What Are the EU Pillar 2 Minimum Tax Rules?

The European Union’s Pillar 2 directive is the region’s adoption of a global minimum tax framework from the Organisation for Economic Co-operation and Development (OECD). The directive’s goal is to ensure large, internationally active corporate groups pay a minimum tax on their income, regardless of where they report their profits.

These rules establish a new baseline for corporate taxation to reduce the incentive for multinational enterprises to shift profits to low-tax jurisdictions. The EU directive legally binds its member states to adopt these internationally agreed-upon rules into their national laws.

Scope of the EU Pillar 2 Rules

The EU Pillar 2 rules apply to large multinational enterprise (MNE) groups and large-scale domestic groups. A group falls within the scope if its annual consolidated revenues are €750 million or more in at least two of the four preceding fiscal years. This threshold aligns with country-by-country reporting (CbCR) requirements.

An MNE group is a collection of related enterprises resident in different tax jurisdictions, and each individual company is a “constituent entity.” The rules capture the income of these entities on a jurisdictional basis to determine if the group meets its minimum tax obligation in each country of operation.

Certain “excluded entities” are carved out from these rules due to their public policy function. These include governmental bodies, international organizations, non-profit organizations, pension funds, and certain investment funds that are the ultimate parent entity of a group.

The Global Minimum Tax Calculation

The global minimum tax is calculated on a country-by-country basis. The core of this process is determining the Effective Tax Rate (ETR) for each jurisdiction using a specific formula from the Global Anti-Base Erosion (GloBE) rules, not the statutory corporate tax rate.

The ETR formula is the total “Covered Taxes” divided by the “GloBE Income” for a jurisdiction. Covered Taxes include taxes on a company’s income or profits recorded in its financial accounts, such as domestic and foreign income taxes, including deferred taxes.

GloBE Income begins with the financial accounting net income or loss for each entity in the jurisdiction. This figure is then subjected to a series of adjustments to create a standardized tax base for the calculation.

The calculated ETR for a jurisdiction is compared against the 15% global minimum tax rate. If a group’s ETR is below this threshold, a “Top-up Tax” is triggered. The Top-up Tax percentage is the difference between the 15% minimum rate and the ETR. This percentage is then applied to the GloBE Income in that jurisdiction, after subtracting a substance-based income exclusion for income related to tangible assets and payroll.

Key Enforcement Mechanisms

Income Inclusion Rule (IIR)

The Income Inclusion Rule (IIR) is the primary enforcement tool. This rule requires the ultimate parent entity (UPE) of the MNE group to pay the top-up tax associated with the low-taxed income of its foreign subsidiaries. The calculation is made at the parent company level, assessing the effective tax rates of its constituent entities in each foreign jurisdiction. If a subsidiary’s jurisdiction has an effective tax rate below 15%, the UPE is liable for the top-up tax in its own home country. This rule took effect for fiscal years starting on or after December 31, 2023.

Undertaxed Payments Rule (UTPR)

The Undertaxed Payments Rule (UTPR) acts as a secondary or backstop mechanism to the IIR. It applies in situations where the IIR is not sufficient to collect the entire top-up tax, for instance, if the ultimate parent entity is located in a country that has not implemented Pillar 2 rules. In such cases, the UTPR allocates the residual top-up tax liability among the other jurisdictions where the MNE group has operations. The UTPR enforces compliance by denying tax deductions for payments or requiring an equivalent adjustment. The UTPR is set to apply for fiscal years starting on or after December 31, 2024.

Qualified Domestic Minimum Top-up Tax (QDMTT)

A Qualified Domestic Minimum Top-up Tax (QDMTT) is an option that allows a jurisdiction to collect the top-up tax from MNEs operating within its own borders before any other country can. By implementing a QDMTT, a country ensures that any additional tax revenue from local entities stays within that country, rather than being collected by a foreign parent’s jurisdiction under the IIR. A QDMTT must be calculated consistently with the GloBE rules to be considered “qualified.” The amount paid is credited against the top-up tax liability that would otherwise be due under the IIR or UTPR.

Safe Harbours and Simplifications

The Pillar 2 framework includes safe harbour provisions to simplify compliance for MNEs in low-risk jurisdictions, reducing the need for detailed data collection in the initial years. The primary mechanism for this is the Transitional CbCR Safe Harbour.

This temporary measure applies to fiscal years beginning on or before December 31, 2026, and ending no later than June 30, 2028. If an MNE group uses data from its Qualified Country-by-Country Report (CbCR) and meets one of three tests for a jurisdiction, the top-up tax for that jurisdiction is deemed zero for that year. This allows companies to avoid the full GloBE calculations for qualifying jurisdictions.

The three tests are:

• The De Minimis Test: The group’s total revenue in a jurisdiction is less than €10 million and its profit before income tax is less than €1 million.
• The Simplified ETR Test: The jurisdiction’s effective tax rate, calculated with a simplified method, is above a specified rate (15% for 2024, 16% for 2025, and 17% for 2026).
• The Routine Profits Test: The jurisdiction’s profit before tax is equal to or less than the substance-based income exclusion amount, which is a carve-out for income from tangible assets and payroll.

Compliance and Reporting Obligations

A standardized reporting framework requires MNEs to file a GloBE Information Return (GIR). This return provides tax authorities with the information needed to enforce Pillar 2 rules, including details on the MNE group’s structure and the data required to compute the ETR and any top-up tax for each jurisdiction.

A single GIR is filed by the ultimate parent entity or a designated filing entity for the entire group. This centralized return is then exchanged among the tax authorities where the group operates, streamlining the reporting process. The standard filing deadline for the GIR is 15 months after the fiscal year-end, extended to 18 months for the first year a group is subject to the rules. For example, a group first subject to the rules in 2024 with a calendar year-end would have an initial GIR due by June 30, 2026.