On 22 December 2021, the European Commission published its proposal for an EU Directive that would implement the Global Anti-Base Erosion (GloBE) rules within the EU. As noted in an accompanying press release, the proposal delivers on the EU's pledge to move swiftly and be among the first to implement the recent global tax reform agreement reached by 137 of the 141 developed and developing countries in the OECD/G20 Inclusive Framework (IF) to address tax challenges posed by the digitalization of the economy.
The proposed directive sets out how the effective tax rate will be calculated per jurisdiction, and includes rules that will ensure that large multinational (MNE) groups in the EU pay a 15% minimum rate in every jurisdiction in which they operate and that the rules are applied consistently throughout the EU. On 20 December, the OECD issued its model rules aimed at assisting jurisdictions in the domestic implementation of the 15% minimum tax on MNEs that fall within its scope (click here for a BDO tax alert on the OECD model rules).
Since all EU member states (except Cyprus) are members of the IF, it is not surprising that the language of the proposed directive is generally in line with the OECD model rules.
By applying a “top-up tax,” the GloBE rules ensure that an effective minimum tax of 15% is levied in each jurisdiction where a group with global consolidated revenues in excess of EUR 750 million is active through a local entity or permanent establishment (“constituent entity”). The GloBE rules are twofold and consist of an income inclusion rule (IIR) that imposes a top-up tax on the ultimate or intermediate parent entity in respect of the low-taxed income of a constituent entity, and an undertaxed payments rule (UTPR) that disallows a deduction or imposes an adjustment if the low-taxed income is not subject to tax under an IIR.
EU member states’ positions in OECD Pillar 2 discussions
The agreement reached by the IF members was welcomed by most EU member states. Germany and France, in particular, had long been pushing for a reform of the international tax system. Some member states initially were resistant to the idea of a global minimum tax. Estonia, Hungary and Ireland did not immediately endorse the IF agreement. In particular, they expressed concerns that the original proposal provided for an effective tax rate of at least 15%, leaving room to eventually implement a higher rate and the possibility that countries would apply a revenue threshold below EUR 750 million. Hungary and Ireland currently have statutory corporate income tax rates of 9% and 12.5%, respectively, and thus feared that they would be hit hardest by the reform.
In light of these concerns, the original IF agreement was amended. The phrase “at least” was dropped from the text and the transitional period for a higher substance-based carve-out envisioned in the original text was extended to 10 years. In addition, the new text clarified that a de minimis exclusion would apply to jurisdictions where an MNE has revenues of less than EUR 10 million and profits of less than EUR 1 million. In October, all three opposing EU member states endorsed the agreement as amended and these changes are reflected in the language of the proposed directive published by the European Commission.
Content of proposed directive
As mentioned above, the proposed directive closely follows the OECD model rules. However, to ensure compliance with the EU fundamental freedoms, the scope of the directive deviates from the OECD rules. The scope of the directive is extended to large-scale purely domestic groups that meet the revenue threshold of EUR 750 million, which in practice, is expected to impact a limited number of companies.
In addition, the directive makes use of an option offered by the OECD model rules whereby the member state of a constituent entity applying the IIR, which is usually the jurisdiction of the ultimate parent entity, is required to ensure effective taxation at the minimum agreed level not only of foreign subsidiaries but also of all constituent entities resident in that member state. In this respect, the directive is stricter than the OECD model rules, which provide that the jurisdiction that applies the IIR takes into account only foreign constituent entities.
Aside from the minor deviations from the OECD model rules, the directive substantively is in accordance with the step-by-step approach included in the OECD rules. The step-by-step approach is used to determine if and to what extent a constituent entity is subject to any top-up tax through application of either the IIR or UTPR.
In summary, the step-by-step approach consists of the following steps:
- Determine whether a group and its constituent entities fall within the scope of companies with consolidated revenues of EUR 750 million or more in at least two out of four fiscal years preceding the tested fiscal year, where constituent entities with GloBE revenues of less than EUR 10 million and GloBE profits of less than EUR 1 million during the tested fiscal year and two preceding fiscal years remain out of scope based on the de minimis exclusion.
- Determine the GloBE profit of each constituent entity based on financial accounting principles, taking into account certain adjustments for permanent book-to-tax differences (for example, dividends, equity gains and disallowed expenses).
