European Commission proposes tax Directive for implementing BEPS 2.0 Pillar Two Model Rules in the EU

Executive summary

On 22 December 2021, the European Commission (the Commission) published a legislative proposal for a Directive setting forth rules to ensure a global minimum level of taxation for multinational groups (the draft Directive). The proposed rules are generally consistent with the agreement reached by the Inclusive Framework on Base Erosion and Profit Shifting (BEPS) on 8 October 2021 (the October Statement),1 and closely follow the Model Rules published on 20 December 2021.2

In its October Statement, the Inclusive Framework announced the global minimum tax rules as a common approach. This means that jurisdictions are not obliged to introduce a minimum tax approach, but if they do introduce such an approach, they will follow the Model Rules. By presenting the draft Directive, the Commission now proposes a binding instrument ensuring the concerted introduction by all 27 European Union (EU) Member States.

The draft Directive aims at consistently implementing among all 27 Member States the Model Rules that include an Income Inclusion Rule (IIR) and an Under Taxed Payments Rule (UTPR), referred to collectively as the “GloBE rules.’’ However, it also extends its scope to large-scale purely domestic groups, in order to ensure compliance with the fundamental freedoms. In addition, the draft Directive makes use of an option contemplated by the Inclusive Framework whereby the Member State of a constituent entity applying the IIR is required to ensure effective taxation at the minimum agreed level not only for foreign subsidiaries but also for all constituent entities resident in that Member State.

The agreed Pillar Two design also includes the Subject to Tax Rule (STTR), which is to be implemented through bilateral tax treaties and is not included in the draft Directive. However, the Commission does state in the explanatory memorandum that the global minimum tax agreement will pave the way for revisions of the Interest and Royalty Directive (IRD). On the other hand, the Commission will not propose adaptions of the Controlled Foreign Company (CFC) rules of the Anti-Tax Avoidance Directive.

The proposal will now move to the negotiation phase among the Member States with the aim of reaching a final agreement. In the EU, the adoption of tax legislation requires unanimity between all 27 Member States. The Commission proposes that the Member States shall transpose the Directive into their national laws by 31 December 2022 for the rules to come into effect as of 1 January 2023, with the exception of the UTPR, for which the application will be deferred to 1 January 2024.

Detailed discussion

Development of the minimum tax rules

Building on its earlier work on BEPS that culminated in 2015 in the issuance of final reports on 15 action areas, the OECD began a new project in 2019 focused on addressing the tax challenges of the digitalization of the economy. This project evolved into a two Pillar approach to address the pressure put on the current international tax system due to digitalization and globalization. The current project, referred to as BEPS 2.0, is being conducted through the G20/OECD Inclusive Framework, which now counts 141 participating jurisdictions. The two Pillars of the project are:

  • Pillar One on development of new nexus and profit allocation rules to assign more taxing rights to market countries
  • Pillar Two on development of new global minimum tax rules

After many months of technical work and negotiations, the OECD released in October 2020 a series of documents with respect to the BEPS 2.0 project, including a detailed Blueprint on Pillar Two.3 In the Cover Statement, the Inclusive Framework expressed the view that while no consensus had been reached yet, the Blueprint provided a solid basis for future agreement.

On 1 July 2021, the OECD released a Statement on a Two-Pillar Solution to Address the Tax Challenges Arising from the Digitalisation of the Economy (July Statement), reflecting the agreement of 130 of the member jurisdictions of the Inclusive Framework on some key parameters with respect to both pillars. At that time, nine members of the Inclusive Framework, including Estonia, Hungary, and Ireland, did not join the July Statement.4

In October 2021, the OECD published a Statement indicating that the Inclusive Framework agreed on the two-pillar solution to address the tax challenges arising from the digitalization of the economy and providing a timeline for implementation.5 136 out of 140 jurisdictions of the Inclusive Framework agreed to the October Statement. Estonia, Hungary and Ireland, which did not join the July agreement, joined the October Statement. Cyprus, who is not a member of the Inclusive Framework, also supported the statement.

Under the October Statement, it was stated that the GloBE rules were to be released by the end of November 2021. Nevertheless, the OECD was not able to meet such an ambitious deadline and the Model Rules together with an overview summary and factsheets became available by late December 2021.

The EU has been a strong supporter of a global consensus-based solution within the framework of the OECD and has embraced the course of direction of BEPS 2.0 through its participation in the G20. In its Communication on Business Taxation for the 21st Century,6 the Commission announced that the principal method for implementing Pillar Two in the EU would be an EU Directive that reflects the Model Rules with the necessary adjustments to guarantee EU law compliance.

Rapid development of the draft Directive

The Commission prepared the draft Directive under significant time pressure while the Inclusive Framework was still finalizing the Model Rules and the Commentary was yet to be agreed. Therefore, it is likely that further adjustments will be introduced during the negotiations starting in the first week of 2022. The first impressions reflected below of the draft Directive are based on the Commission’s own explanations, in particular those included in the Preamble and in the detailed explanation of the specific provisions of the proposal.

