European Union reaches an agreement on minimum corporate tax

On 12 December 2022, the ambassadors of the EU Member States reached an agreement to advise the Council of the EU (the “Council”) on the implementation of the global minimum corporate tax rate (the “CTR”). This initiative, also known as Pillar 2, aims to ensure that multinational enterprises (the “MNEs”) with yearly revenues of at least EUR 750 million pay corporate tax at a global effective rate of at least 15%. A directive on Pillar 2 (the “Directive”) should be implemented into domestic law of the Member States by the end of 2023.

Background

The OECD developed Pillar 2 with the aim of ending tax practices of MNEs which allow them to shift profits to jurisdictions where they are subject to no or very low taxation. These rules, establishing a global minimum CTR, are expected to level the playing field for businesses worldwide and allow jurisdictions to protect their tax bases.

Pillar 2 rules have been approved by the OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting (“BEPS”) in 2021. They are also enshrined in the Directive, adopted unanimously by the ambassadors of the EU Member States.

The following elements pertaining to the Directive will be further considered:

1. General information
2. Income inclusion rule
3. Undertaxed profit rule
4. Next steps
5. Our observations

General information

The implementation of the Directive is expected to limit the race to the bottom in CTRs. In essence, by application of the Directive, the profit of MNEs and domestic groups with annual revenues of at least EUR 750 million should be taxed at a minimum rate of 15%.

In order to reach the minimum level of taxation, the Directive relies on a system of two interlocked rules – the income inclusion rule (“IIR”) and the undertaxed profit rule (“UTPR”), explained further in more detail. Through these rules, an additional amount of tax (the so-called top-up tax) should be collected each time the effective CTR of an MNE in a given jurisdiction is below 15%.

The rules of the Directive apply to entities resident in the Member States, as well as non-resident subsidiaries of a parent entity located in a Member State.

Finally, the Directive should be implemented into national law of the Member States by 31 December 2023. The IIR will apply for fiscal years beginning as of 31 December 2023, while the UTPR will apply for fiscal years beginning as of 31 December 2024.

Income inclusion rule

The IIR is the primary rule to be applied under the Directive. Further to this rule, a minimum tax is paid at the level of the ultimate parent entity resident in a Member State, in proportion to its ownership interests in the entities that have low-taxed income. For the purpose of application of this rule, it is irrelevant whether the entities with low-taxed income are resident in a Member State or a third country.

Furthermore, if the ultimate parent entity is not an EU resident, intermediate parent entities situated below the ultimate parent and located in the EU should be obliged to apply the IIR up to their share of the top-up tax.

Undertaxed profit rule

The UTPR acts as a backstop to the IIR through a reallocation of any residual amount of top-up tax in cases where the entire amount of top-up tax relating to low-taxed entities could not be collected through the application of the IIR.

This backstop is needed to ensure the minimum tax is paid where a low-taxed entity is held through a chain of ownership that does not result in its income being brought into charge under an IIR.

UTPR requires an adjustment (either a top-up tax or a denial of deduction) that increases the tax at the level of the subsidiary. The adjustment is an amount equal to the the top-up tax remaining after the application of the IIR. 

Next steps

The Directive has been drafted and is expected to be formally adopted by the Council in a written procedure. Afterwards, it will be published in the Official Journal of the EU and implemented by the Member States by the end of 2023.

With the EU being the first to initiate implementation of Pillar 2, it is expected that other jurisdictions will follow as well. In this respect, it is important to monitor legislative developments and their potential impact.

Our observations

Given the complexity of the Pillar 2 rules, it is recommended for affected businesses to prepare for additional tax compliance obligations. It would be important to consider the impact ahead of time and be ready before the implementation of the new rules.

If you would like to discuss any aspect of Pillar 2 and how it may affect your business in further detail, please do not hesitate to contact Grant Thornton Luxembourg.

• Jean-Nicolas Bourtembourg - Partner