Pillar 2 is becoming a reality
In December 2022 the EU Member States had reached an agreement to implement a Council Directive on ensuring a global minimum level of taxation for multinational enterprise groups and large-scale domestic groups in the Union (the Pillar 2 Directive). After a couple of prior unsuccessful attempts, the compromised text of the Directive is now formally adopted by the European Council as of December 16, 2022.
Unanimous passing of the Pillar 2 became possible after Hungary had dropped its objections to applying the Directive. It is most likely that the envisaged agreement was reached after the approval by the European Commission of Hungary`s post-COVID recovery plan which was previously blocked due to a rule of law dispute with Hungary.
Now, the EU Member States are required to implement the Directive into their domestic law until the end of 2023 and begin to apply some of its provisions (Income Inclusion Rule) starting from December 31, 2023, and some from December 31, 2024 (Undertaxed Profit Rule). Since the Pillar 2 Directive suggests some elective provisions, the application of the minimum tax rate will depend on the provisions selected by each Member State.
What is Pillar 2?
Pillar 2 is a part of the reform in international taxation guided by the OECD. It aims at eliminating low taxation globally and, thereby, prevent aggressive tax planning and profit shifting to low-taxing jurisdictions through introduction of the global minimum corporate tax level.
The Directive envisages for the Member States to implement an effective corporate tax rate at the level of 15% for any of its globally earned profits. If lower taxation is imposed abroad, the Directive will result in the application of an additional top-up tax for the respective profits.
Whom does it concern?
The minimum tax rate will apply to multinational group of companies which meet an annual threshold of at least € 750 million of consolidated revenue. Certain entities will be excluded from the scope of this Directive due to their specific purpose and status, for instance entities which do not carry on a trade or business and perform activities in the general interest (non-profit organizations, governmental entities, pension funds, international organization).
The Pillar 2 Directive affects both entities – residents in a Member State, non-resident entities of a parent entity located in a Member State and large-scale purely domestic groups of companies.
How will Pillar 2 work?
The 15% tax will be implemented through two interlocked rules called the “GloBE rules”: the Income Inclusion Rule (IIR) and the Undertaxed Profit Rule (UTPR).
How do IIR and UTPR work?
- Income Inclusion Rule (IIR)
The primary GloBE rule imposes the top-up tax if a subsidiary in the group is taxed at a rate lower than the minimum tax rate of 15%, as determined in line with the Pillar 2 regime. Depending on the corporate structure and adoption of the GloBE rules in each particular jurisdiction, the ultimate parent entity (or intermediary parent entity) will be responsible for calculating and remitting the top-up tax within the allocable ownership share.
As the effective tax rate is calculated using Pillar 2 adjustments, the domestic tax rate (with local exemptions, incentives, etc) may not coincide with the recalculated one. Therefore, Pillar 2 will have to be applied for making the conclusion whether the IIR applies in each case.
- Undertaxed Profit Rule (UTPR)
The secondary GloBE rule is used for the allocation of the top-up tax portion left from the application of the IIR. The UTPR denies certain deductions or requires equivalent adjustments under the domestic rules. The mechanics of allocation is based on the number of employees and a value of tangible assets within each jurisdiction.
Pillar 2 also grants Member States the right to select and apply a Qualified Domestic top-up tax which implies a top-up tax specified within the domestic law of relevant jurisdiction computed and paid on the excess profit of all the low-taxed constituent entities located in their jurisdiction pursuant to the Directive.
Member States, which locate no more than 12 ultimate parent entities of the groups, are given the option to defer the application of the IIR and the UTPR for six consecutive fiscal years starting from December 31, 2023.
Considering the above, now that Pillar 2 is becoming real in the EU, it is expected that the other jurisdictions will follow as well, for instance the UK (with draft legislation for Pillar 2 implementation), the UAE (with expected introduction of corporate tax in June 2023), Singapore (with possible tax system adjustments), and others. Thus, it is important to track foreseeable changes in the field of corporate tax around the globe as a response to the adoption of Pillar 2 within the EU.
For instance, the effect of the Pillar 2 may be shown as follows: by the general procedure having a vertical corporate group structure with the ultimate parent entity within the EU and one of the subsidiaries in a low tax country, would result in applying corporate income tax also to the subsidiary in the low tax country. Alternatively, as a response to the Pillar 2 implementation, the low tax country might adopt the rule of the increased domestic corporate income tax of up to 15% for the companies which fall within the Pillar 2 scope, thereby eliminating the necessity of the top-up tax in the EU.
As another example, payment of dividends from an offshore country to an EU Member State with applied domestic participation exemption will not be subject to corporate income tax in the EU. However, with the applied Pillar 2 and the definition of the participation exemption stated there the top-up tax may be calculated at the level of the EU Member State as well.
Please note: This blog merely provides general information and does not constitute legal advice of any kind from Binder Grösswang Rechtsanwälte GmbH. The blog cannot replace individual legal consultation. Binder Grösswang Rechtsanwälte GmbH assumes no liability whatsoever for the content and correctness of the blog.
Please note: This blog merely provides general information and does not constitute legal advice of any kind from Binder Grösswang Rechtsanwälte GmbH. The blog cannot replace individual legal consultation. Binder Grösswang Rechtsanwälte GmbH assumes no liability whatsoever for the content and correctness of the blog.