- Calculate income taxes attributable to the GloBE profit of each constituent entity, including allocation of withholding taxes and taxes charged under controlled foreign company regimes to the constituent entity earning the underlying income. Any taxes paid in excess of the 15% minimum rate may be carried forward to future years, ensuring that local tax volatility does not immediately trigger a top-up tax liability.
- Calculate the effective tax rate of each constituent entity on a jurisdictional basis by dividing the income taxes by the GloBE profit. The difference between the 15% minimum rate and the effective tax rate is the top-up tax rate.
- Calculate top-up tax under the IIR or UTPR by applying the top-up tax rate to the GloBE profit in the relevant jurisdiction after deducting a substance-based income carveout for payroll expenses and tangible assets. Subsequently, this top-up tax liability is based on the IIR, in principle, imposed on the ultimate (or intermediary) parent entity with an ownership interest in the low-taxed constituent entity. Alternatively, if the low-taxed income is not subject to the IIR, the UTPR disallows a deduction or provides for an adjustment of the low-taxed income in the payer jurisdiction.
Constituent entities that fall within the scope of the directive are required to file information returns in a standardized format in each jurisdiction that has implemented the GloBE rules. Through these information returns, the relevant jurisdictions are informed of the MNE’s effective tax calculation and the resulting impact of the GloBE rules. A constituent entity in an EU member state does not have to file a return there if the ultimate parent entity—or another entity designated by the MNE—located in another jurisdiction with which the member state has an exchange of information agreement has already filed a return in the latter jurisdiction.
Reaching unanimity and way forward
The draft directive will be the starting point for negotiations between EU member states on the implementation of the GloBE rules in their domestic legislation. The directive will require unanimous support in the EU Council, which means that any EU member state could potentially block its adoption. Although the European Parliament and European Economic and Social Committee will be consulted, they will have no formal say in the end result.
From 1 January 2022, France will take over the presidency of the Council of the EU for the next six months and will likely use its position to push for an agreement. Cyprus, while not a member of the IF, has previously signaled support for the agreement reached in October and the European Commission expects Cyprus to back the directive.
The next meeting of the Economic and Financial Affairs Council is scheduled for 18 January 2022, and it seems likely that a discussion of the proposed directive will be on the agenda. Assuming that all EU member states eventually agree to the adoption of the directive, member states will have until the end of 2022 to implement the directive in their domestic legislation. The GloBE rules will then enter into force on 1 January 2023, with the exception of the UTPR, which is expected to go into effect from 1 January 2024. This will allow third-country jurisdictions to apply the IIR in the first implementation phase. Although the timeline for implementation of the GloBE rules is highly ambitious and there are various political hurdles to overcome, there currently seems to be significant political momentum and willingness to push for swift adoption and implementation of the initiative within the EU.
Pillar One, EU digital services tax and more
Meanwhile, the OECD’s Task Force on the Digital Economy is working on a multilateral convention that will implement Pillar One of the October agreement. Pillar One will reallocate taxing rights on “residual profits” from the world’s largest MNEs (with global turnover exceeding EUR 20 billion) to participating countries based on a formulaic approach. The multilateral convention is expected to be ready and open for signature by mid-2022 and should enter into effect in 2023. The European Commission has announced that it will come up with a directive on Pillar One in 2022, and has proposed that the equivalent of 15% of the residual profits allocated to EU member states should flow to the EU budget as a new source of revenue.
Plans for a new EU digital services tax announced by the Commission in 2018 meanwhile have stalled. As part of the October agreement, the members of the IF have promised to eventually give up all existing digital services taxes and similar measures, and to not impose any such measures in the future. Around the same time, the U.S. reached a deal with several European countries, including France and Italy, to credit any tax levied under existing digital services taxes after January 2022 against the taxpayer’s future tax liabilities in those jurisdictions under Pillar One.
Notably, also on 22 December, the European Commission published a proposal for a directive that will address the misuse of shell entities within the EU by imposing new reporting obligations on such entities, and denying benefits under applicable tax treaties and secondary EU law. All of these initiatives demonstrate that the EU is stepping up its fight against tax avoidance. By the end of 2023, the European Commission intends to publish a new framework for business taxation in the EU, which may result in more initiatives in this regard.