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Analysing Potential Investor-State Treaty Challenges to the OECD’s Pillar Two Model Tax Rules


The Pillar Two Model Rules constitute the second part of an initiative, which refers to the broader effort led by the Organization for Economic Co-operation and Development (OECD) to address the tax challenges arising from the digitalization of the global economy. This initiative, often referred to as the “Base Erosion and Profit Shifting (BEPS) Project” consists of two pillars, with Pillar Two aiming at addressing specific tax challenges arising from the increasing digitalization of the global economy. This initiative began in the early 2010s as a response to the proliferation of unilateral tax measures adopted by various countries, which posed a risk of potential trade disputes.

Pillar Two primarily addresses harmful tax competition such as that arising from States offering extremely low tax rates or tax incentives to attract multinational enterprises (MNEs) and their profits. In this context, the OECD has put forth a set of Model Rules as part of its proposals with the expectation that these rules will be adopted by the 138 OECD member countries that expressed support for Pillar Two in an October 2021 statement and have indicated their intention to incorporate these proposed rules into their domestic tax legislation.

The Model Rules will be applicable to MNEs with an annual revenue of at least €750 million. In cases where an MNE generates income in countries that do not have a domestic minimum tax rate of 15%, Pillar Two includes two interconnected charging provisions. These provisions are designed to encourage a broader adoption of the 15% minimum tax rate across countries and thereby prevent harmful tax competition. While there are concerns regarding the potential effects of Pillar Two legislation on state sovereignty and economic development, its adoption is gaining traction in multiple jurisdictions. This article explores the use of bilateral or multilateral investment treaties (BITs, MITs) as a possible avenue for challenging the Pillar Two legislation and argues that BITs and MITs could enable affected entities, such as MNEs, to seek compensation from the relevant OECD member states for any economic losses resulting from the imposition of the Pillar Two rule.

Navigating the Storm: Assessing Investment Treaty Challenges to the Pillar Two Framework

While considering the possibility of using investment treaty claims to challenge the implementation of Pillar Two, it is essential to recognize that states have the right to regulate in their own public interest, and taxation is a common exercise of their sovereign authority. International investment treaties generally safeguard investors against a state’s illegal actions, such as discriminatory conduct, expropriation, or violations of an investor’s right to Fair and Equitable Treatment (FET). While these protections can pertain to tax measures, it can be challenging to successfully challenge taxation measures through treaty claims, given that taxation is an inherent fiscal power of the state.

Many investment treaties contain specific provisions, often referred to as “carve-outs,” that limit investors’ rights to challenge taxation measures. Some treaties partially restrict such claims, allowing challenges only for certain types of taxes or in cases where taxes are alleged to constitute expropriation. Newer treaties, especially those entered by the European Union in the last decade, have more explicit tax carve-out language, potentially countering investment treaty challenges to Pillar Two.

Despite these limitations, there have been instances of successful tax challenges under existing BITs. Notably, in Yukos v. Russia, where shareholders of the Yukos Oil Company challenged Russia’s adverse actions, including significant tax assessments, under the Energy Charter Treaty’s (ECT) investment protection provisions, the arbitral tribunal ruled in favour of the shareholders, finding that Russia’s measures were not bona fide taxation actions but rather expropriatory and abusive acts disguised as taxation, thereby breaching ECT provisions.

Regarding the Pillar Two Model Rules, there are potential challenges that could be pursued under standard investment treaty provisions. The implementation of the Undertaxed Profits Rule (UTPR) may be susceptible to challenge by MNEs arguing that its imposition violates their investment treaty rights by potentially expropriating their assets or failing to provide Fair and Equitable Treatment, potentially leading to compensation claims against host countries. The UTPR’s imposition of taxation on global income, regardless of its nexus with the host state, might be seen as violating various investment protections. Differences in the interpretation and implementation of taxation under the UTPR could make some measures more vulnerable to challenge than others.

Two key protections found in most BITs that might be relevant for potential challenges are the FET standard, which often includes protection against discrimination, and the concept of expropriation. Additionally, there is an argument to potentially overcome the tax carve-outs present in many BITs, thereby expanding the number of jurisdictions where challenges to the UTPR implementation may be possible. However, any analysis of how the UTPR could violate a state’s investment treaty protections is highly dependent on specific circumstances and the provisions of the relevant treaties in force.

Potential Violations of Fair and Equitable Treatment and Non-Discrimination in the Context of the Pillar Two Framework

One of the most evident ways in which the UTPR may face challenges is by potentially violating the FET standard present in many BITs. The FET standard encompasses various protections, including safeguarding investors’ legitimate expectations, ensuring transparency, reasonableness, and non-arbitrariness, protecting against discrimination, and providing a stable and predictable legal framework. There are three potential avenues through which the UTPR may violate the FET standard, depending on its implementation in individual states.

