scale domestic groups are exempt from paying top up tax for the first five years during which they fall within the scope of the draft Directive – this mirrors the transitional rules exempting groups that are newly expanding internationally from paying top up tax under the undertaxed payments rule.

Application of the income inclusion rule in the parent entity country

The draft Directive will require parent companies in member states to apply their income inclusion rules to both domestic and overseas constituent entities. The OECD Inclusive Framework model rules do not require countries to apply the income inclusion rule to the profits of constituent entities located in the same country as the group’s parent entity.

No top up tax is payable in respect of low-taxed constituent entities in the same country as the EU parent for the first five years of international activity of the group. Such groups must have entities in no more than six countries and the net book value of their ‘international’ tangible assets must not exceed EUR 50 million (excluding tangible assets in the country with the most tangible assets).

Co-existence of Pillar Two and US Global Intangible Low-Taxed Income (GILTI) regime

The draft Directive sets out criteria against which the domestic law of a country outside of the EU shall be evaluated as an equivalent set of rules, including:

  • the parent entity of a group is required to compute and collect its share of top up tax in respect of low taxed group members;
  • a minimum effective tax rate of at least 15%;
  • effective tax rates to be calculated on a country (jurisdictional) basis;
  • relief for any top up tax paid in an EU member state in the application of the income inclusion rule.

A list of the countries which meet the criteria and are considered equivalent rules will be published in an annex to the Directive. The OECD Inclusive Framework intend to address co-existence with the US Global Intangible Low-Taxed Income (GILTI) rules in early 2022.

Transition rules

Existing tax attributes, including losses, reflected/disclosed in the financial accounts of a constituent entity in the first year during which the rules apply are taken into account in the effective tax rate calculations, as under the OECD Inclusive Framework model rules. Deferred tax assets arising from items excluded from the tax base computation (the ‘qualifying income or loss’) and which arise on a transaction after 15 December 2021 are excluded (the OECD Inclusive Framework model rules apply the exclusion to transactions after 30 November 2021). Deferred tax assets/liabilities in respect of acquired assets transferred between constituent entities after 15 December 2021 and before the group is within the scope of the rules, are based on the disposing entity’s carrying value. (The OECD Inclusive Framework model rules apply to transfers after 30 November 2021).

Compliance and administration

The draft Directive sets out filing obligations, including in respect of elections. Alignment will be needed with the OECD implementation framework on administrative, compliance and co­ordination issues relating to Pillar Two. The OECD implementation framework is currently in development with a public consultation event scheduled for February 2022.

EU Member States are required to apply effective, proportionate and dissuasive penalties to any businesses which do not comply with the draft Directive. A constituent entity that does not file its ‘top up tax information return’ (following any reminder issued) within a period of six months from the deadline shall be charged a penalty of 5% of its turnover in the relevant fiscal year.

Next steps

Under the European treaties, EU measures on taxation require the unanimous agreement of all member states. (All 27 member states have previously indicated their approval of the OECD Inclusive Framework’s approach). Finance ministers from the member states will consider the draft directive in the Economic and Financial Affairs Council (ECOFIN) and, after receiving a formal opinion on the proposal from the European Parliament, plan to adopt the draft directive formally during the first half of 2022.

The EU member states will then be required to transpose the draft Directive’s provisions into their domestic tax law by 31 December 2022. Domestic provisions will take effect from 1 January 2023 for the income inclusion rule, and 1 January 2024 for the undertaxed payments rule, in line with the OECD Inclusive Framework’s timetable.

Deloitte’s EMEA Dbriefs series will hold a webcast on 10 January 2022 at 13:30 GMT / 14:30 CET to discuss the OECD Inclusive Framework’s model rules. For more information and to register visit here.