In 2013, the Organization for Economic Co-operation and Development (“OECD”) launched an initiative to target base erosion and profit shifting (“BEPS”). As a continuation of the initial BEPS initiative, the project “Tax challenges arising from the digitalisation of the economy” (“BEPS 2.0”) has been expanded and contains now two “pillars”:
- “Pillar I” includes new nexus and profit allocation rules for multinational groups with an annual turnover of more than EUR 20 billion and a profit margin of more than 10% per year.
- “Pillar II” aims to implement global anti-base erosion model rules (“GloBE Rules”) ensuring a 15% minimum effective tax rate (“ETR”) across the jurisdictions a multinational group operates.
This article focuses on Pillar II due to its greater impact on M&A deal practice.
The basics
In a nutshell, Pillar II applies to multinational enterprises (“MNEs”) (as well as large domestic groups) with a relevant worldwide turnover equivalent to EUR 750 million or more (subject to certain exceptions, exemptions, and de-minimis exclusions).
To calculate the ETR for a jurisdiction in which the MNE operates, the GloBE Rules standardize (i) the tax base (the “GloBE Income or Loss”) and (ii) the relevant taxes (the “Covered Taxes”). In addition to subsidiaries, also permanent establishments are considered separate business units for the application of Pillar II (and, therefore, included in the definition of the “Constituent Entities”).
Where the ETR of an MNE in a particular jurisdiction is lower than the minimum rate of 15%, the GloBE Rules provide for a set of coordinated top-up taxes:
- Priority: The respective jurisdiction may impose a domestic minimum/top-up tax in line with GloBE Rules (the Qualified Domestic Minimum Top-up Tax, “QDMTT”).
- Main: The jurisdiction of the group’s ultimate parent entity (“UPE”) may impose a top-up tax based on the Income Inclusion Rule (“IIR”). This applies, mutatis mutandis, to the intermediate parent entity if the jurisdiction of the UPE does not apply an IIR.
- Backstop: As a backstop for situations where the UPE is not subject to IIR (or the top-up tax is otherwise not collected), other jurisdictions in which the MNE operates may apply a top-up tax (or deny relief for an undertaxed deduction) based on the Undertaxed Payments Rule (“UTPR”).
As a result, an MNE in the scope of Pillar II has to comply with the minimum ETR even if only one jurisdiction where it operates implemented the GloBE Rules in its domestic legislation. In addition, the OECD has recently supplemented the “IIR” and the “UTPR” rules by releasing a model provision (as well as a commentary) for a treaty-based Subject to Tax Rule (“STTR”).
In the context of M&A transactions, the following concepts and rules are particularly important:
- Excluded entities: The GloBE Rules provide for certain types of Constituent Entities which are excluded for calculating the jurisdictional ETR, the top-up taxes as well as the compliance requirements (“Excluded Entities”). Such Excluded Entities are, among others, Investment Funds and Real Estate Investment Vehicles (both only as a UPE of an MNE) as well as Pension Funds. This exclusion also applies to certain entities which are held directly or indirectly by an Excluded Entity.
- Jurisdictional blending: As the relevant ETR is computed on a jurisdiction-by-jurisdiction basis, the GloBE Rules allow offsetting a “low” ETR of a group entity with a “high” ETR of another entity in the same jurisdiction.
- Transitional provisions: The majority of participating jurisdictions (including the EU member states and Switzerland)1 are expected to implement Pillar II in their national legislation as of 1 January 2024. As part of the provisions covering the transition into Pillar II (“Transition Rules”), the GloBE Rules include certain limitations on intra-group asset transfers to prevent MNEs from manipulating outcomes in the period between 30 November 2021 (publication of the GloBE Rules) and the enactment of the national legislation (the “Transition Period”).
- Safe Harbor Rules: In order to facilitate the implementation of Pillar II for taxpayers as well as tax authorities, the GloBE Rules provide for a “transitional” safe harbor rule (for fiscal years beginning on or before 31 December 2026 and ending 30 June 2028 the latest) as well as the development of “permanent” safe harbor rule. The transitional safe harbor rule excludes a MNE’s operations in “lower-risk” jurisdictions from Pillar II compliance obligations if (i) a de-minimis test, (ii) a simplified ETR test, or (iii) a routine profits test are alternatively met (each test assessed on a per-jurisdiction basis).
Before the M&A transaction: Suitable targets and business combinations
From the buyer’s perspective, the ETR of the target group is material to the commercial considerations as well as the purchase price offered. In this respect, Pillar II has an immediate impact if the target is an MNE in scope.
- An acquisition may push the acquiring group’s turnover above the EUR 750 million threshold, bringing the group immediately within the scope of Pillar II. As a result, Pillar II would not only be relevant for the financial and tax modelling of the target but also impact the acquiring group’s ETR and reporting obligations.
- Conversely, a “high” ETR of a target group may be less detrimental to its valuation if the acquiring MNE can make use of jurisdictional blending (i.e., by “sheltering” some of its own “low” taxed Constituent Entities in the same jurisdiction).
Nonetheless, the importance of Pillar II goes beyond mere ETR considerations. Particularly in auction processes, Pillar II (and the additional complexity it introduces) can also tilt the playing field in favor of certain types of bidders. For example, private equity funds may gain an advantage over strategic buyers (such as industrial conglomerates) in certain cases as the portfolio investments of such funds are typically not subject to consolidation for purposes of the EUR 750 million revenue threshold.