The changes underway in setting global taxes are leading to confusion for many countries that authorities are trying to alleviate.
On Monday, the Organization for Economic Cooperation and Development released a
Pillar Two aims to set a 15% global minimum tax on companies. However, the legislation to implement those tax regimes has not yet been approved in the U.S., although there are provisions in both the Tax Cuts and Jobs Act of 2017 and the American Rescue Plan Act of 2021 that try to achieve some similar goals, but with a lot of loopholes. But the Treasury Department has been working with the OECD on ways to make the tax regimes work, even when Congress is hesitant to make extensive tax changes in an election year.
“The U.S. involvement in the OECD is not new,” said Jose Murillo, a partner and national tax department co-leader at Ernst & Young who recently served as deputy assistant Treasury secretary for international tax affairs at the U.S. Treasury Department and previously led EY’s international tax and transaction services group based in Washington D.C. “The U.S. has always played a central role in anything the OECD does, for obvious reasons. We’re the biggest economy, we’re really influential in tax policy. If anything, back when we did in 2017 the Tax Cuts and Jobs Act, we kind of got out ahead of what the OECD was looking to do with our GILTI [Global Intangible Low-Taxed Income] regime, the BEAT [Base Erosion Anti-Abuse Tax] tax, the 267A hybrid denial of deductions. Those were all consistent, thematically at least, with what the OECD was doing.”
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Even though the Treasury Department is taking the lead on the negotiations with the OECD, it still needs to keep Congress in the loop. “The Treasury, when I was there, I saw it very frequently, meeting with Hill staff primarily, either committee staff or the staff for particular congressmen and women and senators,” said Murillo, “There certainly is dialogue from the administration to Congress, but at the table, it’s the U.S. Treasury Department, so whatever they agreed to is just a political agreement. It’s a commitment from the administration. And it’s not lost on anyone that in our system of government, Congress enacts legislation. You’ve got to convince Congress to go along, and that brings with it complications and limitations.”
He pointed out that the only change the Treasury committed to pursue and get through Congress was changing GILTI to apply on a country-by-country basis, rather than on a global blending basis as it exists today.
“That’s the only commitment we made, so when people talk about, ‘When is the U.S. going to adopt Pillar Two?’ that’s too broad a statement,” said Murillo. “The only agreement was GILTI country by country. Is it going to be different than anyone else’s income inclusion rule? That is probably the most we could get done and it’s close enough. There are differences, but they’re close enough, they’re comparable and doing that would make GILTI Pillar Two compliant. Thereafter, everything else that is part of Pillar Two is optional, as it is for any other jurisdiction.”
He doesn’t believe the U.S. would need to adopt the OECD’s undertaxed profits rule if it made the GILTI regime apply on a country-by-country basis.
“It does require convincing Congress to make that change, and I think the administration was very close to getting that done back in 2021, when the Build Back Better Act stalled,” said Murillo. “They got it through the House, but it sort of stalled in the Senate. I don’t think there was opposition to the policy that Build Back Better represented because it also included a lot of very taxpayer-favorable changes to the GILTI regime, to the BEAT liability, so there were trade-offs. But it included modifying it to be per country, and it ultimately failed to get the support of the senators that were needed, not on policy grounds, but out of concern that why should we go first? What are the assurances that if the U.S. moves first, the rest of the world is going to follow. Where we are today is the rest of the world, for the most part, is moving. Many countries enacted their domestic legislation last year. It’s slowly coming online or going to start implementing this year. That momentum, I think, can’t be stopped if the rest of the world is moving along, and now we’re just kind of waiting behind.”
He sees an impact on U.S. companies. “That means they’re going to be impacted by Pillar Two, whether or not the U.S. does anything to conform because of there being U.S. multinationals with global footprints,” said Murillo. “Everyone at the moment is understanding what the impact is going to be, modeling out the proposed rules, or now enacted rules in some jurisdictions, working hard to stand up systems and internal processes to get all the information that is needed to comply with these rules, much of which doesn’t exist within the tax function. They’re having to work with other parts of their organization to make sure that they can comply with the rules, because they’re finding, a lot of companies are doing the modeling, and they’re recognizing, at the end of the day there is some additional tax liability, but not very material in the grand scheme of things. It is a bigger number, and it’s additional tax, but it’s not the tax liability that is a concern. It’s the compliance and administration because every country is going to require filing new forms, proving out that you’ve met the minimum tax or you’ve calculated the topup tax. That is an annual function, and that is what is really keeping many companies busy at the moment.”
