Will The EU Go It Alone?

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Small flags of European Union on a blurry background of the city.


Sometimes you read something in Tax Notes that causes you to stop and do a double take. The people who write for the publication are not immune from this phenomenon.

The latest occurrence came as I read Elodie Lamer’s recent article on Hungary’s refusal to support the EU’s pillar 2 directive. An interesting nugget was contained in the text, relating to the continuing efforts of the French EU Council presidency to persuade reluctant member states to support the directive.

It took two things to convince Poland to drop its veto. First, the European Commission finally approved Poland’s economic recovery plan, which had been held up because of rule of law concerns. The Netherlands hasn’t let go of the issue but agreed to abstain from the vote, allowing the plan to get the go-ahead.

Second, French officials extended a compromise regarding the fate of pillar 1, reflected by the new article 55a of the draft directive.

Poland, as you may recall, desired a binding linkage between the two pillars. This was motivated by a worry that pillar 1 might not happen because of a lack of interest on the part of specific countries — such as the United States. Poland feared that being legally bound to pillar 2, in the absence of pillar 1, would leave it in a bad place.

This orientation portrays pillar 1 as the prize and pillar 2 as less appealing baggage. To a country like Poland, ending the race to the bottom isn’t such a compelling motivation. It’s that race which works to Poland’s advantage by attracting foreign direct investment. Pillar 1 gets it a marginal gain in taxing rights with little or no fiscal sacrifice.

Poland dropped its veto only for Hungary to take its place and raise the same objections.

Hungary likewise wants the commission to approve its recovery plan. It also seeks a binding linkage between the two pillars, for the same reason as Poland. A global minimum tax, taken in isolation, does nothing to advance Hungary’s interests — but it could be worth the trouble if coupled with the additional taxing rights granted by pillar 1.

Throughout these negotiations, French Finance Minister Bruno Le Maire has been clear on why pillar 1 and the EU directive should not be linked.

French Economy and Finance Minister Bruno Le Maire looks on during a welcoming ceremony for the … [+] newly appointed Ministers following a cabinet reshuffle at the Economy Ministry in Paris on July 4, 2022 – French President reshuffled his government in search of a fresh start for his second term, dogged by his failure to win a parliamentary majority last month. (Photo by Eric PIERMONT / AFP) (Photo by ERIC PIERMONT/AFP via Getty Images)

AFP via Getty Images

Pillar 1 will require another multilateral instrument involving non-EU countries and formal revisions to bilateral treaty obligations. It would undermine EU sovereignty through the legal effect that the directive would be swayed by whether lawmakers in other countries (outside the EU bloc) sign and implement the MLI.

Enter article 55a.

As we read the description, made available by Lamer’s reporting, it appears the EU has a contingency plan to move ahead on pillar 1 on its own if the measure fails at the international level.

Consider the following:

This new article 55a, seen by Tax Notes, says that by June 2023, the commission will have to submit “a report to the council assessing the situation regarding the implementation of [pillar 1] . . . and, if appropriate, submit a legislative proposal to address these challenges in the absence of the implementation of the [pillar 1] solution.”

Those tax challenges are ones “arising from the digitalization of the economy,” a new recital introduced in the directive says. This new recital 21b says the council should assess the situation regarding pillar 1 implementation before the end of each semester starting July 1.

How is that a compromise? It respects Le Maire’s observation about EU sovereignty by narrowing the potential interference from non-EU countries. If you can’t bind the EU’s pillar 2 directive to outside nations’ adoption of pillar 1, you could bind it to EU adoption of pillar 1.

Let’s assume the U.S. Congress does not become enamored with pillar 1 between now and June 2023. In accordance with article 55a, the commission would be obliged to report to the council on the status (failure) of pillar 1 at the international level.

A proposed EU directive on pillar 1 would then follow. That trajectory puts us a year away from the EU taking a stab at pillar 1 via self-help.

It’s possible (and perhaps likely) that such a proposed directive would fail to gain unanimous support from the council. There’s a known history of similar tax harmonization efforts not working out. Nothing in article 55a guarantees that an intra-EU version of pillar 1 wouldn’t meet the same fate as the common consolidated corporate tax base initiative.

It may be that the commission is resigned to that result. Article 55a would have still served a valuable purpose by greasing the wheels for adoption of the pillar 2 directive — which is the real objective here. A more perplexing possibility, however, is what happens if a pillar 1 directive succeeds.

