In broad strokes, the directive follows the rules of the Inclusive Framework Agreement initiated by OECD/G20, to which 137 countries including Estonia have acceded. As the OECD rules are not necessarily aligned with EU law, the directive ensures common rules in the European Union when it comes to applying minimum tax and compliance with European Union law.
Who is affected?
The minimum tax pertains to groups of companies whose consolidated revenue exceeds 750 million euros a year in at least two of the last four years. For the directive to apply, at least one of the group’s entities must be located in the European Union. The minimum tax will not apply to the shipping sector, pension and investment funds, government institutions, international organizations and non-profit organizations.
As an exception, subsidiaries are exempt from the minimum tax obligation if their average revenue in the last three years in a single jurisdiction is not more than 10 million euros and profit does not exceed 1 million euros a year. Thus, the minimum tax regulation is expected to affect fewer than 200 companies in Estonia.
Unlike the OECD agreement, the directive is obligatory and also encompasses domestic groups (groups within a single country).
In general, the parent company would apply the minimum tax, but the directive gives member states the possibility of taxing profit earned by subsidiaries located in these countries at the minimum tax rate. In such a case, the parent company could deduct the minimum tax paid in the subsidiary’s country from its own resident country minimum tax.
How is the minimum tax calculated?
Calculation of minimum tax follows the GloBE rules (based on the OECD agreement) and the first step to determining the tax amount payable is to find the effective tax rate.
If the effective tax rate of entities in one jurisdiction is less than 15%, the top-up tax must be paid to bring the rate to 15%.
For example, if an Estonian subsidiary has a profit of 2 million euros, of which half is distributed, the Estonian subsidiary’s effective income tax rate is 12.5% (250,000 divided by 2,000,000). This is under the minimum tax rate and so an additional 2.5% is due.
The top-up tax payable is calculated based on the “excess” profit, which is means that 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 (substance carve-out).
Both income tax assessed on losses (with a minus sign) and actually paid income tax can be taken into account.
When does the minimum tax have to be declared and paid?
The first minimum tax declaration must be filed 18 months after the end of the financial year, and subsequently, 15 months after the end of the financial year.
For Estonia and other countries where tax is due on profits only upon distribution, the obligation of paying tax can be deferred for up to four years (the four-year exception). If the exception is invoked, the minimum tax must be calculated and declared each year, and if the tax is not paid during the four years, the minimum tax must be paid in the parent company’s country.
When might the new rules enter into force?
The directive has a planned entry into force date on 1 January 2023, but it is unlikely that all countries will be able to or desire to adopt it that quickly. For example, it is not technically possible in Estonia.
The directive must be supported by all member states but currently Estonia holds the position that the minimum tax must be applied in conjunction with the digital services tax, as agreed in October 2021 in the OECD’s Pillar Two model, and furthermore, member states must retain the right to make their own decisions on whether to establish the tax at the national level. Poland and Hungary are likewise in no hurry to impose a minimum tax, as long as the European Commission has not introduced a digital services tax draft legislation.
The draft minimum tax directive can be viewed here.