EU law: 'Global anti-base erosion rules', only an apparent infringement

The EU Directive 2022/2523 (the “Directive”) transposes in the European context the so-called 'Global anti-base erosion rule's (GloBE rules or “Pillar 2”) developed within the OECD (Organization for Economic Cooperation and Development).

As known, Pillar 2 provides, within a multinational group, for group companies with an effective taxation level of less than 15%, a compensatory taxation system in the hands of the parent (so-called Income Inclusion Rule or IIR), as long as it necessary to reach the aforementioned 15% threshold. Pillar 2 applies, with some exclusions, with reference to groups with a consolidated turnover of at least 750 million euros.

Not all the income of the foreign subsidiary is affected by the discipline in question. Pillar 2 applies, in fact, only to the share of income that exceeds a certain threshold. Such threshold is calculated by applying a certain percentage share to certain balance sheet values (personnel costs and intangible assets). This carve out is referred to as 'Substance-based Income Exclusion' or 'SBIE'. The ratio of SBIE is to apply the Pillar 2 model only with reference to the income artificially transferred to a low-tax jurisdiction ('LTJ'). Instead, the SBIE does not affect the right of the LTJ to tax the effective business activities carried out in its territory.

It is appropriate to make certain considerations regarding the compatibility of the Pillar 2 with European Union law

As outlined by both Italian and international scholars, Pillar 2 would operate somehow similarly to the CFC (Controlled Foreign Company) regulations implemented in most European countries. 

The Court of Justice of the European Union, in its landmark case Cadbury Schweppes (12 September 2006, Case C-196/04) clarified that, in principle, the CFC regime represents a restriction of the freedom of establishment by Articles 43 and 48 of the EC Treaty. Such restriction can be justified only in relation to wholly artificial arrangements.

In other words, CFC regulations can not be challenged under EU law as long as the foreign entity carries out an effective business activity.
Based on above, the question arises as to whether or not Pillar 2 conflicts with the principle of freedom of establishment as enucleates by the Court of Justice of the European Union (CJEU).

Pillar 2, as seen, provides for the application in the hands of the parent company of a “top up tax” on the income generated by the subsidiary, provided that the latter was not subject to an adequate taxation.  

De facto, similarly to CFC regulations, Pillar 2 provides for the taxation of the income of foreign subsidiaries, in the hands of the parent company, regardless of distribution.

Moreover, such top up tax applies notwithstanding the fact that the subsidiary carries out or not an effective business activity. 

Based on above, Pillar 2 regulation could trigger a violation of the freedom of establishment, on the basis of the principles formulated by ECJ with reference to CFC regulations. 

Moreover, such infringement can not be avoided because of SBIE. In other words, SBIE is not consistent with the Cadbury Schweppes principles. 

Indeed, SBIE provides for a carve out of the income taxed under Pillar 2, in proportion to certain assets owned by subsidiary. SBIE does not prevent the parent company State from taxing the income exceeding the SBIE (unless the State of the source itself chooses to levy by itsself the top up tax). 

For example, an IP company with a limited structure, consistent with its business activity, should not be subject to the CFC discipline, for the entire amount of its income. The same IP company, on the other hand, as for the income exceeding the SBIE, could be subject to Pillar 2 in the hands  of the parent company. 
However, if you look more closely, the incompatibility between Pillar 2 and EU law is only apparent.

Indeed, the Directive, probably taking into account the aforementioned potential violation of EU law, provided for the application of Pillar 2 also with reference to “national' groups. In other words, Pillar 2 applies also in the case in which the parent company and the subsidiary are located in the same member State. By turning Pillar 2 into a rule that also applies with reference to purely “domestic” cases, the Directive ruled out any discrimination.