Unpacking Pillar Two: US implementation

04 May 2022

The Build Back Better Act, the US legislation that would bring its existing minimum tax rules in line with the OECD’s BEPS 2.0 project, has stalled in the Senate, bringing into question the Treasury’s optimism that they can meet their commitment to enact Pillar Two in 2022.

Build Back Better

US law already includes a minimum tax in the form of the GILTI or global intangible low-taxed income rules. GILTI is not currently aligned with the Income Inclusion Rule and is therefore not compliant with Pillar Two. One of the key reasons for this is that GILTI applies on a global basis so that businesses can still engage in profit-shifting as tax rates are blended between high and low tax jurisdictions in which they operate.

The Build Back Better Act (BBBA) includes amendments to GILTI to apply the tax on a country-by-country basis and increase its effective tax rate to 15.8%, bringing it into line with Pillar Two. The progress of BBBA has stalled in the Senate, however, with Republicans unanimously opposed and one Democratic senator, Joe Manchin, holding out his vote while he is unhappy with the scope of the BBBA.

When the model rules for Pillar Two were released on 20 December 2021, the OECD stated that the following commentary would address co-existence with the GILTI rules, perhaps in light of the BBBA having already passed in the House of Representatives a month earlier. However, perhaps unsurprisingly given the lack of legislative movement in the US, the commentary, published on 14 March 2022, was silent on the interaction of GILTI with Pillar Two.

Despite the legislation stalling, the US Treasury claims to be “optimistic that we will meet our commitment to enact Pillar Two in 2022”. Whether or not that will be the case seems to lie in the court of a single Senator, and whether or not he can be persuaded to support the BBBA (in whatever form) in the coming months, and before the upcoming August recess.

Debate over threat to US businesses benefiting from certain tax credits

Turning now to the details of the Pillar Two rules, in a letter to Treasury Secretary Janet Yellen on 16 February 2022, Republican members of the US Senate’s Committee on Finance (SFC) raised concerns that the rules will “harm U.S. businesses and jobs”.

The letter drew particular attention to “growing evidence that the OECD agreement would surrender a share of the US tax base to foreign countries”, specifically by capturing the benefit of US “tax credits and deductions targeted at domestic innovation, investment, and job creation”. This concern deals with the possibility that certain tax credits (those for R&D, low-income housing, new markets, and foreign derived intangible income are mentioned) could result in a US company operating abroad facing top-up taxes in those foreign jurisdictions as they reduce the company’s effective tax rate (ETR). Broadly, if the effect of those incentives is to reduce the US company’s ETR to below 15%, foreign jurisdictions in which it operates may be required to make up the difference under the UTPR.

The SFC members cite the UK as an example of a country that has “negotiated more successfully to protect their domestic tax laws and companies”. As set out in the UK’s consultation document, the UK’s research and development expenditure credit will be treated as an addition to income rather than a reduction in tax in the effective tax rate calculation, and will therefore continue to be effective in promoting R&D activity in the UK. As noted in the consultation document, the treatment of tax credits in the Pillar Two rules depends on whether or not they are “qualified refundable tax credits” (broadly, refundable within four years of the year in which the taxpayer became entitled to the credit). Such qualified credits are treated as income for the GloBE calculations (and therefore increase the denominator of the ETR computation), while non-refundable credits are treated as a repayment of tax (and so excluded from GloBE income and instead reducing the numerator of the ETR computation).

The letter also raised broader concerns of the possibility of “China and other aggressive economic competitors” engaging in a race to zero corporation tax rates being heightened by the introduction of Pillar Two. This refers to an Oxford University Policy Brief that concluded that for countries “to improve their competitive position over competitors they will have to reduce the Corporation Tax liability they impose by more than they would have had to do in the absence of Pillar Two”, owing, the authors argue, to the rules incentivising some countries to use the Qualified Domestic Minimum Top-up Tax in substitution for higher corporation tax rates to remain competitive.

US Treasury Assistant Secretary for Tax Policy Lily Batchelder has countered arguments such as these and described Pillar Two as being “essential to saving the corporate income tax”, and that it “would end this race to the bottom by largely eliminating the benefits from engaging in it”. She emphasises the aims of Treasury to level the playing field by removing competitive disadvantages faced by small businesses who cannot necessarily engage in profit shifting to low-tax jurisdictions as multinationals have historically done.

She went on to address (indirectly) the comments made in the SFC letter, noting that the number of US taxpayers affected by UTPRs is “incredibly small”, and that “only 0.02% of U.S. corporations” are in that number. Without going into specifics, she implied that not all of the credits about which concerns were raised would fall within the scope of the UTPRs, but reassured critics that Treasury is “committed to working with Congress to explore other ways to protect US tax incentives that promote US jobs and investment”.

The passing of the BBBA in the Senate appears to be the final hurdle for ensuring the US meets its commitment to implement Pillar Two this year. While Republicans raise concerns about the harm they envisage Pillar Two doing to US businesses and jobs, the fate of the current legislative proposals lies in the hands of a single Democrat. In the event that the expected amendments to GILTI are not passed, greater complications will no doubt arise in applying Pillar Two to multinational groups involving the US, and what effect the interaction of GILTI with Pillar Two will have on the taxing rights of the jurisdictions involved. Watch this space.

Keep up to date with the latest developments and other useful information on our OECD BEPS 2.0 hubpage