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A Global Minimum Tax: The OECD Negotiations & the Biden Proposal for Changes to the GILTI Rules

By: John V. Aksak Michael Chen Sonali Fournier Justin Smith Lauren Ansley Alexis Bergman Jason Carter David Flores |

For the last several years, the OECD and several of its key member countries have been engaged in a campaign to take actions that would discourage multinational companies from shifting profits to low-tax countries.  Plans are in place for a final OECD global agreement to be reached on several fundamental changes to international tax rules by October 2021, which coincides with work in the US Congress on major changes to US international tax laws as part of the $3.5 trillion budget reconciliation bill.  

On June 5, 2021, the G-7 countries, which includes the United States, Canada, France, Germany, Italy, Japan, and the United Kingdom, issued a communique that describes a high-level political agreement on global tax changes including the creation of a global minimum tax (GMT).  An OECD Inclusive Framework statement was issued on July 1, 2021, which outlines the overall proposal agreed to by nearly all of the Inclusive Framework member countries. 

The G-20 Finance Ministers met on July 10-11th  and endorsed “the key components of the two pillars on the reallocation of profits of multinational enterprises and an effective global minimum tax.”  They called on the Inclusive Framework members to finalize the design elements within the agreed framework together with a detailed plan for the implementation of the two pillars by the next G-20 meeting on October 15-16, 2021.

This timing aligns with Congressional work on a $3.5 trillion budget reconciliation bill that will consider a Biden international tax proposal to change the global intangible low-taxed income (GILTI) rules, including an increase in the current GILTI minimum tax rate.  

This True Alert is the second in a series of alerts related to our review of the OECD project.  This Alert will focus on the details of Pillar Two of the Blueprints, the Biden proposed GILTI changes, and the interaction of the role of the Biden Administration in the OECD negotiations with Congressional consideration of changes to current international tax rules.

Summary

  • The OECD initiated the BEPS project in 2013 by publishing the OECD’s Action Plan on Base Erosion and Profit Shifting. The BEPS project resulted in the adoption of several anti-tax avoidance measures, but one project as yet unfinished is the taxation of the digital economy. 
  • On January 31, 2020, the OECD released a “Statement by the OECD/G20 Inclusive Framework on BEPS on the Two-Pillar Approach to Address the Tax Challenges Arising from the Digitalization of the Economy” that outlined a two-pillar approach that the Inclusive Framework adopted as the basis for their work program. The two-pillar approach establishes new profit allocation and nexus rules with Pillar One and introduced a global minimum tax with Pillar Two.
  • On October 12, 2020, the OECD Inclusive Framework released Blueprints for Pillars One and Two.
  • The Finance Ministers of the G-7 nations issued a communique on June 5, 2021, that describes a high-level political agreement on global tax changes.  They agreed to a GMT of at least 15% on a country-by-country basis and to provide for “appropriate coordination between the application of the new international tax rules and the removal of all Digital Services Taxes, and other relevant similar measures, on all companies.” 
  • An OECD Inclusive Framework statement was issued on July 1, 2021, which outlines the overall proposal agreed to by nearly all of the Inclusive Framework member countries.
  • The G-20 Finance Ministers met on July 10-11th and endorsed “the key components of the two pillars on the reallocation of profits of multinational enterprises and an effective global minimum tax.”  They called on the Inclusive Framework members to finalize the design elements within the agreed framework together with a detailed plan for the implementation of the two pillars by the next G-20 meeting on October 15-16, 2021. 
  • The new Pillar One nexus and profit allocation rules will be implemented through a new multilateral instrument (MLI) which will be available for signature in 2022 and scheduled to come into effect in 2023. The implementation plan contemplates that Pillar Two should be brought into domestic country law in 2022, to be effective in 2023, although certain transitional rules may be necessary.
  • With respect to implementation, members of the Inclusive Framework are not required to adopt the GloBE rules, but, if they do so, they must implement and administer the rules in a way that is consistent with the outcomes provided for in Pillar Two.
  • The Blueprint addresses the interaction of the proposed rules with the US GILTI regime, which is an important issue for US companies. The agreement appears to accept the co-existence of the GILTI regime with the Pillar Two rules if GILTI is applied on a country-by-country basis and if the rate is at least 15%. 
  • The Biden Administration has proposed changes to the GILTI regime that would better align it with Pillar Two, and these changes are expected to be considered as part of the $3.5 trillion budget reconciliation bill.
  • Aligning with Pillar One would likely require a treaty. Secretary Yellen has said that the Administration likely will not act until at least the spring of 2022 to propose measures that would bring the US into compliance with the OECD deal with respect to Pillar One. 
  • The US made a presentation at the OECD Steering Group of the Inclusive Framework in early April that outlined its negotiating position on the current Pillar One and Pillar Two concepts. The Biden Administration’s release of proposed changes to the Blueprints in April of 2021 helped form a basis for the political agreement reach by the G-7 countries in June 2021.
  • The presentation proposed a new approach on Pillar One which was intended to simplify the OECD’s existing proposals and avoid perceived discrimination against US multinationals. 
  • The presentation also confirmed the Biden Administration support for Pillar Two of the project and outlined the Administration’s legislative proposals to adopt an OECD-compliant minimum tax in the US.
  • In early summer, the Treasury Department issued an update on its negotiationswith members of the OECD, which stated the Administration’s support for a global minimum tax of at least 15 percent. 
  • The timing of moving ahead with US legislative changes is a key issue this fall as tax writers in Congress watch the pace and progress of the OECD negotiations.
  • House and Senate lawmakers from both parties have expressed caution about proceeding with US legislative changes based on expectations about a global deal without assurances that other countries in the Inclusive Framework will also change their tax laws.

