- Updated to reflect the latest developments on the agreement.
- Updated to reflect the latest developments on the agreement.
- Updated to include newer details.
In recent years, countries have debated significant changes to international tax rules affecting multinational companies. In October 2021, after negotiations at the Organisation for Economic Co-Operation and Development (OECD), more than 130 member jurisdictions agreed to an outline for new taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. rules.
Large companies would pay more taxes in countries where they have customers and less in countries where they have headquarters, employees, and operations. Additionally, the agreement sets out a global minimum tax of 15 percent, which would increase taxes on companies with earnings in low-tax jurisdictions.
Governments are currently developing implementation plans and turning the agreement into law.
The OECD proposal follows an outline that has been discussed since 2019. There are two “pillars” of the reform: Pillar One changes where large companies pay taxes (impacting roughly $200 billion in profits); Pillar Two introduces the global minimum tax (increasing tax revenues by an estimated $220 billion, globally).
Due to disagreement and delays in implementation, a draft of the multilateral treaty for Pillar One was only recently published in October 2023, and the implementation of Pillar Two will happen in 2024 for the earliest adopters.
OECD Pillar 1 contains “Amount A” which would apply to companies with more than €20 billion in revenues and a profit margin above 10 percent. For those companies, a portion of their profits would be taxed in jurisdictions where they have sales; 25 percent of profits above a 10 percent margin may be taxed. After a review period of seven years, the €20 billion threshold may fall to €10 billion.
Amount A is a limited redistribution of tax revenue from countries where large multinationals operate to countries where they have customers. U.S. companies constitute a large share of these companies.
The U.S. could lose tax revenue because of this approach. However, U.S. Treasury Secretary Janet Yellen has previously written that she believes Amount A would be roughly revenue neutral for the U.S. But for this to be true, the U.S. would need to collect significant revenue from foreign companies or from U.S. companies that sell to U.S. customers from foreign offices. Also, Pillar Two would need to be somewhat ineffective at changing the behavior of U.S. companies to put (or keep) valuable intellectual property in the U.S. rather than placing it offshore.
The proposed multilateral convention outlines where companies will pay taxes under Amount A. The rules include approaches for identifying final consumers even when a company is selling to another business in a long supply chain. The rules also allow companies to use macroeconomic data on gross domestic product to allocate their taxable profits when the location of final customers cannot be identified.
Pillar One also contains “Amount B” which provides a simpler method for companies to calculate the taxes on foreign operations such as marketing and distribution. Amount B is expected to be incorporated in transfer pricing guidelines when a final version has been agreed to.
OECD Pillar 2 is the global minimum tax. It includes three main rules and a fourth for tax treaties. These rules are meant to apply to companies with more than €750 million in revenues. Model rules were released in December 2021.
The first is a Domestic Minimum Tax which countries could use to claim the first right to tax profits currently being taxed below the minimum effective rate of 15 percent.
The second is an Income Inclusion Rule, which determines when the foreign income of a company should be included in the taxable incomeTaxable income is the amount of income subject to tax, after deductions and exemptions. For both individuals and corporations, taxable income differs from—and is less than—gross income. of the parent company. The agreement places the minimum effective tax rate at 15 percent, otherwise additional taxes would be owed in a company’s home jurisdiction.
The income inclusion rule would apply to foreign profits after a deduction of 8 percent of the value of tangible assets (like equipment and facilities) and 10 percent of payroll costs. Those deductions would be reduced to 5 percent each over a 10-year transition period.
Importantly, Pillar Two rules rely primarily on financial (i.e., “book”) accounting data rather than tax accounting data. These book/tax differences mean that the Pillar Two rules account for timing differences by focusing on deferred tax assets which can include net operating losses and capital allowances. However, those deferred tax assets must be valued at the 15 percent minimum tax rate.
Like other rules that tax foreign earnings, the income inclusion rule will increase the tax costs of cross-border investment and impact business decisions on where to hire and invest around the world—including in domestic operations.
The third rule in Pillar Two is the Undertaxed Profits Rule, which would allow a country to increase taxes on a company if another related entity in a different jurisdiction is being taxed below the 15 percent effective rate. If multiple countries are applying a similar top-up tax, the taxable profit is divided based on the location of tangible assets and employees.
