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Tax challenges arising from the digitalisation of the economy as released by OECD and the EU directive proposal (Pillar II)

In brief 

The Pillar Two Model Rules (also referred to as the “Anti Global Base Erosion” or “GloBE” Rules), released on 20 December 2021 are part of the Two-Pillar Solution to address the tax challenges of the digitalisation of the economy that was agreed by 137 member jurisdictions of the OECD / G20 Inclusive Framework on BEPS and endorsed by the G20 Finance Ministers and Leaders in October. These Model Rules cover the income inclusion rule (IIR) and undertaxed payment rule (UTPR) and have been designed to ensure large multinational enterprises (MNEs) pay a minimum level of tax on the income arising in each jurisdiction where they operate.  

Then, on 22 December 2021, the European Commission (EC) published its proposal for a Council Directive “on ensuring a global minimum level of taxation for multinational groups in the Union” (draft directive) aimed at implementing the OECD Pillar Two Model Rules on a 15% minimum effective tax rate in the EU Member States. 

The Draft Directive closely follows the OECD Model Rules, which set out the rules of the so-called IIR and UTPR (which are explained in more detail below). However, it departs from the Model Rules “with some necessary adjustments, to guarantee conformity with EU law”. The major key differences are: 

  • There is an extension of the IIR to “large-scale” purely domestic groups with consolidated revenues of at least EUR 750 million in at least two of the four preceding years (however, transitional rules provide for a zero-rate application of the top-up tax due for the first five years of application of the rule); 

  • The application of the IIR by an Ultimate Parent Entity (UPE), Intermediate Parent Entity (IPE) or Partially Owned Parent Entity (POPE) is extended also to the low-taxed constituent entities located in the same Member State (including the said UPE, IPE or POPE). 

No EU Action is provided at this stage with regard to the related OECD Pillar Two Subject-to-Tax Rule (STTR). The OECD during the month of March released a set of commentary and examples with respect to Pillar II dispositions.

In detail 

Scope of application

The GloBE Rules will apply to multinational enterprises (MNEs) having a revenue of at least EUR 750 million on their annual consolidated financial statements in at least two of the four fiscal years immediately preceding the relevant fiscal year. Should a MNE fall within the scope of GloBE Rules, the Constituent Entities of the MNE group, will be as well. A Constituent Entity may be defined as any entity or permanent establishment that is part of the MNE.

However, some entities are carved-out from the scope of the OECD / European Union draft directive proposal such as: 

  • Government bodies, international organisations and non-profit organisations; 

  • Pension funds itself and where they head up groups, investment funds or real estate investment vehicles; 

  • Investment or ancillary vehicles which are 95% owned directly or indirectly by an excluded entity; and 

  • Other investment entities subject to special rules (such as difference in the legal qualification of the entity) 

The Key operative provisions that every in-scope MNE would apply

The tax imposed under the GloBE Rules is a “top-up tax” (TPT) calculated and applied at a jurisdictional level. The GloBE Rules use a standardised base and definition of covered taxes to identify those jurisdictions where an MNE is subject to an effective tax rate (ETR) below 15%. It then imposes a coordinated tax charge that brings the MNE’s effective tax rate on that income up to the minimum rate. 

How to compute the effective tax rate?

In order to know if top-up tax is owed, rules are needed to calculate the ETR in each jurisdiction where the MNE operates. This requires first a calculation of the income and then a calculation of the covered tax on that income.

The starting point to determine the aggregated adjusted income will be the net income or loss reported in the consolidated financial statements of the UPE, subject to certain adjustments (for instance gains on exempted income such as dividends, equity gains and so on will be deducted from the net income. Conversely, losses resulting from the same transactions will be added back). The covered taxes are the current tax expense accrued for financial accounting net income or loss with some adjustments tax accruals in profit before tax and deferred tax expense or income booked in the accounts.

As a result, the ETR is computed by dividing the covered taxes with the GloBE income for each related jurisdiction.

In this context, in case an in-scope MNE is subject to an effective tax rate below 15% in its own jurisdiction, a jurisdictional TPT will be computed and will therefore be imposed on a group entity under an IIR or UTPR mechanism.