Background

The OECD initiated the BEPS project in 2013 with the publication of the OECD’s Action Plan on Base Erosion and Profit Shifting.  The BEPS project resulted in the adoption of several anti-tax avoidance measures, but one project as yet unfinished is the taxation of the digital economy.

Members of the BEPS Inclusive Framework include 139 participating member countries — not only developed countries who are OECD members but many developing countries.  The Inclusive Framework has been working for several years on a comprehensive, consensus-based solution to the challenges arising from digitalization.

On January 31, 2020, the OECD released a “Statement by the OECD/G20 Inclusive Framework on BEPS on the Two-Pillar Approach to Address the Tax Challenges Arising from the Digitalization of the Economy” that outlined a two-pillar approach that the Inclusive Framework adopted as the basis for their work program.  The two-pillar approach establishes new profit allocation and nexus rules with Pillar One and introduced a GMT with Pillar Two.

On October 12, 2020, the OECD Inclusive Framework released Blueprints for Pillars One and Two of the ongoing Base Erosion and Profit Shifting (“BEPS”) project on digital taxation. 

Pillar One is designed to establish new rules on where tax should be paid and a fundamentally new way of allocating taxing rights between countries.

Pillar Two would introduce a GMT that would address issues related to base erosion and profit shifting by ensuring that large companies pay a minimum level of tax on income regardless of where it arises.  Pillar Two includes two main rules, specifically the Global Anti-Base Erosion (GloBE) rules and the Subject to Tax Rule (STTR).

Considerable progress has been made toward agreeing on some of the key aspects of Pillar One and Pillar Two, but there are still many key details and implementation issues that must be addressed before the effects of Pillar One and Pillar Two is seen in practice around the world.  The Blueprints acknowledge that implementation of any agreement will require changes to treaties and domestic law, and that it would be helpful if a multilateral treaty were developed to cover key elements of the two pillars.

Proposals will have to be agreed to by the US Congress, and the EU will have to implement the changes with the requirement for unanimity (if a EU Directive is used).  Those are significant hurdles that must be faced once the design of the two pillars is agreed upon.

Status & Timeline of the OECD negotiations

The Finance Ministers of the G-7 nations, which includes the United States, Canada, France, Germany, Italy, Japan, and the United Kingdom, issued a communique on June 5, 2021, that describes a high-level political agreement on global tax changes.  

In the communique, the G-7 Finance Ministers committed to an approach for Pillar One put forward by the Biden Administration that would focus new profit allocation rules on the largest and most profitable multinational enterprises, rather than solely on companies providing automated digital services and consumer-facing businesses.  It would also use a lower revenue threshold — market countries would be awarded at least 20% of profit exceeding a 10% margin.

They agreed to a GMT of at least 15% on a country-by-country basis and to provide for “appropriate coordination between the application of the new international tax rules and the removal of all Digital Services Taxes, and other relevant similar measures, on all companies.”

