Let’s Talk About Tax

If you have been concerned about how the Organisation for Economic Co-Operation and Development’s (OECD’s) “Pillar 2” proposal would apply to U.S. companies and their foreign affiliates, you are not alone… For years, since the OECD initiated its Base Erosion and Profit Sharing (BEPS) project in 2015, a key issue was how the international community would stop the ubiquitous efforts by multinational companies to allocate material profits to low or no tax jurisdictions, hence reducing their worldwide tax obligations. 

Transfer pricing audits were certainly one tool used by tax authorities. But that approach was lengthy, costly, and analytically capable of widely diverse outcomes depending on which data set (or comparables) were used. It was also frustrating for all parties, as audits of certain triggering years took so long to resolve — especially if litigation was involved — that the intervening years often created different results or data that would cast doubt on the future efficacy of the initial issue’s resolution on later years' transactions. In fact, some tax treaties included shorter resolution processes via arbitration instead of the traditional competent authority processes to speed up treaty-based disputes, especially relating to transfer pricing.

Pillar 2

After much discussion/negotiation, the OECD introduced Pillar 2 which was approved by more than 135 countries in October 2021. This concept required a 15% global minimum tax for large multinational groups. The idea was simple: no matter where one of the affected large groups operated, it would have to pay at least a baseline worldwide tax of at least 15% in the aggregate.  The implementing rules for Pillar 2, formally known as the Global Anti-Base Erosion (GloBE) Model Rules, were designed to implement this minimum global tax through mechanisms like the Income Inclusion Rule (IIR) and the Undertaxed Profits Rule (UTPR).

The US Response

While many countries rushed to implement Pillar 2, the U.S. objected. One argument raised by the U.S. in the early response to the OECD’s proposed worldwide minimum tax was that Global Intangible Low-Taxed Income (GILTI) and Subpart F were already a global minimum tax, so layering Pillar 2 on top of that statutory system could amount to taxing the same income twice. The U.S. also asserted that ceding U.S. taxing jurisdiction to the OECD (and the proposed multilateral implementing treaty) would violate U.S. law — hence requiring further U.S. legislation and significant complexities in implementing revisions to and reconciling our bilateral tax treaties as well as the larger concerns with the OECD implementation process for countries with which the U.S. does not have tax treaties. Further, U.S. multinationals were understandably aghast at the significant compliance and data collection/allocation nightmares, to say nothing about the significant cost increases that they foresaw, if Pillar 2 applied to them. Lastly, of course, there were the undeniable complexities Pillar 2 would impose on country-specific income reporting/allocations, tax calculations and the added impact of the OECD’s “top up” tax requirements, and the materially adverse impact on the U.S. foreign tax credit system.

The Great Compromise 

After months of negotiations (and more than a few tense G7 and OECD meetings), the Great Compromise, a/k/a the “Side-by-Side Arrangement,” was achieved. Under this deal, U.S.-headquartered multinationals are exempt from the IIR and UTPR. Instead, they remain subject only to the U.S. minimum tax rules embodied (now) in the Subpart F rules of Section 951 and the Net CFC Tested Income (NCTI) rules in recently amended Section 951A. In other words, Pillar 2 and the U.S. tax system are now to operate side by side. The arrangement also introduces new safe harbors to simplify compliance, including an Effective Tax Rate (ETR) safe harbor and a substance-based tax incentive safe harbor.

We will need to see more detailed guidance from the U.S. Treasury Department (including the IRS), but at least this U.S. carve-out from Pillar 2 global minimum taxation seems to result in a form of peaceful coexistence rather than mutually assured destruction… 

Stay tuned.