Where questions arise on the alignment between the Model Rules and the draft Directive or on the detailed explanations supporting the rules, a better assessment of these issues can be made in the coming period, in particular, once the Commentary to the Model Rules becomes publicly available.

Objectives of the draft Directive

With the draft Directive, the Commission proposes to introduce minimum effective taxation for large multinationals, with profits of at least €750 million, operating in the EU's internal market and beyond. It provides a common framework for implementing the Model Rules into Member States' national laws in a coordinated manner, adjusted for EU law requirements, and taking into account specifics of the EU Single Market.

The agreed Pillar Two design also includes the STTR, which is to be implemented through bilateral tax treaties and is not included in the draft Directive. However, the Commission does state in the explanatory memorandum that the global minimum tax agreement will pave the way for agreement on an amendment to the IRD which has been pending for a long time. These amendments could effectively lead to the introduction of a subject to tax approach in the IRD. Proposals to this effect have not been included in the draft Directive.

Also, in preparation of the draft Directive, the Commission communicated that adaptions of the CFC rules of the Anti-Tax Avoidance Directive may be required in connection with introducing Pillar Two. In the explanatory memorandum they have now come to the conclusion that such CFC rules are compatible with the Model Rules and that changes are not required.

As referred above, the draft Directive sets forth a system consisting of two interlocked rules - the IIR and the UTPR - through which an additional amount of tax called a “top-up tax” should be collected each time that the effective tax rate (ETR) due on the income of a multinational enterprise (MNE) group in a given jurisdiction is below 15%. In such case, the jurisdiction is considered to be low-tax.

Under this system, the parent entity of an MNE group located in a Member State has an obligation to pay an IIR top-up tax calculated according to its allocable share in every entity of the group that is low-taxed, whether such entity is located within or outside the Union. According to the text of the draft Directive, the UTPR should apply in cases where the ultimate parent entity (UPE) is located outside the EU in a jurisdiction that does not apply a qualifying IIR or where this jurisdiction operates a qualifying IIR but the UPE and its resident subsidiaries are low-taxed, by allocating any residual amount of top-up tax to constituent entities of the MNE group located in the Union.

Key differences between the draft Directive and the Model Rules

The draft Directive generally follows the content of the Model Rules, with some systematic and structural differences. The key differences include the following:

  • Structure of the draft Directive: to align with the usual structure of tax Directives a number of structural changes have been made compared to the Model Rules. Although the draft Directive and the Model Rules have approximately the same number of chapters and largely contain the same provisions, the differences in ordering, headings, numbering and the wording of the articles themselves introduce additional complexity when analyzing and comparing both sources. Additionally, while the Model Rules include a chapter dedicated to definitions of terms relevant to the understanding of the rules, under the draft Directive, only part of the definitions is included in chapter 1 with the rest of them being scattered throughout the text of the draft Directive.
  • Extension of the scope to large-scale purely domestic groups: The draft Directive extends its scope to large-scale purely domestic groups that have a combined annual group turnover of at least €750 million based on consolidated financial statements. With this extension, the Commission intends to avoid discrimination between domestic and cross-border situation, ensuring compliance with the fundamental EU freedoms.
  • Election to apply a qualified domestic top-up tax: In order to preserve the sovereignty of Member States, the Commission proposes that a Member State may opt to apply a domestic top-up tax to constituent entities located in its territory. This election would allow the top-up tax to be charged and collected in a jurisdiction in which low-level of taxation occurred, instead of collecting all the additional tax at the level of the UPE or other group entities through the UTPR. When a Member State has exercised this election and charges a domestic top-up accordingly, a credit would be available for the qualified domestic top-up tax when calculating the top-up tax in respect of the relevant jurisdiction. The draft Directive grants some flexibility in the technical implementation of the domestic top-up tax system, provided that it is consistent with the rules set forth in the Directive and that such system ensures the minimum effective taxation of the qualifying income or loss of the constituent entities in the same, or in an equivalent manner, to the IIR and UTPR of the Directive.
  • IIR top-up tax in respect of low-taxed constituent entities located in the same Member State: Under the draft Directive, the Member State of a constituent entity applying the IIR, which is usually the jurisdiction of the UPE, would be required to ensure effective taxation at the minimum agreed level not only of foreign subsidiaries, but also of all subsidiaries resident in that Member State, and permanent establishments of the MNE group established in that Member State. The Model Rules provide that the jurisdiction that applies the IIR takes into account the ETR of only foreign constituent entities.
  • Assessment framework: the draft Directive includes an additional Chapter in which an assessment framework is provided, setting the conditions that third country regimes should meet to be considered equivalent to the qualified IIR set under the draft Directive. The legal frameworks that fulfill such requirements, would then classify as “equivalent,” and included in an Annex. For this purpose, the Commission proposes that it receives a delegated power. Under this delegation, the Commission adopts delegated acts, subject to the Council's objection and the Parliament's notification. Despite the fact that this proposed assessment framework has particular relevance for the ongoing discussions on the United States (US) Global Intangible Low-Taxed Income’s (GILTI) co-existence with the IIR and the UTPR, the Commission states that the conditions for such co-existence are to be established by the Inclusive Framework for the purposes of ensuring the level playing field.
  • Filing obligations: The draft Directive introduces a filing obligation for constituent entities located in a Member State. Such entities need to file a top-up tax information report comprising of the information points mentioned under the draft Directive. By derogation of this rule, either the UPE or the designated filing entity, i.e., the entity pointed by the MNE group as the one carrying the reporting obligation, should file the return. In cases where the relevant entity fails to file the return either in time or correctly, a minimum administrative pecuniary penalty of 5% or more of the constituent entity's turnover is prescribed. With respect to the introduction of additional penalties when national rules adopted in the Directive's context are breached, the Pillar Two Directive renders the Member States competent.
Next steps