An OECD Inclusive Framework statement was issued on July 1, 2021, which outlines the overall proposal agreed to by nearly all of the Inclusive Framework member countries. 

The G-20 Finance Ministers met on July 10-11th  and endorsed “the key components of the two pillars on the reallocation of profits of multinational enterprises and an effective global minimum tax.”  They called on the Inclusive Framework members to finalize the design elements within the agreed framework together with a detailed plan for the implementation of the two pillars by the next G-20 meeting on October 15-16, 2021.  They also discussed the consultation process with developing countries, many of whom have expressed reservations about Pillar One.

Once a global agreement is reached, it will likely take many months of negotiation to work on the implementation rules.  Member countries are expected to make changes to their current laws and/or treaty agreements in order to implement the new rules.  This will also involve how to coordinate the global rules with existing unilateral measures that several EU and other countries have introduced.  In the US, Congress will need to rewrite the US international rules and agree to treaty changes, which may prove to be challenging.

The Blueprints – Pillar One and Pillar Two

The new Pillar One nexus and profit allocation rules will be implemented through a new multilateral instrument (MLI) which will be available for signature in 2022 and scheduled to come into effect in 2023.   The implementation plan contemplates that Pillar Two should be brought into domestic country law in 2022, to be effective in 2023, although certain transitional rules may be necessary.  It will also include the development of model income inclusion and undertaxed payment rules with coordination mechanisms for a model Subject to Tax rule, an MLI to facilitate its adoption, and transitional rules.

It is proposed that implementation of the Pillar One and Pillar Two reforms will be coordinated with the removal of all digital services taxes (DSTs), but there is uncertainty both as to the timing of this removal and what specific taxes are covered.

Pillar One

Pillar One establishes a unified approach to addressing nexus and profit allocation issues that arise from a digitalized economy.  The Blueprint states that Pillar One will “adhere to the concept of net taxation of income, avoid double taxation, and be as simple and administrable as possible.”

Currently, income is allocated to countries where a taxpayer has a physical presence, and that system has been criticized because it has allowed certain large digital services companies to earn significant revenue from users or consumers in a jurisdiction without paying taxes to that jurisdiction.  The proposal is to require a certain defined category of large multinationals to pay taxes on certain percentage of their residual profits to countries where they do not have a physical presence if they earn a set level of revenue in those countries.

Pillar Two

Pillar Two would provide a framework that would address the issue of base erosion designed to ensure that multinational enterprises pay a GMT of at least 15% with respect to their global profits.  The Blueprint sets out the technical design components of the GMT proposals and the additional technical work needed prior to completion.  There are several political and technical issues where differences of views must be resolved.

A GMT is a tax regime that is established by international agreement which would allow participating countries to impose a specific minimum tax rate on the income of companies subject to tax in that country.  A GMT would apply a standard tax rate to a defined corporate income base worldwide.

Defining the tax base on which the GMT would be applied will be an important step.  Tax laws in individual countries vary in design and complexity, which create different income tax bases in each jurisdiction, so a standard definition of tax base must be considered.

Each country would be entitled to the revenue from the GMT after they incorporate the rate and the rules into the country’s tax system.  Governments would continue to be allowed to set their own corporate tax rates, but if companies are able to pay lower rates in a particular country, their home country could increase their taxes to the GMT, so that the advantage of profit shifting would be eliminated.

Under Pillar Two, a GMT would apply both to companies investing abroad and foreign companies investing domestically.  The rules would apply for each jurisdiction where a company operates.

The proposed rules adopt an approach that includes two elements – the GloBE rules and the Subject to Tax Rule.

  • Global Anti-Base Erosion Proposal (GloBE)
    • Income Inclusion Rule (IIR): This would operate as a top-up tax when income of controlled foreign entities are taxed below a minimum effective tax rate.
    • Undertaxed Payments Rule (UTPR): This rule applies where income is not subject to an IIR.
  • Subject to Tax Rule (STTR): The STTR would apply to royalties, interest, and other defined payments made to an Inclusive Framework member state that applies a nominal corporate tax rate lower than a minimum STTR rate of between 7.5-9%.

The proposed rules would apply to companies with more than €750 million in annual gross revenues.

