The EU has adopted a directive implementing the OECD global minimum tax rules (‘Pillar 2’). Even though the US did not adopt the Pillar 2 rules, they can have a significant tax impact on US multinational enterprises (‘MNEs’).
Pillar 2 will apply to MNEs with annual global revenues exceeding € 750 million. It seeks to enforce a global minimum income tax at an effective rate (‘ETR’) of 15% for each country in which the MNE operates. The starting point for the ETR calculation is book income, which is subsequently adjusted to eliminate certain book-to-tax-differences.
The primary rule under Pillar 2 is the Income Inclusion Rule (‘IIR’). The IIR gives taxing rights to the country of the ultimate parent entity (‘UPE’) of the MNE group. Such top-up tax is equal to the difference between 15% and the ETR in the relevant country. For example if the ETR in a country is 5%, the top-up-tax will equal 10% (15% minus 5%). In case of a US UPE, the IIR will not be applied at the level of the US UPE but at the level of its first subsidiary located in a country that has adopted the IIR.
The Undertaxed Profits Rule (‘UTPR’) is the secondary rule. It becomes effective if no top-up tax is imposed under the IIR, e.g. because the UPE country has not adopted the Pillar 2 rules. Under the UTPR, the country of a group company can levy top-up-tax on a pro-rata share of the undertaxed income of (a) its direct or indirect parent company (see example 2 below) or (b) another group company in a situation where there is no direct ownership link (see example 3 below). This pro-rata share of the income is determined pursuant to an allocation key based on employees and tangible assets in countries that have adopted the UTPR.
Based on the directive, each EU country should adopt legislation pursuant to which the IRR and the UTPR will enter into force for book years starting as from Dec 31, 2023, and Dec 31, 2024, respectively.
US MNEs could incur additional taxation due to Pillar 2 in the following situations:
1. A US parent company (‘USCo’) holds an EU subsidiary (‘EU Sub’) which holds a subsidiary (‘SubCo’) with an ETR of less than 15% (e.g., because it benefits from a preferential IP regime, a tax holiday or is located in a tax haven). EU Sub will be subject to tax on SubCo’s income under the IIR.
2. USCo itself does not meet the 15% ETR threshold (e.g., because it benefits from tax incentives in the US such as FDII and/or tax credits). EU Sub could impose tax on the undertaxed income of USCo under the UTPR.
3. USCo holds a (low-taxed) SubCo in another chain than EU Sub. EU Sub could be subject to tax on SubCo’s income under the UTPR even though it does not hold an interest in SubCo.
Particularly situations 2 and 3 could result in unexpected outcomes for US MNEs and should be taken into account by MNEs in their Pillar 2 impact analysis.
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