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. 

In an effort to reach agreement, two compromise texts were published in March 2022. These made a number of significant changes to the original draft including:

• a one-year extension to the date for the transposition of the directive into Member State’s national law, meaning that that Member States will only be required to apply the IIR from 31 December 2023 and the UTPR from 31 December 2024; and

• a temporary deferral for Member States with fewer than 12 in-scope UPEs located in their jurisdiction – these States can elect not to apply the directive for six consecutive fiscal years provided they notify the European Commission of their intention to exercise this opt-out right before 31 December 2023.

The EU Council reached agreement on the implementation of Pillar Two on December 12, 2022. The EU issued a press release stating that ‘the ambassadors of EU member states decided to advise the Council to adopt the Pillar 2 directive, and a written procedure for the formal adoption will be launched.’

On December 22, 2022 the EU Global Minimum Tax Directive was published in the EU official journal as Council Directive (EU) 2022/2523 of 14 December 2022. 

The Income Inclusion Rule will apply in the EU for fiscal years beginning from  December 31, 2023 and the Under-Taxed Payments Rule will apply for fiscal years beginning from 31 December 2024.

EU member states  are required to enact laws, regulations and administrative provisions necessary to comply with the EU Pillar Two Directive by 31 December 2023.

See our Articles: Full Steam Ahead For EU Pillar Two Implementation and Mapping the Model Rules to the EU Global Minimum Tax Directive.

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