With respect to implementation, members of the Inclusive Framework are not required to adopt the GloBE rules, but, if they do so, they must implement and administer the rules in a way that is consistent with the outcomes provided for in Pillar Two.  The IIR and UTPR can be implemented through domestic legislation, but the July 1st statement provides for the possible development of an MLI to facilitate the coordination of GloBE rules that have been implemented by IF members.  The STTR can only be implemented through bilateral negotiations and amendments to individual treaties or as part of a multilateral convention.

The Blueprint addresses the interaction of the proposed rules with the US GILTI regime, which is an important issue for US companies.  The agreement appears to accept the co-existence of the GILTI regime with the Pillar Two rules if GILTI is applied on a country-by-country basis and if the rate is at least 15%.  The Blueprint also encourages the US to limit the application of the base erosion and anti-abuse tax (BEAT) where payments are made to entities subject to the IIR.

A Review of the Role of the US in the OECD Negotiations & Congressional Work on New International Tax Rules

The Biden Administration has expressed support for the OECD proposal.  In order to align the US tax system with the changes proposed in the OECD global agreement, legislative and treaty changes would be necessary.

The Biden Administration has proposed changes to the GILTI regime that would better align it with Pillar Two, which are expected to be considered as part of the $3.5 trillion budget reconciliation bill.  That legislation requires only a majority vote in both the House and Senate for passage.  President Biden has suggested that a global minimum tax would ensure that multinational companies pay their fair share of taxes and countries would no longer have to compete against one another for business by lowering their tax rates.

Aligning with Pillar One, however, would likely require a treaty.  Secretary Yellen has said that the Administration likely will not act until at least the spring of 2022 to propose measures that would bring the US into compliance with the OECD deal with respect to Pillar One.  An international treaty would require two-thirds Senate approval, and, therefore, Republican support.

US Participation in the OECD Negotiations

The US has been a key player in the OECD negotiations from the beginning, but the prior Administration created significant challenges to reaching a global consensus.  With the Biden Administration, however, and new personnel at the Treasury Department, including the appointment of Ital Grinberg in a new position designed to focus on multilateral tax issues, the US has played a more active and constructive role in the negotiations.

Early in 2021, the US dropped its insistence on a “safe harbor” with respect to Pillar One.  That was viewed as a positive development that helped advance negotiations.

The US made a presentation at the OECD Steering Group of the Inclusive Framework in early April that outlined its negotiating position on the current Pillar One and Pillar Two concepts.  The Biden Administration’s release of proposed changes to the Blueprints in April of 2021 helped form a basis for the political agreement reach by the G-7 countries in June 2021.

The presentation proposed a new approach on Pillar One which was intended to simplify the OECD’s existing proposals and avoid perceived discrimination against US multinationals.  The Biden Administration’s plan would significantly reduce the number of multinationals subject to Pillar One with fewer than 100 MNEs to be taxed under the US plan.  The US proposed that Pillar One, Amount A, apply to all types of multinationals — with some sector-based carve-outs — not just multinationals that sell automated digital services or that are engaged in consumer-facing businesses.  Total revenue and profit margin thresholds would ensure that only the largest and most profitable MNE groups are taxed.

The US also said that it was prepared to be flexible regarding nexus thresholds to ensure that some Pillar One tax flows to developing countries. The proposal was less subjective and simpler to administer, the US argued, especially since the need for business line segmentation would usually be avoided.

The presentation also confirmed the Biden Administration’s support for Pillar Two of the project and outlined the Administration’s legislative proposals to adopt an OECD-compliant minimum tax in the US.  The US also committed to:

  • Reforming the GILTI regime to more closely align with the IIR, including the adoption of a country-by-country foreign tax credit limitation, and
  • Repealing the US BEAT and replacing it with a regime resembling the UTPR.

At that time, SFC Chair Wyden (D-OR) expressed support for these positions and stated that they could be the basis for a global deal.  In contrast, however, House Republican Ways & Means members sent Treasury Secretary Yellen a letter saying they were concerned that the Pillar Two negotiating position would permit other countries to enact minimum taxes at rates lower than the current GILTI effective rate, while the Biden Administration seeks to double the GILTI rate paid by US companies.

In early summer, the Treasury Department issued an update on its negotiations with members of the OECD, which stated the Administration’s support for a global minimum tax of at least 15 percent.  The Treasury update explained that 15% “is a floor and that discussions should continue to be ambitious and push that rate higher.”  The Biden Administration has proposed a 21% minimum tax rate on the foreign income of US corporations in the GILTI rules as part of its agenda for business tax reform.

