European Commission issues a draft Directive on a minimum corporate tax
On 22 December 2021, the European Commission published the draft of a Directive ensuring a minimum effective tax rate for the global activities of large multinational groups. This is in line with the international agreement orchestrated by the OECD and known as Pillar 2 and sets out how the principles of the 15 per cent effective tax rate (ETR) will be applied within the EU.
The Directive is long and complex and introduces a mind-bending lexicon of new acronyms. Far be it for this brief blog to try to unravel all of the Directive’s contents, but it attempts to pick out some of the material principles.
The Directive will apply to any large group, domestic and international, with an ultimate parent company (UPE) or a so-called “constituent entity” (a group member) located in the EU. By “large” is meant a group with annual revenue of at least €750 million in at least two of the last four years. There are some exclusions that may frequently be applicable in an EU context – these include:
- Investment funds or real estate investment vehicles that are ultimate parent entities
- Entities held as to at least 95 per cent by such entities
- Entities held as to at least 85 per cent by such entities and whose income substantially (this term is not defined) consists of dividend income or capital gains that are not “qualifying income”
Where the UPE is located in the EU, it will have the primary responsibility for collecting and paying the additional tax necessary to achieve the minimum effective rate of 15 per cent (the top-up tax) of all its constituent entities, regardless of where they are resident. This it will do by way of the Income Inclusion Rules that will operate similarly to, but in parallel with, CFC rules. The minimum ETR is determined on an entity by entity basis and constituent entities located in the EU may elect to pay its own top-up tax.
Where the UPE is resident outside the EU then the top-up tax will be collected by constituent entities located in the EU by way of the Undertaxed Payments Rule.
The minimum tax requirement applies to “qualifying income”. The starting point is to determine an entity’s net income based on accounting principles used by the UPE for consolidated accounts purposes. The net income is then adjusted, including for the following:
- Dividends or distributions received on an ownership interest in an entity (excluding so-call portfolio shareholdings of less than 10 per cent)
- Gains or losses realised on an ownership interest (except for a portfolio shareholding)
- Certain foreign currency gains or losses
Excluded from any top-up tax requirement are entities in a particular jurisdiction where their average qualifying income is less than €10 million and their average qualifying net income or loss is less than €2 million.
EU member states are required to implement the Directive into local legislation so as to be in effect from 1 January 2023. This appears to be a shorter timetable than is envisaged by the OECD and may present serious challenges for both tax authorities and taxpayers, particularly given a number of other initiatives that are currently being considered or implemented. This brings with it a number of risks not least the risk that member states will simply enact the Directive on a word for word basis rather than providing a degree of precision or guidance that is inevitably needed given the way Directives are drafted.
The press release can be found here.
Detailed information on this proposal can be found here.