Re-born in the USA: Will the OECD tax plans now be made in America?

16 April 2021

A number of documents from the US have been circulating that set out the US’s ambitions for its domestic tax system and the wider international tax system.

These documents include the Treasury’s Made in America Tax Plan (a 19 page document that accompanies the American Jobs Plan aimed at increasing investment in infrastructure, the production of clean energy, the care economy, amongst other priorities); a presentation by the US to the Steering Group of the OECD/G20 Inclusive Framework (a 21 page slide deck prepared by the US government for the most recent OECD/G20 meeting to discuss the tax challenges arising from the digitalisation of the economy); and the Senate’s Overhauling International Taxation (a 9 page contribution that sets out the Democratic vision for a revised international tax system).

These documents are an important development. They not only reassert the US’s role in the OECD tax plans for multinational enterprises (MNEs), but they shed some light on where the negotiations might be heading. By way of reminder, the broad aim of the OECD’s latest plans for the taxation of MNEs are set out in their “Two Pillar” approach (the detail of which can be found in our report). Based on the latest OECD blueprints (published in October 2020) the Pillar One objective was to update an analogue tax system to deal with the realities of the digital world, but it cast its net wider than the tech giants by including consumer facing businesses in proposals to allocate new taxing rights to market jurisdictions. Pillar Two, by contrast, had less to do with digitalisation and more to do with multinational enterprises obtaining unintended advantages in respect of their overall tax rate through the structuring of their intragroup transactions. The aim of Pillar Two was to insert a floor on international tax competition and forestall a race to the bottom with the introduction of a global minimum effective tax rate.

These recent interventions (summarised in the breakout boxes below) by the US highlight a shift in US tax policy, that increases corporate tax revenues to boost post-Covid investment in the US and secures the US tax base. The result is US support for the global minimum tax proposals in Pillar Two to ensure that the increased US tax rates are not undermined by a race to the bottom on tax rates in other jurisdictions. The Biden administration clearly sees the price of international agreement to a minimum corporate tax rate as conceding limited limited increased taxation by others (principally the EU) of US MNEs selling in their jurisdictions. Until this point the US had opposed the Pillar One proposals as they appeared to disproportionately impact US multinationals, however, the US has tried to limit the reach of the proposals by removing the bias towards tech and consumer facing businesses and seeking to abolish the multitude of DSTs.

The US proposals could substantially change the scope of the OECD Pillars. Assuming that the US is successful in negotiating these changes, there are five key implications for how the international tax system may evolve.

1. Pillar One no longer targets tech and consumer businesses

New taxing rights allocated to market jurisdictions under Pillar One proposals may no longer be focussed only on automated digital service (ADS) providers and consumer facing businesses (CFBs). Instead a more comprehensive scope is being proposed by the US based on revenue and profit margin rather than targeting specific sectors. This should offer a material simplification as disputes arising from a qualitative activity test was a major concern with the original proposals. The list of ADS activities went further than the obvious digital activities like online advertising services, online search engines, social media platforms, and captured, for example, manufacturers of internet-connected products. Furthermore, bringing CFBs within the scope of Pillar One meant that many traditional businesses that have been disrupted to a lesser degree by digitalisation were caught because they engaged with customers in a “meaningful way” which may have resulted in them “substantially improving” the value of their products and increasing sales. The question of scope has been at the top of the political agenda and while the US proposals are vastly simplified, they may not reduce tensions as some jurisdictions may find their largest companies are now in scope. A further significant point of negotiations will be whether the US can persuade other territories to abandon their DSTs. The US calls for the proliferation of DSTs (that predominantly target US tech businesses) to be rolled-back to re-stabilise the international tax system, as absent of this it does not see how Pillar One or Pillar Two will be successful. This could be seen as a veiled threat to walk away from the negotiating table if the US proposals are not adopted. 

2. Largest 100 businesses now in the spotlight for Pillar One market-jurisdiction tax

Under the US proposals the scope of Pillar One should only target the largest 100 MNEs. They are seeking quantitative criteria to bring in scope only the largest and most profitable MNE groups, regardless of industry classification or business model. This presents a significant narrowing of the OECD rules that had sought to target some 2,300 businesses. The proposed quantitative screening criteria would be based on revenue with a secondary profit margin test to capture the businesses that are most profitable, and likely to be intangibly driven and have most potential for profit shifting. No doubt this will become a major boundary issue with significant cost and compliance obligations for businesses if the tests are breached.