Republican reaction to the June G-7 agreement was cautious and skeptical about the details of a final agreement.  Treasury Secretary Yellen has told SFC Ranking Republican Crapo (R-ID) that their objectives are “aligned,” but her efforts to connect the OECD proposals to some of the Biden Administration’s tax proposals could complicate an attempt to get Republican support.

Budget Reconciliation Legislation & an Increase in the GILTI Minimum Tax Rate

The GILTI rules are the US version of a minimum tax on foreign earnings of US companies.  The Biden proposal calls for increasing the current tax rate on GILTI from 10.5% to 21% for US companies operating abroad.  The OECD agreement calls for a rate of “at least 15%.”

There are several other rules that determine the operation of the GILTI rules, which differ in certain ways from the proposal in the OECD agreement.  The Biden Administration has participated in and supported the OECD discussions, but more burdensome rules may be adopted as part of the GILTI changes this fall.  This could have significant effects on US businesses who arguably would then be operating at a disadvantage compared to foreign competitors.

Thus, the timing of moving ahead with US legislative changes is a key issue this fall as tax writers in Congress watch the pace and progress of the OECD negotiations.  House Ways & Means Committee Chair Neal (D-MA) has said that he is working closely with Treasury Secretary Yellen on the timing issues.  If the current deadline is met, a final OECD global agreement would be announced at the G-20 meeting on October 15-16, 2021, and it is likely that negotiations on the budget reconciliation bill will not have been completed before that time, so there would be an opportunity to ensure that the US legislation reflects recommendations in the global agreement.

House and Senate lawmakers from both parties have expressed caution about proceeding with US legislative changes based on expectations about a global deal without assurances that other countries in the Inclusive Framework will also change their country’s tax laws.  They do not want to put US businesses at a disadvantage, but the budget reconciliation legislation may offer the only opportunity in the near future for such changes to be made, especially if there is a change in party control in either the House or the Senate as a result of the 2022 mid-term elections.

How will Unilateral DSTs be Affected by a Global Agreement?

Several countries around the world moved ahead to enact DSTs when the OECD negotiations failed to produce a global consensus.  Based on the original deadline to complete a deal at the end of 2020, most countries suspended the application of those taxes, but now that the deadline has been delayed to October 2021, many countries are moving ahead with either enacting their proposals or collecting taxes due under enacted laws.

In early 2021, the US Trade Representative (USTR) announced the conclusion of its Section 301 investigations of Digital Service Taxes (DSTs) adopted by Austria, India, Italy, Spain, Turkey, and the United Kingdom.  The final determination of the investigations was to impose additional tariffs of up to 25% on certain goods from these countries, but to immediately suspend the tariffs for up to 180 days to provide additional time to complete the ongoing multilateral negotiations on international taxation at the OECD and in the G-20 process.  The USTR stated at the time that they would continue to monitor the effect of the trade actions, the progress of the OECD and G-20 discussions, and the progress of discussions with the six affected countries.

To date, several EU member countries have expressed opposition to a GMT, suggesting that such a rule would conflict with their right to establish corporate tax rates.  In the EU, it may be difficult to achieve unanimous support for EU directives implementing the new framework.  France holds the presidency of the EU in early 2022 when this matter will likely be considered, and the French Finance Minister supports the OECD project and has vowed to work to get unanimous support for it.  A proposed European digital tax has been taken off the European Commission’s agenda of meetings for the rest of 2021.  This aligns with a statement from the EU that it was postponing the tax to allow for completion of the OECD global talks.

Conclusion

It will continue to be a challenge to reach agreement within the Inclusive Framework on Pillar One and Pillar Two of the OECD project by the fall of 2021.  If an agreement is reached, countries will then have to amend their tax laws, and the changes will have to be implemented in individual countries.

In the US, work on aligning with the Pillar Two concepts will be ongoing this fall with Congressional work on the budget reconciliation legislation, while work on aligning with any agreements on Pillar One will likely not be undertaken until 2022.  The mid-term elections in the fall of 2022 will impact the ability of Treasury to advance proposals next year, and any change in control of Congress after the mid-term elections could impact the ability to make any changes to the current international tax rules in the US.

If you have any questions about the information in this True Alert, please contact a member of your TPC engagement team or any of our international experts below.