Article 115 of the Treaty on the Functioning of the EU is the legal basis for the draft Directive. Proposals put forward under this special legislative procedure are subject to the Council’s unanimity, while the European Parliament only has an advisory role.

The Model Rules were agreed at the level of the Inclusive Framework to which 26 out of the 27 Member States of the EU form part. Also, according to the explanatory memorandum of the draft Directive, Cyprus, that is not a member of the Inclusive Framework, has stated that they do not oppose to the content of the Statement by the Inclusive Framework.

Given the fact that the Directive broadly follows what has been agreed at the global level, France, that holds the Council Presidency as of 1 January 2022, is aiming at reaching agreement within the Council during its six-month term. At the same time, some Member States have already raised some concerns regarding the draft Directive and thus negotiations may not conclude as fast as expected. For example, in recent public reports, Estonia made clear that its adoption of the Pillar Two Directive is highly conditional upon the possibility to retain Estonia’s current investor-friendly corporate tax system.7

The Commission proposes that the Member States shall transpose the provisions of the Directive by 31 December 2022, and then shall apply these provisions from 1 January 2023 with the exception of the UTPR which would apply as of 1 January 2024.

For coordination purposes, the Commission proposes that it shall review the Directive in the first 12 months after its entry into force, in line with the agreement reached by the Inclusive Framework on filing requirements under the GloBE implementation framework.

In its Communication on Business Taxation for the 21st Century, the Commission announced they will table a proposal for an EU Directive requiring in-scope MNEs to publish their ETRs calculated on the basis of the Pillar Two methodology. This proposal is expected in the first part of 2022.


If adopted, the Directive would mark a milestone on the harmonization of direct taxation within the EU. In this regard, the draft Directive provides rules for ensuring a minimum level of effective direct taxation of large multinational groups and large-scale purely domestic groups operating in the single market, aiming to put a floor on excessive tax competition between jurisdictions in the Union and beyond.

The Model Rules incorporated in the draft Directive would effectively introduce a new common tax base. The Commission could use this as a basis for the development of a single corporate tax rulebook for the EU, announced as the “Business in Europe: Framework for Income Taxation” or “BEFIT.” The Commission plans to present a proposal for BEFIT in 2023 as announced in the Communication on Business Taxation for the 21st century of 18 May 2021.

Considering that the EU represents a single market and a closely integrated economy, the draft Directive may facilitate implementation of the Pillar Two rules in a coherent and consistent manner across Member States which is critical for legal certainty purposes within the EU. However, since a Directive requires transposition into the national laws of the Member States differences in implementation may still arise.

Whether the draft Directive will be amended and eventually adopted will depend on negotiations that commence in the first week of 2022. It is expected that various Member States will express concerns about the complexity of the rules. It is also expected that tax administrations will raise concerns that systems of tax administrations will not be ready to deal with the vast amounts of new data and the administration of a parallel tax system.

It is important for companies to evaluate the potential impact of the Model Rules and draft Directive and monitor activity in the EU as well as in other relevant countries related to the implementation of new rules through changes in domestic tax rules and bilateral and multilateral agreements, especially given the very ambitious implementation timeline. Companies should also monitor developments in the US with respect to the GILTI rules as well as the responses of other G20 members and investment hubs.

The Pillar Two Directive and other EU tax policy developments will be discussed on the upcoming EY EMEIA webcast “Tax policy matters: Impact of reform on your business” on 25 January 2022.

For additional information with respect to this Alert, please contact the following:

EY Société d’Avocats, Paris
  • Jean-Pierre Lieb
Ernst & Young GmbH Wirtschaftsprüfungsgesellschaft, Munich
  • Klaus von Brocke
Ernst & Young Belastingadviseurs LLP, Rotterdam
  • Marlies de Ruiter
  • Maikel Evers
  • Andromachi Anastasiou
Ernst & Young Belastingadviseurs LLP, Amsterdam
  • Max Velthoven
  • Konstantina Tsilimigka
Ernst & Young SA (Portugal), Porto
  • Mariana Lemos
Ernst & Young LLP (United States), Global Tax Desk Network, New York
  • Jose A. (Jano) Bustos

For a full listing of contacts and email addresses, please click on the Tax News Update: Global Edition (GTNU) version of this Alert.