On 22 December 2021 the European Commission proposed a Directive to ensure that large multinational groups are subject to a global minimum effective tax rate. The proposal follows the terms of the international agreement on Pillar 2 of the OECD proposals.

The proposed Directive would apply to any large groups with combined revenues of more than EUR 750 million a year, where either the parent company or a subsidiary are located in an EU Member State.

Certain entities would not be within the scope of the proposed Directive, including government entities, international or non-profit organisations, pension funds or investment funds that are parent entities of a multinational group. Also, international shipping would be excluded from the rules.

The effective tax rate would be calculated per jurisdiction by dividing the taxes paid by the entities in the jurisdiction in proportion to their income. Under the Income Inclusion Rule (IIR), if the effective tax rate for the entities in a particular jurisdiction is below the 15% minimum rate the group will be required to pay a top-up tax covering the difference between the effective rate and the 15% minimum rate.

The appropriate computations would be performed by the ultimate parent entity of the group unless the group assigns the task to another entity.

If an entity is based in a non-EU country where the global minimum rate is not imposed, the EU Member States would apply the Undertaxed Payments Rule (UTPR) as a backstop to the IIR. Using this rule, a Member State will collect part of the top-up tax due at the level of the group if some jurisdictions tax group entities below the minimum level and do not impose any top-up tax. The amount of top-up tax to be collected is determined by a formula based on employees and assets.

The Directive would include a de minimis amount below which no top-up tax would be charged on the profits of the group in a particular jurisdiction.

The Directive would also provide for a “substance carve-out”, an exclusion from the top-up tax for an amount of income representing 5% of the value of tangible assets and 5% of payroll. This would be phased in gradually over ten years beginning with an exclusion of 8% of the tangible asset value and 10% of payroll costs and reducing annually over the ten years.

To comply with EU freedoms including freedom of establishment, the proposed Directive would include purely domestic groups within the scope of the proposals. The proposed Directive would give EU Member States an option to apply a domestic top-up tax to low taxed domestic subsidiaries. This would permit the top-up tax due from subsidiaries of the group to be charged within the relevant Member State instead of being charged at the level of the parent entity.

The proposal by the Commission must be agreed unanimously by the Member States in Council, and the European Parliament and European Economic and Social Committee will be consulted.