Together, the domestic minimum tax, income inclusion rule, and Undertaxed Profits Rule create a minimum tax both on companies investing abroad and foreign companies investing domestically. They are all tied to the minimum effective rate of at least 15 percent and would apply to each jurisdiction in which a company operates.
The fourth Pillar Two rule is the “subject to tax rule,” meant to be used in a tax treaty framework to give countries the ability to tax payments that might otherwise only face a low rate of tax. The tax rate for this rule would be set at 9 percent.
For Pillar One to work, all countries must adopt the rules in the same fashion and override their existing tax treaties. This would avoid companies dealing with different approaches across the globe.
Pillar Two is more optional. The outlined version of Pillar Two is like a template that countries can use to design their rules. If enough countries adopt the rules, then a significant share of corporate profits across the globe would face a 15 percent effective tax rate.
Both Pillar One and Pillar Two represent major changes to international tax rules. Agreement on Pillar One would remove several specified digital services taxes.
In January 2024, the OECD updated its global minimum tax revenue estimates. It is now estimated that the global minimum tax will raise $155-192 billion globally each year, or between 6.5 percent and 8.1 percent of global corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. revenues. Previously, the OECD estimated that the global minimum tax would generate around $220 billion in additional annual global tax revenue.
After months of negotiations, the European Union unanimously agreed to implement Pillar Two. The EU Directive must be imposed into each country’s national law by the end of 2023, but this timeline seems challenging for some countries, such as Portugal and Poland. Companies with an annual turnover of at least €750 million will begin to pay the 15 percent minimum rate starting in 2024. This includes wholly domestic groups that meet the revenue threshold.
Member States with more than 12 in-scope multinational groups must implement the Income Inclusion Rule from 31 December 2023, and the Undertaxed Profits Rule from 31 December 2024. Those Member States with fewer than 12 can elect to defer implementing both rules for six years. According to reports, these include Estonia, Latvia, Lithuania, Malta, and the Slovak Republic.
As of 12 January 2024, 37 countries have either introduced draft legislation or adopted final legislation transposing Pillar Two’s model rules into their national laws. An additional 13 jurisdictions intend to implement Pillar Two, although they have not proposed legislation to do so.
So far, the U.S. Congress has chosen not to implement changes in line with the global tax deal. Though the Biden administration supports the agreement, Congress left those changes out of the 2022 InflationInflation is when the general price of goods and services increases across the economy, reducing the purchasing power of a currency and the value of certain assets. The same paycheck covers less goods, services, and bills. It is sometimes referred to as a “hidden tax,” as it leaves taxpayers less well-off due to higher costs and “bracket creep,” while increasing the government’s spending power. Reduction Act. Furthermore, Chairman of the House Ways and Means CommitteeThe Committee on Ways and Means, more commonly referred to as the House Ways and Means Committee, is one of 29 U.S. House of Representative committees and is the chief tax-writing committee in the U.S. The House Ways and Means Committee has jurisdiction over all bills relating to taxes and other revenue generation, as well as spending programs like Social Security, Medicare, and unemployment insurance, among others. , Representative Jason Smith (R-MO), recently introduced retaliatory legislation that would counter laws adopted by foreign countries applying minimum tax rules to American multinationals.
Tax treaty ratification requires 67 votes in the Senate, making the adoption of Pillar One challenging without broad, bipartisan support in the U.S.
If U.S. policy does not shift, U.S. companies will be caught in a confusing web of minimum taxes including Global Intangible Low-Tax Income (GILTI), the Base Erosion and Anti-Abuse Tax, the new Corporate Alternative Minimum Tax from the Inflation Reduction Act, and likely some portion of the global minimum tax rules. Recent guidance on Pillar Two means that U.S. GILTI would apply after foreign minimum taxes, reducing U.S. tax revenues from that policy.
The structure of the rules means adoption in the 27 EU countries, Japan, Korea, the United Kingdom, and a number of other significant jurisdictions will dramatically impact multinationals across the globe. It also creates pressure for other countries to adopt some version of the rules or make other changes to their tax codes.
The rules clearly incentivize subsidies to businesses to offset some of the increased costs from the minimum tax. This is because standard tax credits are at a disadvantage relative to government grants and refundable credits.
The agreement represents a major change for tax competition, and many countries will be rethinking their tax policies for multinationals. If Pillar One implementation fails, a return to a world of distortive European digital services taxes and retaliatory American tariffs could be on the horizon.
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