3. Previously excluded financial services may become in scope for Pillar One

A number of specific sector exemptions were identified in Pillar One focussed on natural resources, certain financial services, construction, sale and leasing of property and international air and shipping businesses. Despite some of these sector’s digital functionality they were distinguished from ADS businesses given the level of deemed human intervention/judgment required or simply because the policy rationale did not extend to them. Under the US proposal these exemptions would no longer be relevant. A quick look at some of the largest global businesses by revenue indicate they tend to be in energy, financial services, and the motor industry. The addition of the profit margin test may leave financial services more exposed than the others and somewhat surprised that it is suddenly within scope of Pillar One.

4. Pillar Two global minimum tax unaffected by Pillar One’s narrowing of scope

A key point to note is that while the US proposals seek to shift the Pillar One proposals away from US companies to just the largest 100 companies, the scope of Pillar Two proposals remains unchanged. There has always been broader international agreement on the scope of Pillar Two rules to introduce a global minimum tax. As the proposals stand, the CbCR threshold has been suggested which would mean MNE groups that have a consolidated revenue threshold of €750m or more would be caught – some 2,300 businesses. Pillar Two seeks to introduce a top up tax (akin to CFC rules) or deny deductions or treaty benefits if the profits or certain payments are not subject to a globally agreed minimum tax rate.

5. US signals global minimum tax of 21%

The big political question surrounding Pillar Two’s global minimum tax has been what an appropriate effective rate of tax is. The Pillar Two blueprint uses proxies in some of its examples that some have taken to suggest a rate between 10%-12% for the income inclusion top-up tax and undertaxed payment rule, and 7.5% for the subject to tax rule. Under the US proposals, the 21% default rate trigger for its SHIELD proposal could be taken as meaning what the US thinks is an acceptable minimum tax rate. For some territories that use a low corporation tax rate to encourage business to invest in their jurisdiction, a global minimum rate as high as 21% will erode any sense of their sovereignty over rates. For others, the ability to impose a top-up tax to a rate of 21% will close any remaining perceived profit shifting activity and present a new revenue stream. The FT reports that Europe’s low-tax nations have welcomed the measures, but much depends on the detail and the rate has been conspicuously parked as a point of discussion so far. Meanwhile with the UK is set to increase its corporation tax rate to 25% in 2023, we might expect the UK to fall in behind the US to support these proposals.

The OECD has said a political agreement will be reached by mid-2021 when it will deliver a global consensus-based solution to the July G20 finance ministers’ meeting. With the US back at the table proposing some serious changes to Pillar One to focus on the largest 100 MNEs yet indicating its willingness to introduce a higher than anticipated global minimum tax rate, it will no doubt create equal amounts of pleasure and displeasure amongst the Inclusive Framework members. The political tensions that existed before will still be there, they may just be different now.

Key changes

US domestic tax
  • Increase the US corporate income tax rate to 28% from 21%
  • A series of reforms to Global Intangible Low-Taxed Income (GILTI) by increasing the GILTI minimum tax to 21%; ending the tax exemption for the first 10% return on foreign assets; calculating the GILTI minimum tax on a per-country basis
  • Replace the base erosion and anti-abuse tax (BEAT) with the SHIELD (Stopping Harmful Inversions and Ending Low-tax Developments), to deny multinational corporations US tax deductions by reference to payments made to related parties that are subject to a low effective rate of tax. The low effective rate of tax would be defined by reference to the rate agreed upon in the multilateral agreement, and in absence of that agreement the rate would be 21%
  • Introduction of a minimum tax on firms with large discrepancies between income reported to shareholders and that reported to the IRS at a rate of 15% minimum
Pillar One
  • The US will not accept any result that is discriminatory towards US firms
  • Pillar One should focus on the largest and most profitable MNE groups, regardless of industry classification or business model and not only target ADS and CFB
  • Due to the complexity of the measures proposed, the US suggests that Pillar One proposals are limited to the largest 100 MNEs based on revenues and profit margins as these are companies who have most benefited from global markets, are most intangibles-driven, and are equipped to handle the compliance burden that Pillar One entails
  • The US will be flexible on the nexus rules (that give a new taxing right to “market jurisdictions” in which an MNE engages in an active and sustained way, irrespective of physical presence) to ensure that Pillar One benefits developing countries
  • A binding, non-optional dispute prevention and resolution process is seen as a key aspect of meaningful tax certainty
Pillar Two
  • A commitment to end the race to the bottom and to work robustly on architecture of a global minimum tax through Pillar Two
  • A global agreement for the undertaxed payment rule that implements a minimum tax rule worldwide to deny of deductions on related party payments to foreign corporations residing in a regime that has not implemented a strong minimum tax (like the US SHIELD measure) is being sought
  • Pillar Two will only be possible if there is a “standstill and rollback” of proliferation of unilateral digital tax measures and equitable allocation of taxing rights under Pillar One