European Union (EU) member states finally reached an agreement to implement, at the European level, the OECD’s 15% minimum tax rate known as Pillar Two. This announcement cements the EU’s commitment to the adoption of Pillar Two and reinforces the leadership role played by the EU in making Pillar Two the reality of a new international tax landscape, to a point where Pillar Two could be viewed, as largely a European-led initiative. The announcement by the EU of the adoption of the directive by its member states will have implications that go above and beyond the strong signal of commitment it sends. The OECD and Inclusive Framework (IF) have struggled in the past year to achieve the progresses that were expected to take place in 2022 and lead to the staged adoption of Pillar One and Pillar Two in 2023 and 2024. With these deadlines postponed by at least one year, the announcement by the EU to the commitment to Pillar Two made by its 28 European member states will undoubtedly inject new momentum in the remaining efforts by the OECD and IF to finalize the Pillar Two design.
Specifically, with respect to the adoption of Pillar Two, the ambassadors of EU member states have advised the EU Council to adopt the December 22, 2021, EU Pillar Two directive. A written procedure for its formal adoption will now be initiated following the Committee of Permanent Representatives reaching unanimous support on December 12, 2022. The directive will need to be adopted in the domestic law of member states by the end of 2023.
For some historical background, about a year ago, on December 22, 2021, the European Commission (EC) presented a proposal for a directive aiming at implementing Pillar Two in a way consistent and compatible with European law. The EC’s draft directive quickly followed the historical October 8, 2021, political agreement on international tax reforms reached by almost 140 countries participating in the OECD and IF on Base Erosion and Profit Shifting (BEPS). These international tax reforms included (i) Pillar One aimed at allocating taxing rights to markets in which some of the largest multinational enterprises, with annual turnover of at least 20 billion (bn) euros, operate without a physical presence; and (ii) Pillar Two aimed at imposing a minimum 15% tax rate in each market in which multinational enterprises with annual turnover of at least 750 million (mn) euros operate. The December 22, 2021, proposed EC directive received strong support from most EU member states, with only a few members such as Poland and Hungary voicing various concerns about its impact on competitiveness and employment. Ultimately, Hungary was left as the sole EU member state blocking its unanimous adoption. The termination by the United States of its tax treaty with Hungary, broadly viewed as U.S. retaliation for Hungary’s opposition to the EC directive, contributed to the slow political resolution, within the EU, of the standoff between Hungary and all other member states. Hungary has a 9% corporate income tax rate and offers generous subsidies to attract foreign capital; its economy has suffered serious collateral damage from Russia’s war on Ukraine, and its political environment is often criticized for erring towards autocracy. Hungary’s newly found support for the EC’s directive cleared the way for its adoption by the Committee of Permanent Representatives.
Although it is still unclear that the OECD and IF will be successful at a broad adoption of Pillar Two, with several technical issues still unresolved (e.g., treatment of withholding taxes), the adoption by the EU of the EC directive puts pressure on other countries to implement a qualified minimum domestic tax top-up (QMDTT) or to adopt the income inclusion rule (IIR) or the undertaxed profits rule (UTPR).
Taxpayers should expect new adoptions of QMDTT by low tax jurisdictions preferring to impose a domestic minimum tax of 15%, such as the United States just did (although on book income), rather than seeing EU member states receiving taxing rights over their taxable income. Similarly, high-tax countries will have more incentives to adopt the IIR and UTPR, not out of concern for their own taxable base, but out of a desire to join EU member states in receiving taxing rights through the IIR or UTPR, over income without nexus with their tax jurisdiction, taxed below 15% in low tax jurisdictions without a QMDTT.
Please consult your Kroll transfer pricing advisors for further information about the EU Pillar Two directive.