1) Proposal for Directive implementing BEPS 2.0. Pillar 2 Model Rules
The draft Directive aims at implementing among all EU Member States the Model Rules minimum level of effective taxation (i.e., in the form of top-up taxation in line with agreed minimum tax rate) by applying the Income Inclusion Rule (“IIR”) and an Under Taxed Payments Rule (“UTPR”), referred to collectively as the "GloBE rules.''
Income Inclusion Rule (“IIR”)
The IIR will apply in respect of the low-taxed income of group entities (referred to constituent entities) based in jurisdictions in which they do not meet the minimum effective tax rate of 15%. The designated parent entity of the group within the meaning of the proposal when located in the EU will collect and pay its allocable share of top-up tax due to the tax authorities in its country. Specific and complex rules for calculation of the effective tax rate and the top-up tax within the multinational groups as well as the subsequent top-up tax allocations and entities obligations in this regard are outlined in the proposal. The expected provisions even cover cross-border taxes or income streams in situations involving permanent establishments, transparent entities, CFCs, hybrid entities, specific dividend tax regimes etc.
To preserve the sovereignty of each Member State though, the Directive provides that a Member State can opt to apply and collect the top-up tax domestically for subsidiaries located in its jurisdiction i.e., in which no or low-level of taxation occur.
Under Taxed Payments Rule (“UTPR”)
On the other side, the UTPR will function as a backstop rule to the primary IIR if the global minimum rate is not imposed by a non-EU country (normally not applying the IIR or in case it does but provides for no or low level of taxation) where an ultimate group entity is based. In such event, constituent entities of such an MNE group that are located in a Member States will have to pay in their jurisdictions, a share of the top-up tax linked to the low-taxed subsidiaries of the group. Similar to the above, specific rules are set out with respect to the calculation and the allocation of the top-up tax under this rule.
Scope of the Directive
The new rules follow closely the OECD Model Rules and are directed to large multinationals with combined group turnover of at least EUR 750 million (based on consolidated financial statements), operating either in an EU Member state or in a third country. Opposing to the OECD Model Rules, however, purely domestic EU companies’ groups will be also captured by the proposed regime. Government entities, international or non-profit organizations, certain type of funds (e.g., pension or investment) that are parent entities of a multinational group will not fall within the scope of the Directive to extent those entities are usually exempt from domestic corporate income tax.
Substance carve-outs of up to 5% (gradually reducing from 10% for payroll costs and 8% for assets in a transitional ten-year period) in general are also envisaged of the value of tangible assets and payroll unless not been elected to apply by an entity in a given state. In addition to that, the minimum taxation rules will not be applicable in case a constituent entity within a multinational group realizes an average revenue of less than EUR 10 million and an average qualifying income or loss of less than EUR 1 million in a jurisdiction (referred to “de minimis rule”) and provided that the election of the de minimis income exclusion is taken as well.
The Directive also considers special rules for corporate restructurings and similar transactions, holding structures together with tax neutrality and distribution regimes.
Filing obligations
Companies falling within the scope of the Directive will be subject to a filing obligation through a top-up tax return in the respective jurisdictions unless the return is filed by the MNE group in another jurisdiction, with which the respective Member State has an exchange of information agreement. Failure to comply with the obligations stemming from the proposed Directive could lead to envisaged penalties amounting to 5% of the entity turnover in the relevant fiscal year.
Implementation deadline
The proposed rules under the draft Directive will need to be approved by all Member states and then, transposed into their national legislations by 31st December 2022 and effective as of 1st January 2023.
The rules for the application of the UTPR should apply however as of 1 January 2024 to allow third country jurisdictions to apply the IIR as first phase of the implementation of the GloBE rules.
Additional objectives
Along with the above, the agreement under Pillar Two provides for a treaty-based rule, namely the Subject to Tax Rule (“STTR”) allowing source jurisdictions to impose limited source taxation on certain related party payments that are subject to tax below a minimum tax rate. However, the rule appears presently excluded from the scope of the Directive and the OECD Model Rules but it is envisaged to be addressed in the bilateral tax treaties.
In addition, the Commission considers an amendment to the Interest-Royalty Directive leading to the introduction of a subject to tax approach. Likewise, adaptions of the present CFC rules under the EU ATAD were discussed in relation with the introduced rules under Pillar 2.
2) Proposal for Directive against the misuse of shell entities (“ATAD 3”)
The proposal for a Council Directive consists of rules to prevent the misuse of shell entities for tax purposes (“ATAD 3”) following the published Communication on Business Taxation for the 21st Century (“the Communication”) setting out the EU Commission’s vision to provide a fair and sustainable EU business tax system. Opposing to the draft Directive introducing minimum level of taxation, this proposal is aimed to tackle tax abusive practices through low-substance EU tax residents regardless of their legal form.
The Commission proposed a seven-step approach for the entities in scope of the Directive key considerations of which are briefly discussed below:
Gateway assessment and corresponding reporting obligations
The first step consists of three cumulative “gateway” criteria based on specific tests mainly concerning the cross-border activities, the type of income earned as well as the management performance and availability of administration for the businesses captured by the new provisions. Several carve-outs and exceptions (for example for listed entities, specific regulated financial entities, certain holding entities of operational businesses in the same Member State etc.) are envisaged within the new rules.
If no exception applies and the gateway criteria are fulfilled, an entity is considered to be at risk for the purposes of the draft Directive, and thus, should face additional reporting requirements to support the level of substance it maintains in the respective jurisdiction.
Companies considered meeting the risk factors discussed above while failing to cross the substance indicators (e.g., regarding the premises of the company, presence of active bank accounts, the tax residency of its directors and that of its employees) through their tax returns are considered “shell company” and hence, fall within the ambit of the Directive.
Rebuttal of presumption and consequences for alleged “shell companies”
The EU tax residents not able to demonstrate that satisfy the substance indicators will have the opportunity to rebut the presumption of being a shell company. They will have to present additional evidence substantiating that conduct a genuine economic activity or either do not benefit or create a tax advantage for itself and/or for the entire group as a whole.
Failure to do so, however, could lead to denial of benefits provided under the tax treaties and the EU Directives. In such outturn, the tax administrations may refuse granting a tax residency certificate to the shell company or only provide a tax residency certificate indicating its shell nature and characteristics.
In addition, withholding tax at the level of the paying entity to the shell company may apply for payments to third countries while the flow-through nature of the shell entity interposed (if considered as such) will be disregarded for tax purposes.
Automatic exchange of information
The proposal introduces an information disclosure regime between the Member States on all entities considered at risk with the aim to amend also the Directive on administrative cooperation in the field of taxation (“DAC”) with this effect.
Most importantly, a Member State will be able to request another Member State to initiate a tax audit for entities reporting in the former jurisdiction.
Penalties
The draft Directive proposes a minimum penalty for non-compliance consisting of at least 5% of the entity’s turnover.
Additional considerations
It is expected the draft Directive to bring additional compliance obligations to the EU tax residents as well as administrative burden for the tax authorities. Given that, and the additional uncertainties around the new provisions, changes and clarifications may be needed to be done prior adoption.
In fact, the minimum substance requirements could be a useful tool in the application of the Principal Purpose Test (“PPT”) in the context of requested tax relief under a tax treaty.
Implementation deadline
If adopted by the Member States, the draft Directive should be transposed into their national laws by 30 June 2023 and come into effect as from 1 January 2024.
