Editor’s note: This article was written prior to the OECD’s new administrative guidance on Pillar Two, released June 17.
This article examines two central points for multinational enterprises as they grapple with the complexities and novelties of Pillar Two. We first address nuanced interpretations of various points of guidance and how they interact within the European Union. Second, we address issues to consider during mergers and acquisitions (M&As).
Part 1: Some EU Aspects Related to Pillar Two
Besides the disputes that inevitably will arise due to the complexity of the Pillar Two rules and from various interpretations of the rules that legislators and local tax authorities will make, we expect certain specific disputes will arise in the European Union context. One likely issue stems from the possible late transposition of the rules, and another relates to the difficulties created by the numerous sources of the rules.
Potential Issues Related to Late Transposition of Pillar Two Legislation Within the EU
In constructing Pillar Two, several EU member states, among them France and Germany, repeatedly supported a global minimum level of taxation. Before the release of the global anti-base erosion (GloBE) rules on December 14, 2021, the Council of the European Union reiterated its firm support of the global minimum tax reform and committed to implementing that reform swiftly by means of the EU directive. The EU directive was one of the first pieces of law implementing Pillar Two. “Council Directive (EU) 2022/2523 of December 14, 2022, on Ensuring a Global Minimum Level of Taxation for Multinational Enterprise Groups and Large-Scale Domestic Groups in the Union” (hereinafter the Pillar Two Directive) was adopted exactly a year after the release of the GloBE rules.
As is always the case for EU directives, the Pillar Two Directive had to be transposed—incorporated—into the domestic laws of the European Union’s member states. The deadline for transposition was set for December 31, 2023, except for those EU member states in which no more than twelve ultimate parent entities of groups were within scope. Those member states could elect not to apply the income inclusion rule (IIR) and the undertaxed payments rule (UTPR) for six consecutive fiscal years.
As of this writing, of the twenty-seven EU member states:
- seventeen transposed the Pillar Two Directive into domestic law before December 31, 2023;
- five have opted for delayed transpositions: Estonia, Latvia, Lithuania, Malta, and Slovakia;1 and
- five are late in transposing: Greece, Spain, Cyprus, Poland, and Portugal.
On January 25, 2024, the EU Commission started infringement procedures against Cyprus, Estonia, Greece, Latvia, Lithuania, Malta, Poland, Portugal, and Spain, after they missed the December 31, 2023, deadline to (fully or partially) transpose the Pillar Two Directive into their national laws.2
These late transpositions may raise uncertainty for taxpayers, since the question of retroactivity could become a matter of controversy. In the event that these transpositions occur in the 2024 calendar year, questions remain as to whether the Pillar Two provisions would still apply to fiscal years beginning after December 31, 2023, or only to fiscal years beginning after the transposition date.
The response varies depending on the relevant national laws. In Spain, for example, recent legislation was enacted retroactively, as shown below, but that likelihood is less clear in countries like Poland, where retroactive legislation is very unusual.
In Spain, considering that the tax accrual date is the last day of the fiscal year, it is expected that Pillar Two will apply to those taxpayers whose fiscal years end after the publication of the transposition act. For example, if the transposition bill is finally enacted on December 15, 2024, Pillar Two would affect taxpayers whose fiscal year matches the calendar year, since the provisions would have been enacted before the end of the fiscal year ending on December 31, 2024.3 Although such a late transposition is unlikely, the answer would differ if the transposition were to occur in 2025, given that Spanish rules do not permit retroactivity to a closed fiscal year.
Taxpayers must follow the implementations closely to ensure they pay the right amount of top-up tax to the right jurisdiction and to comply with complex reporting obligations, noncompliance with which can lead to hefty fines.
Issues Possibly Related to Multi-layered Sources of Pillar Two Rules
Another element that could lead to controversy in the European Union relates to the articulation between 1) several Organisation for Economic Co-operation and Development (OECD) publications, specifically the 2021 GloBE rules, the 2021 commentary to the GloBE rules, the 2022 safe harbors and penalty relief rules, and various agreed administrative guidance both published in 2023 and yet to be published, 2) the EU Pillar Two Directive, and 3) domestic laws transposing the Pillar Two Directive.
The Pillar Two Directive incorporates the contents of the OECD publications published prior to its adoption on December 14, 2022. The recitals of the Pillar Two Directive directly refer to the existing OECD publications at the time of the Directive’s adoption: “[The Pillar Two Directive] closely follows the content and structure of the OECD Model Rules” (Recital 6). Furthermore, it seems that the Pillar Two Directive also refers to guidance the OECD has not yet released:
“[f]urther guidance to be developed in the OECD’s GloBE Implementation Framework will be a useful source of illustration” in Recital 22; and, in Recital 24, as follows:
[I]n implementing this Directive, Member States should use the OECD Model Rules and the explanations and examples in the Tax Challenges Arising from the Digitalisation of the Economy—Commentary to the Global Anti-Base Erosion Model Rules (Pillar Two) released by the OECD/G20 Inclusive Framework on BEPS, as well as the GloBE Implementation Framework, including its safe harbour rules, as a source of illustration or interpretation in order to ensure consistency in application across Member States to the extent that those sources are consistent with this Directive and Union law.
