Background of Pillar Two
On 8 October 2021, 137 jurisdictions of the OECD/G20’s Inclusive Framework reached agreement on the two-pillar solution, followed by a set of model rules (the Global Anti-Base Erosion Rules; the “GloBE Rules”). The objective of Pillar Two is to guarantee a minimum level of taxation by introducing new rules that grant jurisdictions additional taxation rights, and to limit tax competition between jurisdictions. A minimum tax rate of 15% under Pillar Two was agreed; see also our previous Tax Alert of 24 December 2021 in this respect.
The European Commission published a proposal for a directive on 22 December 2021, which included a similar set of model rules to implement Pillar Two (the “Draft Directive”). The Draft Directive aims to target both international and domestic groups whose consolidated group revenue exceeds EUR 750 million in at least two of four consecutive years. Compared with the OECD GloBE Rules, the scope of the Draft Directive is extended by the inclusion of large-scale domestic groups, to ensure compliance with EU freedoms (especially the freedom of establishment). The aim is for the rules to be implemented in all 27 EU Member States by 2023, effective as of 1 January 2024. EU Directives related to tax can currently be adopted only unanimously and, at this moment, approval of the Draft Directive is being blocked by Hungary. On 9 September 2022, the Dutch government stated, in a joint statement with France, Germany, Italy and Spain, that it wishes to reach an agreement at EU level and that it is committed to implementing Pillar Two in 2023 ‘by any possible legal means’. It remains to be seen whether these “legal means” will in the end result in unilateral implementation of Pillar Two or implementation by certain individual jurisdictions. By signing the statement, the Netherlands has shown its commitment and that a veto from Hungary, or any other Member State, would not stop the implementation of Pillar Two. One of Hungary’s reasons for its veto (during the last vote on 17 June) was that ongoing technical work is still required with respect to the Draft Directive and that, in principle, the EU is on schedule with its implementation, whilst neither the US or any Asian jurisdiction has started this process. Recently, in August 2022, the US enacted the Inflation Reduction Act of 2022, which includes a minimum corporate tax of 15% for certain highly profitable corporations. In the summer of 2022, the UK, South Korea and Australia also presented proposals to implement Pillar Two.
The Draft Bill
It is not common practice that a draft proposal implementing an EU Directive is already published for public consultation before EU Member States have reached agreement. The Dutch Government noted that inviting the public to provide input now already could potentially improve the quality of the definitive legislation. If the Dutch government had to wait for agreement at EU level, there may be insufficient time for such a consultation process. This will enable the Draft Bill to be implemented quickly in the Netherlands once agreement has been reached. The Dutch Government also noted that, although the Directive is still subject to change, it expects the ultimately agreed Directive to be similar to the current Draft Directive. Considering the scope and complexity of the Dutch consultation documents, technical improvements are expected to be made in the coming period.
The Draft Bill envisages implementation of Pillar Two in a separate new act (the Minimum Tax Rate Act 2024) instead of incorporating it into the existing Dutch Corporate Income Tax Act 1969. The reason for this is that the Pillar Two rules are conceptually different from the Dutch Corporate Income Tax Act, because the Draft Bill uses profits based on financial reporting standards rather than the profit determination for (Dutch) tax purposes. In addition, implementing the rules into existing laws would make the law even more complex, and a separate act is also justified according to the Dutch Government because the minimum tax will be levied as a separate tax.
The Draft Bill is based on and in general aligns with the proposed Draft Directive. Large multinational enterprises and large-scale domestic groups, both with a consolidated group revenue of at least EUR 750 million, will fall within the scope of the proposed rules. The Draft Bill primarily consists of two domestic rules (the GloBE Rules), which will introduce a global minimum effective tax rate of 15% for in-scope groups. The two domestic rules consist of the Income Inclusion Rule (“IIR”) and the Undertaxed Payment Rule (“UTPR”). Under the IIR, the minimum effective tax rate is paid at the level of the ultimate parent entity, in proportion to its ownership rights in subsidiaries that are taxed at a low effective tax rate (i.e. lower than 15%). The effective tax rate is, in short, calculated by dividing the payable corporate tax by the net qualifying income. The UTPR is regarded as a backstop and is needed to ensure that a minimum effective tax rate is due when a low taxed subsidiary is held through a chain of ownership that does not result in an IIR. In addition, the Draft Directive contains an optional introduction of a Qualified Domestic Minimum Top-up Tax (“QDMT”). The Dutch government intends to introduce this QDMT, whereby any top-up tax to be paid by Dutch entities with an effective tax rate of less than 15% that are part of an in-scope group will be collected by the Dutch government (instead of by the ultimate parent entity in another jurisdiction).
Like the Draft Directive, the Draft Bill provides for some exceptions. Certain entities will not be in scope, including governmental entities, international organisations, non-profit organisations, pension funds and investment funds that are the ultimate parent entity of a multinational group. Furthermore, an exception applies to minimal amounts of income (known as the ‘de minimis income exclusion’), whereby the rules do not apply if the qualifying turnover and income in a specific jurisdiction are below €10M and €1M, respectively. A second exclusion applies to a fixed amount of income relating to substantive activities, such as buildings and employees (a ‘substance carve-out’), based on which companies may exclude an amount of income that is at least 8% of the value of tangible assets and 10% of payroll expenses (instead of 5% based on the Draft Directive).
Taxes due following the Draft Bill must be declared using what is known as an ‘information’ tax return, since the taxpayers subject to these rules (approximately 3,000 multinational groups) themselves will have the best access to the relevant information to complete the tax return. As a result, the administrative burden will increase significantly for these companies.
In line with the Draft Directive, the Draft Bill proposes that the IIR and the QDMT become effective for financial reporting years starting on or after 31 December 2023 and the UTPR for financial reporting years starting on or after 31 December 2024.
Interested parties may submit their input on the public consultation until 5 December 2022. After consultation, the amended Draft Bill will be sent to the Council of State for advice before being submitted to the House of Representatives and the Senate for enactment. Since no agreement has been reached yet between the EU Member States, it remains to be seen what will happen if no unanimity is reached shortly. In any event, the Netherlands, Germany, France, Italy and Spain seem to be determined to continue implementation of Pillar Two. It is therefore important for multinational and large-scale domestic groups to assess whether they would be in scope of the Draft Bill and to determine the potential impact on the group and, more specifically, the Dutch entities.