The primary rule is the IIR. Under the IIR, the minimum tax is paid at the level of the parent entity, in proportion to its ownership interests in those entities that have low taxed income. Generally, the IIR is applied at the top, at the level of the UPE. Should the latter be located in a jurisdiction that did not choose to apply the IIR, based on a top-down approach, the highest Intermediate Parent Entity will apply the IIR and apply the top-up tax with respect to constituent entities located in low-taxed jurisdiction. As a result, the IIR is applied at the top and works its way down the ownership chain. Rules are also provided to allow the IIR to be applied by a parent entity in which there is a significant minority interest, to minimise leakage of low taxed income. 

A backstop is needed to ensure the minimum tax is paid where an entity with low taxed income is held through a chain of ownership that does not result in the low-taxed income being brought into charge under an IIR. This backstop is UTPR. This rule works by requiring an adjustment (such as denial of a deduction) that increases the tax at the level of the subsidiary. The adjustment is an amount sufficient to result in the group entities paying their share of the top-up tax remaining after the IIR. 

As mentioned above, the TPT is being charged under the IIR or the UTPR to ensure co-ordinated outcomes. However, given that there will typically be subsidiaries in several different jurisdictions, the UTPR requires a higher level of administrative co-operation, which underlines the importance of standardised information reporting requirements. This is also one of the reasons the UTPR is a backstop rather than the primary rule. 

The draft directive in the nutshell: some deviations 

The implementation provisions of the Draft Directive closely follow the OECD Model Rules. However, they depart from that document in certain aspects, in the Commission’s words, “with some necessary adjustments, to guarantee conformity with EU law” and “to provide taxpayers with legal certainty that the new legal framework is compatible with the EU fundamental freedoms, including the freedom of establishment”. 

  • The draft directive extends the application of the IIR to so called “large-scale domestic groups”: The Pillar Two Draft Directive provides for the extension of the scope of the IIR not only to an MNE group having at least one entity or a permanent establishment not located in the same jurisdiction of the UPE, but also to a so called ‘large-scale domestic group,’ namely an MNE group of which all constituent entities are located in the same Member State with an annual revenue of EUR 750 million or more in its consolidated financial statements in at least two of the last four consecutive fiscal years.

  • The Draft Directive extends the application of the IIR by an UPE, IPE or POPE to the low-taxed constituent entities located in the same Member State: Based on the OECD Model Rules, the jurisdiction which applies the IIR shall apply the top-up tax only to the foreign low-taxed constituent entities. The Draft Directive differs by providing in addition that where an UPE, or in certain specific cases, an IPE or POPE located in a Member State is itself a low-taxed constituent entity, it shall be subject to the IIR top-up tax together with its low-taxed constituent entities located in the same Member State of which it is a resident.

  • The Draft Directive extends the UTPR temporary exclusion in favour of MNEs in the initial phase of their international activity to the IIR as well: The OECD Model Rules provide for an exclusion from the application of the UTPR for small MNE groups in the initial phase of their international activity provided that such MNE Group: (i) has Constituent Entities in no more than six jurisdictions, and (ii) the sum of the Net Book Values of Tangible Assets of all Constituent Entities located in all the jurisdictions excluding the Reference jurisdiction (being the jurisdiction with the highest total of tangible assets) does not exceed EUR 50 million. In the Draft Directive, the abovementioned exclusion is extended to the application of the IIR. This additional exclusion, whilst deviating from the OECD Model Rules ensures consistency with the ‘large scale domestic groups’ provision referred to above.

  • The Draft Directive provides an option for the Member States to adopt a ‘qualified’ domestic top-up tax: The Draft Directive provides an option for the Member States to elect to apply a ‘qualified’ domestic top-up tax. The definition of ‘qualified domestic top-up tax’ provided in the Draft Directive is consistent with the corresponding definition provided in the OECD Model Rules. In particular, it refers to domestic rules ensuring a minimum effective tax rate in accordance with the rules laid down in the Draft Directive without allowing for any additional ‘benefits’ related to the said rules. Member States applying the election for the domestic top-up tax have to notify this choice to the Commission within four months following its adoption. If a constituent entity of an MNE Group is located in a Member State that adopts the qualified domestic top-up tax, such constituent entity shall pay the top-up tax to its Member State.