Additionally, the Council of the European Union recently recognized “the need to ensure consistency with the [OECD Model Rules] when applying the Pillar Two Directive by Member States in order to avoid non-alignment or applicability of diverging standards.”4 The Council of the European Union indicated that it:
[r]ecalls that the recitals of the Pillar Two Directive refer to the use of the guidance developed by the Inclusive Framework as a source of illustration or interpretation, and notes the intention of the EU Member States to follow this guidance when transposing the Pillar Two Directive into their national law in order to avoid divergences and inconsistencies in interpretation of the provisions of that Directive.
However, the legal force of the recitals of the Pillar Two Directive is open to question, given that it is settled case law (at the European level) that if a recital “may cast light on the interpretation to be given to a legal rule, [it] cannot, since it has no binding legal force of its own, constitute (…) a rule.”5 The EU Court of Justice (CJEU) concluded on this point that:
[t]he preamble to an EU act has no binding legal force and cannot be validly relied on either as a ground for derogating from the actual provisions of the act in question or for interpreting those provisions in a manner clearly contrary to their wording.6
Since EU member states must transpose the Pillar Two Directive into their domestic laws, a question arises concerning the hierarchy of standards if an EU member state—relying on the Pillar Two Directive recitals—decides to incorporate the OECD guidance and commentaries published after the Pillar Two Directive into its domestic law, which would go beyond the rules the Pillar Two Directive provides for. For instance, the preparatory work of the French Finance Bill for 2024, adopted on December 29, 2023, which transposed the Pillar Two Directive into French law, stated that the bill’s purpose was to
[t]ranspose [the Pillar Two Directive] in the light, where appropriate, of the comments and administrative guidance adopted by the OECD/G20 Inclusive Framework, including after the [Pillar Two Directive]’s publication.7
Since EU member states’ domestic laws must comply with both primary and secondary EU law, taxpayers should contemplate their interest in challenging domestic rules that follow the content of the most recent OECD work on Pillar Two but that might conflict with the Pillar Two Directive.
Without any evolution of CJEU case law, the European Union may wish to amend the Pillar Two Directive and prevent such controversies by making the Pillar Two Directive consistent with evolving OECD work, thus enabling EU member states’ legislation to remain both “qualified” with regard to the OECD Pillar Two model rules and compliant with EU rules.
A second question arises as to whether domestic courts and tax authorities could use the OECD Pillar Two model rules, which were issued subsequent to the adoption of the Pillar Two Directive, in interpreting domestic law. As mentioned above, various recitals of the Pillar Two Directive refer to the work of the OECD, denoting that “the intention of the legislator” cannot be invoked against the letter of the Pillar Two Directive in the current state of EU law. However, domestic courts/tax authorities in EU member states might consider that the rules of dynamic interpretation of the OECD Model Convention also apply to Pillar Two rules. The OECD recommends this method in relation to the Model Convention, as the OECD invited tax authorities to:
[f]ollow the Commentaries on the Articles of the Model Tax Convention, as modified from time to time, when applying and interpreting the provisions of their bilateral tax conventions that are based on these Articles.8
This also includes those applied by certain EU member states. For example, the Netherlands applies this rule,9 whereas France10 and Spain11 do not.
For its part, the CJEU does not rule out using persuasive OECD commentaries to interpret concepts from the OECD Model Convention that are incorporated into a European directive, even if these commentaries are released after the relevant European directive.12 Even in EU member states, where this dynamic approach is possible, it is unclear whether such an approach will comply with EU law. Unlike international tax treaties, which are concluded between two states on the basis of the OECD Model Convention, EU member states’ domestic Pillar Two rules will be based on the Pillar Two Directive, not on the OECD model rules directly. Accordingly, if the transposition into domestic law ensures perfect compliance with the Pillar Two Directive, a dynamic approach could be possible as long as the OECD model rules interpret the Pillar Two Directive. If the OECD model rules evolve and diverge from the Pillar Two Directive, applying this dynamic approach would not appear possible.
Interestingly, another situation might be envisaged in relation to Article 32 of the Pillar Two Directive, which provides for implementing Pillar Two safe harbors. Article 32 states that implementation shall fulfill the conditions of a “qualifying international agreement on Safe Harbours,” defined as:
[a]n international set of rules and conditions which all Member States have consented to and which grants groups in the scope of this Directive the possibility of electing to benefit from one or more Safe Harbours for a jurisdiction.