The UTPR could potentially breach an investor’s legitimate expectations. In general, without specific commitments from the host state, foreign investors do not have the right or legitimate expectation that the tax regime will remain unchanged throughout the investment period. However, some states may offer individual investors assurances about their regulatory, legal, or tax framework to encourage foreign direct investment. Such assurances, whether explicitly or implicitly made, can give rise to “legitimate expectations.” If a state later breaches these assurances, it may be considered a violation of the FET standard under applicable investment treaties. Although instances of specific tax-related assurances are relatively uncommon, companies considering challenges to the UTPR may examine the circumstances of their investment and the commitments made at the time to form the basis for a claim.

Another way in which the UTPR may infringe on the FET standard is by potentially violating the principle of non-discrimination. This principle is protected not only under BITs but also separately under bilateral tax treaties, leading to international law commitments by the state. The adoption and application of the UTPR might result in unequal tax treatment of certain investors, which could potentially clash with these investment treaty protections. The extent of any discriminatory treatment will depend on how the UTPR is implemented in different jurisdictions. For example, if a jurisdiction imposes the UTPR on a MNE with subsidiaries in both Pillar Two and non-Pillar Two jurisdictions, resulting in disparate tax rates for similar entities within the MNE, it may be seen as discriminatory. Investors may argue that such disparate treatment based on the jurisdiction of the MNE’s subsidiaries violates non-discrimination provisions under relevant BITs. It is worth noting that investors claiming discrimination may need to demonstrate that the state’s implementation of the UTPR was arbitrary, grossly unfair, unjust, or idiosyncratic to strengthen their case.

Given the novelty of the Pillar Two regime and the complexity of its tax consequences for individual companies, there may be other claims that resemble violations of the FET standard. For instance, a jurisdiction with a low effective tax rate might choose to protect itself from the impact of Pillar Two by implementing a flexible tax rate. Companies with no members in a Pillar Two jurisdiction could continue enjoying the low tax rate, but those with members in such jurisdictions would pay a higher rate to offset the UTPR. While such measures could be understandable from the perspective of the host state, viewed through the lens of a BIT and its non-discrimination protections, they could raise potential treaty violations. Nonetheless, any assessment of potential violations of investment treaty protections would be fact-specific and dependent on the specific language and provisions of the relevant treaties in force.

Unravelling Indirect Expropriation: Assessing the Implications of Taxation within the Pillar Two Framework

Riffel has argued that a common provision in most BITs is the protection against expropriation, which can occur directly (e.g., when a state nationalizes a foreign-owned interest) or indirectly (e.g., through dispossession and deprivation of use without affecting legal title). The focus of concern regarding the UTPR is on its potential as a measure of indirect expropriation. This means that challenges may arise against taxation measures, including those that are considered indirect expropriation, even when BITs contain carve-outs for tax measures. Tribunals typically assess whether the measure leads to a substantial deprivation of the investment’s value, effectively destroying its worth. Some tribunals set a higher standard, requiring the tax measure to be abusive, arbitrary, or discriminatory. Depending on the circumstances, the UTPR could be seen as a form of indirect expropriation. For example, if the UTPR significantly reduces the value of an investor’s shares, it may give rise to a claim of indirect expropriation.

Examining the Tax “Carve-out” in Bilateral Investment Treaties and its Relevance to the Pillar Two Framework

As mentioned earlier, numerous investment treaties include carve-outs for tax measures, making them less susceptible to challenge under the relevant BIT, particularly in regards to breaches of the FET standard. Despite these carve-outs, some treaties allow claims for expropriation. This limitation might restrict the number of countries where challenges to the UTPR’s implementation can occur if it doesn’t reach the level of expropriation. To be considered a tax, tribunals generally interpret the measure broadly, assessing whether it involves a law imposing liability on classes of persons to pay money to the state for public purposes. However, the determination of whether a particular measure constitutes a tax is evaluated on a case-by-case basis, considering the specific circumstances at hand. Given the UTPR’s potential extreme effects, investors may argue that it isn’t genuinely a tax measure. Instead, they might contend that it represents a departure from fundamental norms of the global tax system, operating independently of the customary principles that define taxation measures. Moreover, the UTPR’s purpose is not merely to ensure proper taxation of entities at the source, but also to coerce states into adopting Pillar Two and increasing taxation levels to the OECD’s required minimum of 15%. Consequently, investors might assert that the UTPR is, in essence, an economic sanction designed to influence the behaviour of other states, irrespective of its impact on the investor. Therefore, there is potential to argue that the UTPR’s implementation should not be classified as a “tax” measure, as defined in investment treaties, and thus does not fall within the measures excluded by any tax “carve-out” provisions in BITs.


The newness of the UTPR and its potential far-reaching consequences may negatively impact investors, leading to direct claims for compensation against the country that incorporates the Pillar Two Model Rules into its domestic legislation. The strength of these claims will heavily rely on various factors, such as the specific circumstances of the affected entity, the language and extent of the relevant investment treaties, and the method of adoption by the state. Thus, a thorough analysis will be necessary. Nevertheless, resorting to investor-state dispute resolution is a crucial remedy in this context, and MNEs that could potentially be affected should carefully assess their treaty options considering the upcoming implementation of Pillar Two.

Rupam Dubey

Rupam Dubey is a B.A.LL.B (hons) student at National Law School of India University Bangalore (NLSIU). He is also a blog editor at Indian Journal of International Economic Law.

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