Closely after the publication of the Pillar 2 rules by the OECD, the European Commission published a proposal for a Directive on 22 December 2021 to ensure a consistent implementation of the global minimum tax rules by the EU Member States. Once the EU Member States unanimously vote in favor, the directive must be transposed into their national laws and applied as from 1 January 2023. In this tax alert, our tax team in Amsterdam provides the highlights of this proposal.

Purpose

Tackle tax avoidance and create a multijurisdictional system to tax all large multinational enterprises with a minimum effective tax rate of 15%.

Scope

Similar to the OECD rules, the directive applies to multinational enterprises with either a parent company or a subsidiary company situated in the EU and an annual consolidated revenue of at least EUR 750 million in at least two of the four preceding years.

Certain types of entities are excluded from the scope based on their particular purpose and status: (quasi) governmental entities, international organizations, non-profit organizations, pension funds, investment funds and real estate investment vehicles. Subsidiaries (95% or more) of these entities are also excluded.

Calculation of the effective tax rate

The starting point is the calculation of the effective tax rate (ETR) of the entities part of the group on a per jurisdiction basis. The ETR is calculated on the basis of taxes paid by group companies in the respective jurisdiction. These so-called covered taxes include income or profit taxes and taxes on distributed profits under certain distribution tax systems.

The amount of covered taxes is then divided by the adjusted financial accounting income of the group companies in that jurisdiction. The adjusted financial accounting income is the income as determined under the applicable GAAP with certain adjustments such as tax expenses, dividends received (except for portfolio interests that are less than 10%) and international shipping income (due to the global prevalence of tonnage tax regimes that are not based on profits).

Similar to the OECD rules, a substance carve-out applies which reduces the income (denominator) to take into account for the ETR calculation. This substance carve-out starts at 10% of payroll costs reducing to 5% in 2033 and 8% of the carrying value of tangible assets reducing to 5% in 2033.

Top-up tax

If the resulting ETR is below 15% then depending on the location of the ultimate parent entity of the group the following applies:

• If the parent company is located in the EU, it will be subject to the top-up tax in respect of its low taxed subsidiaries in the same EU Member State, other EU Member States and in third country jurisdictions. However, in order to preserve sovereignty of each Member State, the Directive provides that a Member State can opt to apply the top-up tax domestically to subsidiaries located in its jurisdiction. This alternative allows that the top-up tax is charged and collected in a jurisdiction in which low-level of taxation occurred, instead of collecting all the additional tax at the level of the parent company. When a Member States chooses for this alternative, the parent entity applying the top-tax will be obliged to provide a credit for the qualified domestic top-up tax.
• If the parent company is located outside the EU, the ‘Undertaxed Payment Rule’ is applied as a backstop. In this circumstance, subsidiaries that are located in a Member State will have to pay in their Member State, a share of the top-up tax linked to the low-taxed subsidiaries of the group. The share is determined by two factors: number of employees and carrying value of tangible assets in the relevant jurisdiction.

Next steps

First, the European Parliament and European Economic and Social Committee need to be consulted on this proposal. EU Member States must unanimously vote in favor of this proposal before it becomes a directive.