For years, we’ve been hearing OECD officials explain how the pillar 1 reforms require global participation — which makes sense when you consider the chosen methods for assigning new taxing rights. What’s the purposes, then, of attempting a regional version of pillar 1, mandated by an EU directive and limited in reach to EU member states?

As readers will recall, these nations host only a smattering of in-scope multinationals. The whole point of pillar 1 is to respond to the challenges of the digital economy, and you can’t realistically do that through a regional assortment of participants that omits U.S. tech giants.

Three questions come to mind.

Question #1

Will the insertion of article 55a in the pillar 2 directive be sufficient to get Hungary to drop its veto? It could be, if the commission approves Hungary’s recovery plan. It worked for Poland.

This could be a positive development for those hoping to see the United States act on pillar 2. I’ve previously written on the desirability of a timing trigger.

Knowing that the EU has committed to pillar 2 via a binding directive is the next best thing. Functionally, it’s the same thing as a timing trigger. U.S. officials would be aware of the directive’s effective date and could adjust any U.S. legislation as needed to avoid being the first actor.

Question #2

A year from now, when confronted with a draft directive on pillar 1, would the EU member states go along with it? Or would the measure face perpetual veto threats along the lines of the CCCTB?

There’s reason to think a pillar 1 directive would have an easier go of it. The uncurable deficiency of the CCCTB was that it created winners and losers within the EU ranks. Pillar 1 doesn’t do that, at least not to the same degree as the CCCTB. That’s because there are so few in-scope taxpayers hosted by EU member states.

Question #3

Does it make any kind of sense for a project as far-reaching and multifaceted as pillar 1 to be implemented by a regional grouping of 27 like-minded nations, acting on a stand-alone basis? Or does pillar 1, by its fundamental nature, need to be implemented by a broader collection of countries to function as intended?

A related element is what to do with digital services taxes in the event an intra-EU pillar 1 takes form next June. EU governments have promised to stand-down their DSTs, for now, to give the OECD an opportunity to make pillar 1 work at the international level.

The premise of an EU pillar 1 directive, however, is that those efforts would have fallen short. It follows that DSTs, at least those implemented by EU member states, would be revived and aimed at countries that balked at pillar 1 — which is to say everywhere outside of the EU.

Polish flag with Hungarian flag on a tree stump isolated


Instinct also tells me that an EU directive on pillar 1 could be viewed from an entirely different perspective. It translates to an institutional power grab.

Would the commission, through the act of drafting EU primary law, essentially be dictating the details of the next MLI? This would be a further manifestation of the so-called Brussels effect, in which regulatory decisions made at the EU level are strategically intended to spill over to the rest of the world.

Once an EU directive on pillar 1 is up and running, how is the text of that thing not the boilerplate for subsequent expansion of the concept? Outside the EU bloc, any nation wishing to implement pillar 1 (for example, China or India) might simply be asked to sign on to the terms that Brussels has already developed.

If a subsidiary purpose of this endeavor is to export local tax burdens on to nonresidents (U.S. tech firms), why wouldn’t the interests of India and China conveniently align with those of EU governments? They wouldn’t be poaching the residual profits of each other’s national champions.

With the Brussels effect in full bloom, a pillar 1 directive (to be unveiled in June 2023) wouldn’t so much compete with an OECD-brokered MLI as it would subsume the MLI. The public consultations of the inclusive framework could be absorbed into the less transparent deliberations of the commission and the council. The latter displaces the former.

Would the OECD, itself, object to an EU directive on pillar 1 — or to how article 55a binds the fate of pillar 2 to pillar 1? At this point, it’s hard to imagine the OECD objecting to anything that moves the pillars forward, as these directives would do.

From the very outset, the root energy of the base erosion and profit-shifting project was driven by European desires. Ditto for the inclusive framework and the two-pillar solution, which sprang from the unsatisfactory resolution of BEPS action 1 on the digital economy.

It’s suitable, then, that a set of EU directives would play the decisive role in bringing the two pillar solutions to life.

With the advent of article 55a, Poland and Hungary might have gifted the EU something quite precious: an intractable path forward that could see EU officials as final regulators of how multinational profits are taxed globally.

Nobody wants to be first on pillar 2; but there could be serious advantages to Brussels in being first on pillar 1.