  • The Draft Directive sets out the rules under which the legal framework of a third country jurisdiction shall be considered as equivalent to the EU GloBE’s IIR. The Draft Directive specifies under which circumstances a foreign (i.e. non-EU) IIR implemented by a third country jurisdiction can be considered ‘equivalent’ to the EU GloBE’s IIR for purposes of the interaction between the two sets of rules. In particular, the equivalence assessment, which will be performed by the Commission, is met if the following conditions are fulfilled by the non-EU IIR:

  • it provides for a set of rules where the parent entity shall compute and collect its allocable share of top-up tax in respect of the low-taxed constituent entities of the MNE group;

  • it provides for a minimum effective tax rate of at least 15%;

  • it allows only the blending of income of entities located within the same jurisdiction; and

  • it provides for relief for any top-up tax that was paid in a Member State in application of the IIR set out in the Draft Directive.

The European Union, with respect to the draft directive on ensuring a global minimum level of taxation for multinational groups in the Union, opened a consultation where stakeholders may provide their feedback up to 6 April 2022. Member States are required to transpose internally the directive by 31 December 2022 at the latest.

Conclusion and take away

The OECD as well as the EU directive proposal provides policy makers with an ambitious deadline to adapt their international tax rules with an entry into force of the IIR by 2023 and of the UTPR by 2024. However, the complexity of the calculation and allocation of the top-up tax as well as the lack of more detailed guidelines makes the implementation difficult. 

The desire to introduce a fairer tax regime, both in the European Union and within the 137 jurisdictions of the OECD that have signed the Inclusive Framework, is well present, binding MNEs’ group entities to be taxed at a minimum of 15%. Even if the OECD Pillar Two model rules and the European directive proposal are similar, the slight differences in the two models add an additional layer of complexity. 

From a compliance tax perspective, a constituent entity will have to file within the 15 months following the end of the fiscal year, a standardised GloBE Information Return, or a top-up tax return under the European directive proposal (extended to 18 months for the first transitional year). However, should the UPE or another constituent entity of the group have already filed such return, other constituent entities would be exempt to the extent that a bilateral or multilateral agreement concluded between two or more jurisdictions, provides an exchange of information. This additional reporting obligation introduces additional filing obligations for taxpayers and implies strong cooperation and discussion with the tax authorities. 

However, in order to reduce the compliance and administrative burden, safe harbours rules may be opted by jurisdictions. Constituent entities of a jurisdiction that has opted for safe harbour provisions will not have to calculate the GloBE ETR calculation, as the minimum tax rate would be deemed to be above the 15% minimum rate. As a result, the top-up tax for the safe harbour jurisdiction is considered to be zero. Nevertheless, tax authorities may challenge the application of the safe harbour 36 months following the filing of the GloBE Information Return. The constituent entity would have to prove that it satisfied the GloBE ETR test, otherwise its right to take advantage of the safe harbour rules will be denied. 


1. For completeness, covered taxes regarding Luxembourg entities include the following: Corporate Income Tax, Municipal Business Tax, Net Wealth Tax, Withholding Tax on dividends allocated to the distributing entity and taxes due to Controlled Foreign Company (“CFC”) rules.

2. The jurisdictional TPT amount is the difference between the 15% GloBE tax rate and the ETR applied to an amount of excess profit equal to net GloBE income minus the substance based income exclusion for that jurisdiction.

3. Remark: In case of split-ownership situations, a Partially Owned Parent Entity (“POPE”) that owns directly or indirectly more than 20% in its profits held, will be entitled to apply the top-up tax over a constituent entity of the group.

Contact us

Wim Piot

Tax Partner, Tax policy, PwC Luxembourg

Tel: +352 49 48 48 2568

Murielle Filipucci

Partner, PwC Luxembourg

Tel: +352 49 48 48 3118

Philippe Ghekiere

Director, PwC Luxembourg

Tel: +352 621 333 228

Laura Maniglia

Senior Associate, PwC Luxembourg

Tel: +352 62133 4252

Juliette Le Prat

Associate, PwC Luxembourg

Tel: +352 621 333238

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