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 $125 billion in profits); Pillar Two introduces the global minimum tax (increasing tax revenues by an estimated $150 billion, globally).
Delays in implementation and disagreement on the policy details have pushed the timeline for a final text of a multilateral treaty on Pillar One to mid-2023 and implementations of Pillar Two to 2024 at the earliest.
Pillar One 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.
Recent draft rules outline 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 draft rules also allow companies to use macroeconomic data on consumer spending to allocate their taxable profits.
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.
Pillar Two 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 allowanceA capital allowance is the amount of capital investment costs, or money directed towards a company’s long-term growth, a business can deduct each year from its revenue via depreciation. These are also sometimes referred to as depreciation allowances. s. 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. 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 ruleInternational tax rules apply to income companies earn from their overseas operations and sales. Tax treaties between countries determine which country collects tax revenue, and anti-avoidance rules are put in place to limit gaps companies use to minimize their global tax burden. s. The outline specifically states that digital services taxes and similar policies will need to be removed as part of Pillar One. The U.S. Trade Representative has negotiated with some countries that have digital services taxes to ensure a smooth transition. Countries would have to write new laws, adopt new tax treaty language, and repeal policies that conflict with the new rules.
After months of negotiations, the European Union (EU) has unanimously agreed to implement Pillar Two. The EU Directive will need to be imposed into each country’s national law by the end of 2023. 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.
As of 30 May 2023, 11 countries globally have either introduced draft legislation or adopted final legislation transposing Pillar Two’s model rules into their national laws. Additionally, a Swiss referendum is set for 18 June to give the country’s consent to implement the rules.
So far, 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 for the new rules.
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 EU adoption dramatically impacts 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 creditA tax credit is a provision that reduces a taxpayer’s final tax bill, dollar-for-dollar. A tax credit differs from deductions and exemptions, which reduce taxable income, rather than the taxpayer’s tax bill directly. s 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. Now that the EU has moved, many companies will be preparing to comply with the policy in 2024. If Pillar One implementation fails, a return to a world of distortive European digital services taxes and retaliatory American tariffTariffs are taxes imposed by one country on goods or services imported from another country. Tariffs are trade barriers that raise prices and reduce available quantities of goods and services for U.S. businesses and consumers. s could be on the horizon.
Note: This post was originally published on July 1, 2021 but was updated on June 13, 2023 to reflect the latest details on the global tax agreement.
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