First Observations on Pillar 2 EU Directive adoption

It took the full EU 51 weeks and 3 days to agree on the Directive to implement Pillar 2 (the Pillar 2 Directive). The initial Directive proposal of 22 December 2021 was amended several times and finally survived the strong Hungarian and Polish concerns. As a result, on 15 December 2022, the Council of the EU announced in a press release that the Pillar 2 Directive was formally adopted following a written procedure. The adoption is the final step in the Council’s legislative process.

Following the formal adoption, the Pillar 2 Directive will be published in the Official Journal of the European Union. Subsequently, it will be transposed into all EU Member States’ laws. The EU Member States shall apply the Pillar 2 measures (including the Income Inclusion Rule - IIR) in respect of the fiscal years beginning from 31 December 2023. However, the Undertaxed Profit Rule (UTPR) shall apply in respect of the fiscal years beginning from 31 December 2024. Earlier implementation is possible, though.

What does this mean for your organisation/company?

It is generally expected that the financial impact (in terms of additional taxation) of Pillar 2 rules for many companies, at a first glance, appears to be modest. Nevertheless, matters may differ in individual cases. Also, considering that the EU is the first region moving towards effectuating the Pillar 2 rules, any subsequent potential top-up taxation in the EU (via either the IIR or UTPR) in relation to foreign investment returns could give rise to divergences in terms of financial impact. On top of this, administrative and compliance obligations will arise from this (separate) tax act, in addition to the obligations under our current corporate tax systems.

The complex Pillar 2 legislation effectively introduces an entirely new corporate income tax regime alongside the current Dutch corporate tax regime and will have an impact on your organisation. It is therefore essential to determine the (potential) impact of the new rules. Questions such as "What does Pillar 2 mean for my organisation in terms of data and the readiness of (IT) systems within my organisation?" and "Which stakeholders inside and outside my organisation should I engage about the potential impact of Pillar 2?" are crucial here.

Hungary abstained from voting

According to the communication on the written procedure (the communication), Hungary abstained from voting. Nevertheless, we read in the communication that “the required unanimity has been reached. Therefore, the above Directive of the Council is adopted and the accompanying statement is approved.” What does Hungary’s abstention mean? According to Article 235 TFEU, “abstentions by members present in person or represented shall not prevent the adoption by the European Council of acts which require unanimity (PwC: like the P2 Directive).”

Although Hungary abstained from voting, it is undeniably bound by the Pillar 2 Directive. In other words, it shall implement and apply it as per the agreed timeline. Failure to do so may result in Hungary being brought to the Court of Justice of the EU (CJEU) by the European Commission.

Poland’s concerns addressed

Poland’s concerns related to the desired link between Pillar 1 and Pillar 2. As per the statement of Sweden in the communication, “in order to accommodate the concerns of one Member State [PwC: Poland], a new Article 55a has been added to the Directive at a late stage. Sweden is prepared to accept the newly added Article since it is perceived necessary to reach a compromise on which there can be unanimity. However, Sweden wishes to make clear that the added language does not in any way prejudge our position on any proposal presented by the Commission based on the new Article 55a.” We understand that this statement was important for Sweden as it takes up the presidency of the Council of the EU as per 1 January 2023.

The presidency is responsible for driving forward the Council's work on EU legislation, ensuring the continuity of the EU agenda, orderly legislative processes and cooperation among EU Member States.

Article 55a [PwC: currently Article 57 of the latest compromise text] was added to the compromise text of the Pillar 2 Directive in June 2022 to address Poland’s concerns about linking implementation of the two Pillars. It requires the European Commission to submit by June 2023 a report to the EU Council assessing the implementation of Pillar 1 “and, if appropriate, submit a legislative proposal to address these tax challenges in the absence of the implementation of the Pillar One solution.” The Swedish statement clarifies, in essence, that accepting this Article does not set in stone its position on a possible future proposal based on it.

First reactions from the US

In a letter dated 15 December 2022 and signed by all Republican members of the Senate Finance Committee and House Ways and Means Committee, as well as Senate Foreign Relations Committee Ranking Member Risch, the signatories criticise the Pillar 2 reform initiative. According to the letter, “a critical first step is to recognise the fundamental flaws with the Pillar Two enforcement mechanism – the UTPR – and stop encouraging other countries to assert it on U.S. companies.” In addition, “there is growing consensus among tax experts, including former Treasury officials, that the Pillar Two UTPR is inconsistent with our bilateral tax treaties. That this Administration has encouraged foreign countries to assert new taxing rights against American interests, in violation of existing treaties, is unprecedented.”

