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Pillar 2 Directive: Maximum complexity for minimum taxation

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On 22 December 2022, the European Union adopted Directive 2022/2523, known as "Pillar 2", which transposes the OECD's global anti-base erosion rules (the "GloBE" or "Pillar 2" rules) within the EU. These rules aim to ensure that multinational enterprises (MNEs) that operate in the EU pay an effective minimum rate of tax of 15% on their profits, regardless of the country in which those profits are generated. Member States must transpose this directive into their national law by 31 December 2023, for entry into force on 1 January 2024. A tight schedule that means that those impacted need to pay close attention.

The adoption of this directive comes almost a year after the publication of the GloBE Model Rules by the OECD and the publication of the draft Directive by the European Commission - texts widely commented on at an international and European level and whose debates seem to have culminated in the adoption of this Directive.

There are few other ideas that have been raised to such an extent as banners of coordinated action against tax avoidance and that have been debated on a political level at the summit of the highest international organisations, such as the G20, which approved the OECD's project in October 2021.

Of course, there was the ATAD saga (Anti-Tax Avoidance Directives). A saga which is still ongoing and whose third phase, which concerns minimum substance requirements, seems to be struggling to obtain a consensus. The other epic set of directives worth mentioning is that of the “DACs”, a veritable flurry of directives related to administrative cooperation in the tax field. This also contrasts with the lack of progress on the project for an-EU wide "common consolidated corporate tax base", which has been on hold for years. But, the Pillar 2 project, and the very short deadline given to Member States (and taxpayers ...) to prepare for it, are of a whole different magnitude.

GloBE rules: a logical mathematical approach?

Essentially, the term "Pillar 2" comes from the OECD/G20 Inclusive Framework BEPS project (Base Erosion and Profit Shifting), and the 15 actions published in 2015. Pillar 2, logically, envisages a "Pillar 1", this pillar relates to the allocation of taxing rights regardless of physical presence, and should itself be the subject of a global multilateral convention, rather than a directive, but whose adoption is still pending.

In concrete terms, the GloBE Directive establishes a minimum level of taxation through a top-up tax. This top-up tax applies to MNEs (and large domestic companies) whose annual consolidated turnover exceeds EUR 750 million and whose effective tax rate, in a given country, is below 15 per cent.

The obligation to pay this top-up tax tax is allocated on the basis of two rules: (i) the income inclusion rule (IIR), the main rule targeting the parent entity (ultimate, intermediate or partial), and (ii) the undertaxed payments rule (UTPR), a back-up rule targeting other constituent entities of the group, to deal with cases where the parent entity is not subject to the IIR.

Investment funds are in principle excluded from the scope of the Pillar 2 Directive, but their managers should not infer that they are immune from the GloBE rules. Indeed, fund managers will have to carefully examine the scope of accounting consolidation and the specificities of each entity in the holding chain, above and below the fund, i.e. both at the level of the investors and the investments (and any intermediate vehicles).

A concept with multiple unknowns

What remains of national sovereignty? Luxembourg has, like its European partners, a certain amount of room to manoeuvre and will be able, in accordance with the Directive, to have its "own" Pillar 2; provided that this domestic law mechanism still ensures the same minimum level of taxation and is determined to be "qualified", that is, equivalent to the IIR and UTPR rules.

It is no longer time to criticise, but to understand. There is no doubt that the text of the law and the work done by parliament will help clarify the application of the GloBE rules in a Luxembourg context. Nevertheless, it is essential to anticipate and integrate the technical and practical challenges that will be imposed on relevant taxpayers as of 1 January 2024. What will be the potential impact for banks and large groups present in Luxembourg? What are the local adjustments that have to be made to the profit or loss to determine the effective tax rate for Pillar 2 purposes? How will the reporting entity collect and centralise tax data relating to subsidiaries?

There are therefore numerous questions of which we must and will have to pay close attention - especially for fund structures - in order to avoid crashing into these new Pillar 2 rules.

This article first appeared in PaperJam Luxembourg.

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