New Rules on Corporate Tax in the EU
How the bloc’s new ultimate beneficiary regulations work
As part of the EU’s two-pillar strategy to make taxation fairer, the bloc has introduced new rules on corporate taxes as of January 2024. This introduces a minimum effective tax rate of 15% for multinational companies active in EU Member States.
The rules will apply to any large group, both domestic and international, with combined financial revenues of more than €750 million a year, and with either a parent company or a subsidiary situated in an EU Member State.
This is an EU-wide attempt to stop the unfair shifting of profits around the world in multinational and transnational organisations, in an attempt to pay less tax than is due. The rules are also designed to make corporate taxes fairer and more stable, as well as more responsible to modern business, which is increasingly globalised and digital. The result of much work, the new legislation standardises corporation tax across the bloc.
How will the effective tax rate be calculated?
The effective tax rate is established per jurisdiction, by dividing taxes paid by the entities in the jurisdiction by their income. If the effective tax rate for these entities in a particular jurisdiction is below the 15% minimum, then the Pillar 2 rules are triggered and the group must pay a top-up tax to bring its rate up to 15%. This top-up tax is known as the ‘Income Inclusion Rule’. This top-up applies irrespective of whether the subsidiary is located in a country that has signed up to the international OECD/G20 agreement or not.
Non-EU Parent Companies
If the global minimum rate is not imposed by a non-EU country where a group entity is based, Member States will apply what is known as the ‘Undertaxed Payments Rule’. This is a backstop rule to the primary Income Inclusion Rule. It means that a Member State will collect part of the top-up tax due at the level of the entire group if some jurisdictions where group entities are based set their tax below the minimum level and do not impose any top-up. The amount of top-up tax that a Member State will collect from the entities of the group in its territory is determined via a formula based on employees and assets.
Non-EU Parent Companies
If the global minimum rate is not imposed by a non-EU country where a group entity is based, Member States will apply what is known as the ‘Undertaxed Payments Rule’. This is a backstop rule to the primary Income Inclusion Rule. It means that a Member State will collect part of the top-up tax due at the level of the entire group if some jurisdictions where group entities are based set their tax below the minimum level and do not impose any top-up. The amount of top-up tax that a Member State will collect from the entities of the group in its territory is determined via a formula based on employees and assets.
Exceptions
While the new rules aim to simplify and standardise corporation tax EU-wide, thereby making compliance simpler, there are some exceptions accounted for in the new legislation.
The rules provide for an exclusion of minimal amounts of income to reduce compliance burden. When revenues and profits in a jurisdiction are under a certain minimum amount, no top-up tax will be charged on the profits of the group earned in this jurisdiction, even when the effective tax rate is below 15%. This is known as the de minimis exclusion.
Moreover, companies will be able to exclude from the top-up tax an amount of income that is at least 5% of the value of tangible assets and 5% of payroll. This is called a ‘substance carve-out’.
The policy rationale for this is to exclude a fixed amount of income relating to substantive activities such as buildings and people. This seeks to encourage investment in economic substance by multinational enterprises in a particular jurisdiction, and is a common aspect of corporate tax policies worldwide. It should be noted that this does not amount to a tax “cut” for larger corporations, more a fair way to reward entities for siting themselves in the European Union.
While tax evasion and the offshoring of profits remain a problem in today’s business environment, the new rules make it ever-harder for bad actors to hide money, and ever easier in terms of compliance. Designed to protect legitimate business, make operating environments fairer and limit complexity for accountants and their clients, it’s a subtle change with huge repercussions.
You can find out more about the EU’s rationale and how the rules work here:
https://taxation-customs.ec.europa.eu/taxation-1/corporate-taxation/minimum-corporate-taxation_en