Accordingly, this provision refers to safe harbors that the OECD would specify and thus might allow for direct application of OECD rules, even if they are issued after the Pillar Two Directive.
Pillar Two creates an environment full of uncertainties for taxpayers, who must navigate a set of complex rules that are further complicated by the addition of rules specific to the European Union. In this context, taxpayers must be careful how they apply the rules, since directly applying the OECD work may put them at risk, while there might be some avenues to challenge some local interpretations.
Part 2: Key Considerations From an M&A Perspective
Historical tax law concerning M&As has mostly produced a set of predictable considerations that taxpayers have had to sort through as they structure their M&A transactions, for example, determining whether the transaction should be structured as an asset or stock sale, analyzing available attributes and any limitations placed on them after acquisition, structuring the transaction to minimize tax leakage, and positioning assets to favorably align with post-acquisition operating models, among other tasks. Pillar Two’s structure and methods for imposing a global minimum tax have implications for how each of these and other M&A considerations are evaluated. In this part of the article, we discuss some expected effects Pillar Two will have at various stages of an M&A transaction.
M&A structures include taxable and nontaxable transactions. The former are typically carried out via sales/purchases of stock or assets, and the latter involve continued equity ownership in the target. For taxable transactions, the main difference between an asset deal and a stock deal from a tax perspective is that, absent a tax election, the buyer in an asset deal typically receives a step up in the basis of the assets, which can lead to increased depreciation or amortization deductions. The seller typically recognizes gain in both types of taxable transactions. However, for Pillar Two purposes, a seller who disposes of equity interests in a stock deal does not recognize GloBE income, unless the seller owns a minority interest in the target. “Pushdown” accounting adjustments are generally not available in a stock deal, and the historical carrying value of assets and liabilities must be used to determine Pillar Two implications post-acquisition. As an exception to this rule, stock acquisitions are treated as asset acquisitions if the target’s jurisdiction treats the transaction as an asset acquisition and taxes the seller based on the gain that would have been imposed in an asset sale. Conversely, a seller of assets recognizes GloBE income on its sale of assets, and the buyer receives a step up in the basis of the purchased assets. To the extent that book amortization and tax amortization rules differ, a potential top-up tax liability may be created in future years. For instance, there are specific GloBE rules that could reduce the benefit of a basis step up, such as the denial of amortization deductions for long-held intangible assets, such as goodwill, that are amortizable for tax purposes but may not be deductible in financial accounting.
If business and legal considerations permit, certain asset deals can be structured in a way that satisfies the definitional requirements of a “GloBE reorganization.” To qualify as a GloBE reorganization, the transaction must meet certain requirements that are typical for what would be needed for tax-free reorganizations in many domestic contexts. For example, assets must be transferred in a nontaxable transaction, the buyer or a related person must issue, in whole or in part, its equity in consideration for the assets, and the buyer’s post-acquisition tax basis in the assets must be the seller’s tax basis in those assets. Since certain jurisdictions allow cross-border, tax-free mergers, GloBE reorganizations could occur in both domestic and cross-border contexts.
Below, we highlight some Pillar Two–related items that should be considered at various stages of an M&A transaction.
Pre-acquisition Considerations
Buyers should carefully think about the impact of a stock acquisition on their Pillar Two status and whether the acquisition of a standalone target corporation or a target group would cause a buyer group that is not currently subject to Pillar Two to exceed the €750 million threshold and therefore bring the buyer group within the scope of Pillar Two after the acquisition.
When analyzing financing options for an acquisition, buyers should consider the Pillar Two implications of the choice of financing instrument or debt strategy, such as the impact on jurisdictional effective tax rates (ETRs), whether the financing structure falls under anti-abuse rules, and whether the financing structure facilitates an efficient reallocation of interest expense and income across jurisdictions.
Due Diligence
The Pillar Two rules provide for “jurisdictional blending,” which requires the results of all consolidated group entities in a particular jurisdiction to be aggregated to determine the ETR in that jurisdiction. Due to jurisdictional blending, if a consolidated group entity has a standalone ETR of under fifteen percent, the group could avoid being subject to the Pillar Two top-up tax in that jurisdiction if the entity’s results are blended with other consolidated group entities located in the same jurisdiction, resulting in a jurisdictional ETR of at least fifteen percent. In performing due diligence on the target corporation, a potential buyer should therefore focus on the target’s standalone Pillar Two ETR to identify potential post-acquisition top-up tax exposure. This may also impact pricing considerations and how much a buyer may be willing to pay for the target corporation. For instance, if a buyer with no operations in a particular jurisdiction contemplates buying a target corporation in that jurisdiction with low-taxed operations, it may wish to pay less due to potential post-acquisition top-up tax exposure. Conversely, a buyer with existing high-tax operations in the same jurisdiction as the target corporation could potentially avoid being subject to top-up tax in relation to a target with low-taxed operations, depending on the results of the jurisdictional blending calculation.
