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Review of the Draft EU Pillar Two Directive

EU Directive, Generally

On 20 December 2021, the EU released a draft directive to implement the Pillar Two GloBE Rules. On 12 March 2022, an amended draft compromise text was published. 

In this members report we take a detailed look at the directive, including key differences from the OECD Model Rules.

In general, the EU draft directive follows the OECD Model Rules, however, there are a few tweaks to the application of the rules for EU jurisdictions. 

Part of this is due to the application of the EU directive being to a block of countries as opposed to a single domestic jurisdiction, as would usually be the case. 

Income Inclusion Rule in the EU

With a single jurisdiction, the impact of the income inclusion rule and the under-taxed payments rule (or under-taxed profits rule as it is renamed in the compromise text) effectively requires a consideration of whether an Ultimate Parent Entity (UPE), intermediate parent entity or partially-owned parent entity (POPE) is within that jurisdiction or outside that jurisdiction. 

In the EU context, this changes and the application of these rules depends on whether the entity is in the member state jurisdiction, is within another EU jurisdiction or is in a third country jurisdiction. 

If we take the income inclusion rule (IIR) for instance:

  • If the UPE is in the EU, it would apply the IIR for all low-taxed constituent entities
  • If the UPE is in the EU and a POPE is in the EU, the POPE would apply the IIR
  • If the UPE is outside the EU, but there is an intermediate parent entity or POPE in the EU, the EU entity would apply the IIR if the UPE jurisdiction did not apply an IIR

Domestic Groups

A big difference to the OECD Model Rules is that the EU directive extends the application of the GloBE Rules to purely domestic groups.

This has a number of ‘knock on’ effects in the application of the rules. The main one is that under the OECD model Rules, when applying the IIR, only low taxed foreign entities (or permanent establishments) are considered.

However, under Articles 5, 6 and 7 of the EU draft directive, the Member State of a constituent entity applying the IIR, is required to apply it to not just foreign low-taxed subsidiaries but also low-taxed constituent entities and PEs resident in that Member State.

This then impacts the application of the UTPR where the UPE is itself a low-taxed entity. 

The OECD Model Rules provide that where a UPE is a low-taxed entity, top-up tax is applied via the UTPR rather than the IIR. 

However, in the EU this would only happen when the UPE is located outside the EU. If the UPE was in the EU it applies the IIR to itself and to its domestic subsidiaries.  

Domestic Minimum Tax

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