The application of Pillar 2 legislation in the EU could lead to the application of the UTPR rule on US sourced business profits of US headquartered multinationals. However, only to the extent that the US does not levy a sufficient level of company taxation and/or does not collect a sufficient top-up tax to meet the Pillar 2 minimum standard (e.g. under a tax incentive regime). This raises questions as to the (in)compatibility of top-up taxation under Pillar 2, for instance, with bilateral tax treaties (DTTs) and/or bilateral investment treaties (BITs) in place. Similar issues arise in relation to any potential top-up taxation by EU Member States under the Directive on investment returns in other regions and (emerging) economies in the world.

Dutch Pillar 2 legislation

On Monday 24 October 2022, the Dutch Government submitted the draft legislative proposal “Minimum Tax Act 2024 (Pillar 2)” to public consultation. The proposal seeks to implement the Pillar 2 Directive in the EU. The consultation period has expired. Given that we now have an agreement on the Pillar 2 Directive, we expect that the draft legislation submitted to public consultation will be adjusted to reflect the final text of the Pillar 2 Directive. It is not clear to us whether a second public consultation will take place.

Interaction Of Pillar 2 with other EU Directives

The Pillar 2 Directive introduces an entirely new corporate tax system alongside existing and proposed tax harmonisation mechanisms in secondary EU law, such as the EU Parent Subsidiary Directive, Merger Directive, ATAD1, ATAD2, draft DEBRA and draft Unshell Directive (ATAD3).

We expect to see questions raised as to the legal implications of any mutual interactions. For instance:

How does the required operation of the double tax relief mechanisms for eligible dividend proceeds under the EU Parent Subsidiary Directive impact the Effective Tax Rate (ETR) for Pillar 2 purposes and potential consequent top-up taxation?
How does the required tax deferral upon eligible business reorganisations under the EU Merger Directive impact the ETR for Pillar 2 purposes?
How will any required fair value step-up of asset values upon inbound asset movements (onshoring) under ATAD1 impact the Pillar 2 ETR?
How will the allowance for corporate equity (DEBRA) - having no equivalent in Pillar 2 - impact the ETR, and potential following top-up taxation?
Will the GLOBE participation exemption apply to shell entities that fall in the scope of the operation of the proposed Unshell rules?

Answers to these questions in relation to possible EU secondary law conflicts (e.g. ATAD 1 vs Pillar 2) does not seem not evident at this point, and is subject to interpretation by the CJEU.

Pillar 2 and national laws

The Directive introduces an entirely new tax system, with its own definitions, alongside the current corporate tax regime of EU27. We expect to see a transition from domestically oriented and operating company tax systems to an EU-wide approach on company taxation. This is because the minimum tax will inevitably end-up operating as an EU-wide coordinated minimum company taxation system on top of which the EU27 corporate tax systems. It seems to us that the national company tax systems, including their underlying doctrines (such as the Dutch notions of fraus legis, totaalwinst, goedkoopmansgebruik and the Dutch participation exemption) will become gradually less important for in-scope multinational firms.

Relevant to note is that the Pillar 2 rules under the Directive are subject to the interpretation of the CJEU in an EU harmonious manner. The (tax) courts of the EU Member States will have to refer preliminary questions to the CJEU on the interpretation of the Pillar 2 system. Another aspect to take note of is that commercial accounting, under the accounting standards in the country of the ultimate parent entity of the in-scope European or non-European multinational, constitute the basis for top-up taxation under the Directive. This means that it will be ultimately up to the CJEU to interpret these accounting rules (e.g. IFRS or the relevant GAAP) for Pillar 2 ETR calculation purposes and Pillar 2 top-up tax assessment purposes. As such, the tax developments in this regard potentially also impact the role of the accountant.

Pillar 2 - tax accounting considerations

Notwithstanding the EU political agreement reached on the Pillar 2 Directive, the Pillar 2 rules are not considered to be (substantively) enacted yet from a tax accounting perspective. For this to happen, the Pillar 2 Directive should be first translated into national legislation by the respective EU Member States. In the case of the Netherlands, the Dutch Pillar 2 legislation will be considered as substantively enacted when the Dutch Senate (“Eerste Kamer”) adopts the proposed legislation.

Upon (substantive) enactment, companies will need to account for the (numerical) impact of Pillar 2 in their financial statements. In this respect, we note that there is currently no formal guidance available on how to account for Pillar 2 top up taxes in the financial statements. The International Accounting Standards Board is currently starting up a project to draft the guidance (by amending IAS 12) and it is expected that a consultation document will be published in January 2023.