In a carve-out transaction, whereby the seller separates the assets of a business out of a group of entities and either sells the assets directly to the buyer or contributes the assets to another group entity and sells that entity to the buyer, the buyer will need insight into the seller’s tax profile and attributes to analyze the potential Pillar Two impact of the acquired assets or corporation going forward.
Due to Pillar Two’s focus on accounting principles, buyers must be keenly aware of tax accounting adjustments and how they affect the Pillar Two calculation. Examples of adjustments include the carryforward of losses in groups with permanent differences, local tax incentives, foreign exchange differences, and debt for equity swaps.
Given the complexities of Pillar Two and the associated calculations, sellers should expect to provide more information to potential buyers during due diligence than they likely would have in a pre-Pillar Two world. Buyers should also be prepared to perform modeling during due diligence to fully understand the Pillar Two impact of a potential acquisition.
Negotiating the Purchase Agreement
Some jurisdictions have introduced secondary tax liability in their domestic Pillar Two legislation, according to which entities within a group have joint and several liability for the Pillar Two top-up tax due in that jurisdiction. Depending on the particular legislation at issue, secondary tax liability might apply to group entities located outside the jurisdiction where the legislation has been introduced. In the context of an M&A transaction, a buyer should ensure that it will be indemnified for secondary liability if the target is incorporated in a jurisdiction that has introduced legislation providing for secondary liability and is being purchased out of a group that is subject to Pillar Two. This is relevant for a buyer even if it itself is not subject to Pillar Two, as long as the target corporation was part of a group that was. In US deals, a similar concept arises when a buyer purchases a company out of a US federal income tax consolidated group. The US Treasury Regulations provide that each member of a consolidated group is severally liable for the consolidated group’s tax. To prevent a buyer from being liable for any of the consolidated group’s taxes post-acquisition, provisions are often included in the representations and warranties, and indemnification sections, to address this liability.
In a so-called locked box deal, in which the parties agree on the final purchase price based on current financials, without providing for a post-completion adjustment, the seller continues to conduct the target’s operations on behalf of the buyer for the period between the signing date and the closing date. During this period, the target’s financials typically continue to be reported in the seller’s consolidated financial accounts until the closing date. Sellers that are part of a group subject to Pillar Two should consider the possibility that Pillar Two top-up tax may arise between signing and closing and should ensure they will be indemnified for any Pillar Two top-up tax liability that materializes in this period.
Finally, buyers should contemplate whether to require the seller to provide Pillar Two–specific representations, including assurances related to the recognition of deferred tax assets and liabilities, the accuracy of financial statements, and Pillar Two elections made by the seller, among other items.
Conclusion
Although the implementation of Pillar Two is unlikely to generate seismic shifts in the M&A landscape, buyers and sellers should be aware of the novel issues that Pillar Two presents to M&As and prepare to address them during the phases of the M&A life cycle.
Jean-Baptiste Tristram and Mathieu Valeteau are partners in Baker McKenzie’s Paris office. Amir-Kia Waxman and Reza Nader are partners in Baker McKenzie’s New York office.
Endnotes
- European Union, Commission Notice: Election to delay application of the IIR and UTPR under Article 50 of the Pillar Two Directive (C/2023/1536), Official Journal of the European Union, December 12, 2023, https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=OJ:C_202301536.
- European Commission, “Commission Takes Action to Ensure Complete and Timely Transposition of EU Directives,” news release, January 25, 2024, https://ec.europa.eu/commission/presscorner/detail/en/inf_24_286.
- A similar situation occurred with the DAC 7 implementation in Spain.
- Council of the European Union, “Two-Pillar Solution to Address the Tax Challenges Arising From the Digitalisation of the Economy,” November 9, 2023, Council statement 14732/1/23 REV 1—FISC 241—ECOFIN 1095.
- CJEU case C10/18, Mowi ASA, March 4, 2020, point 43.
- CJEU case C10/18, Mowi ASA, March 4, 2020, point 44.
- Draft Finance Bill for 2024, explanatory statement of Article 4 of the Finance Act for 2024.
- Recommendation of the OECD Council concerning the Model Tax Convention on income and on capital.
- The rules of dynamic interpretation were set out in the 2011 Fiscal Treaty Policy Memorandum published by the Dutch Ministry of Finance.
- In France, the OECD commentaries are not considered a source of law and can be used only to the extent they were released only for clarification and interpretation purposes (Supreme Court, December 11, 2020, number 420174, Conversant International Ltd. and opinion of the “advocate general” L. Cytermann).
- Spanish Supreme Court, October 19, 2016, case number 2558/2015; 3-3-2020, case number 5448/2018.
- J. Kokott, Sections 109 to 125 about ECJ 10-6-2020, case number C-245/19, Luxembourg v B.
