EU directive sets out approach to global minimum tax, adds domestic application

By Doug Connolly, MNE Tax

The European Commission today released its proposed directive to implement within the EU the global minimum tax under Pillar 2 of the OECD agreement reached between 137 countries in October. The directive largely tracks the OECD agreement, while adding domestic application to comply with EU anti-discrimination requirements.

“The directive we are putting forward will ensure that the new 15% minimum effective tax rate for large companies will be applied in a way that is fully compatible with EU law,” EU Commissioner for Economy Paolo Gentilioni said. “The European Commission worked hard to facilitate this deal,” he added, “and I am proud that today we are at the vanguard of its global rollout.”

The directive is subject to certain legislative steps before it can be adopted, including unanimous agreement in the European Council. However, nearly all EU states have already in principle agreed to the rules under the OECD Inclusive Framework. The one exception, Cyprus – because it’s not a member of the Inclusive Framework – has indicated that it also supports the agreement.

The Commission’s directive does not address the other half of the OECD deal – that is, Pillar 1, relating to the reallocation of taxing rights between nations. The Commission plans to release a directive addressing Pillar 1 in summer 2022, following the planned signing of the associated multilateral convention.

Broadly consistent with OECD rules

The EU’s Pillar 2 directive is intended to ensure consistent application of the global minimum tax within the EU.

Like the OECD rules, the directive imposes a 15% minimum effective tax rate on multinational groups with revenues of more than EUR 750 million that are based or have a subsidiary in the EU. If the group is subject to an effective tax rate below the minimum in a country in which it operates, the rules enable EU states to apply a “top-up tax” through either the income inclusion rule or undertaxed payments rule.

Also in line with the OECD rules, the directive includes a de minimis exception, exempting small amounts of profits in a country, and substance carve-outs, which soften the application in countries in which the multinational group has significant tangible assets or payroll (i.e., economic substance). The substance carve-outs partially phase down over several years under transition rules.

Added application to domestic groups

The main difference from the OECD rules is that the EU directive adjusts the scope of the rules to include purely domestic groups, while the OECD rules only apply top-up tax to multinational groups’ foreign subsidiaries. This distinction is required to prevent discrimination between domestic and cross-border groups to comply with EU fundamental freedoms.

As a result, for large in-scope domestic groups, ultimate parent entities in EU member states will be subject to the income inclusion rule top-up tax with respect to low-taxed constituent entities. The directive further allows member states to apply top-up tax domestically to constituent entities located in their state, rather than having all the tax collected at the level of the ultimate parent entity.