EY recently released a
“Pillar Two makes transfer pricing more important because the location of the profits, where they’re earned, where they’re booked, is probably more important, because in a global tax regime where each jurisdiction is separate on an ETR [effective tax rate] basis, and you don’t get credit for paying more tax in one country against lower-taxed income in another jurisdiction, finding that right balance, where you’re close enough to 15% everywhere, but nowhere really above it is really important,” he said. “And that is where transfer pricing comes in. That means the stakes are much higher because there’s going to be more focus on it.”
He noted that Pillar One has a huge transfer pricing element to it, as well. “There’s no minimum amount of return to in-country marketing and allocation of additional profits to a market jurisdiction,” he said. “That’s all transfer pricing based, so it’s going to be even more important, and it’s going to require a lot closer coordination between jurisdictions to make sure everyone agrees on what those allocations are, which is probably one of the more challenging aspects of this entire exercise. It’s one thing to agree to get everyone to agree to enact this. It’s another to get everyone to agree to the results once everything is enacted, because it’s a zero sum game. If there’s a single pot of tax revenue, everyone’s going to want as much as they can, so there’s got to be a way for everyone to agree and resolve differences, whether it’s by arbitration or mutual agreement procedures.”
Companies will need to try out different scenarios to see where the impacts will be from the OECD tax changes.
“It starts with modeling the impacts,” said Murillo. “It tells you where your pressure points are in your structure and your supply chain, and where the focus ought to be. To be able to do that requires access to all the information that is needed to make the calculations.”
Tax won’t be the only impact. “It’s not all in tax,” said Murillo. “It’s in controllership, it’s in audit, it’s in financial accounting more broadly. What systems are required? How many more people do I need? Can I do this just with additional technology? And then just getting the processes in place because the rules are being implemented and they’re taking effect in many jurisdictions this year in 2024. Some countries are on a more delayed basis. Some countries are just waiting to see what else is happening around the world and they’re probably one or two years behind. But they’ll be online here pretty soon. There’s more focus internally on the financial statement treatment of various tax items, on how tax items are treated and classified for financial statement purposes has a huge impact on whether you’re paying a top-up tax.”
The OECD regime includes a number of new taxes, he noted. “There is what is referred to as a Qualified Domestic Minimum Top-up Tax, a QDMTT,” said Murillo. “Then there is an income inclusion rule, which is very much like our GILTI rule, but those two are designed to be similar. GILTI is not quite the same as it applies on a blended basis. If it were on a country-by-country basis, it would be comparable. And then there is the Undertaxed Profits Rule, the UTPR. Those are the three Pillar Two taxes: the Qualified Domestic Minimum Top-up Tax, income inclusion role, and undertaxed profits rule. And that is the order in which they are, at least at the moment, prioritized. The Qualified Domestic Minimum Top-up Tax applies first, then the income inclusion rule, and then the undertaxed profits rule, and they apply in that order, bottom up. The Qualified Domestic Minimum Top-up Tax is designed to give the jurisdiction in which the income is earned the primary right to collect the top-up tax.”
U.S. companies will face pressure in complying with such taxes in other countries, whether or not they’re passed in Congress. But not all the other countries are on board yet either.
“We get the question sometimes of why would a country not adopt Pillar Two,” said Murillo. “Some have announced they’re not doing it or they’re adopting a corporate tax, but it looks very different. I think it just depends on the profile of the jurisdiction. If you’re a country that just has a lot of foreign direct investment coming in, but you yourself don’t have multinationals that are investing outbound, you’re not a headquarter jurisdiction and you’re not really interested in collecting UTPR tax and your regime is too complicated for your taxing authorities, you probably aren’t going to adopt everything. Maybe you do a Qualified Domestic Minimum Top-up Tax to protect your own tax base, but that’s it. And many jurisdictions have also said, yes, I get it that we have to change the way we do business. We can’t just do these rulings and provide these incentives. But the rules do allow certain incentives, and they treat certain incentives differently. That just means those countries are still going to try to compete on the basis of taxes and design their own regime that works for them. I don’t think everyone is going to go all in. You’ll see differences. But the big countries, the countries that are really driving this project, they will go all in.”
Companies have called for greater certainty and uniform implementation, application and administration, and that will come down to the regulations, which could differ from country to country.
“That could prove challenging, because many countries have adopted Pillar Two legislation, but they’ll need implementing regulations,” said Murillo. “They’ll need regulations explaining how the rules apply. And you can see differences between jurisdictions because they use different languages and different words. They may not be exactly the same, and that’s going to just add to the complexity. Then you can see changes continuing to be released from the OECD: additional administrative guidance, things that are described as clarifications or changes. How all that is incorporated in a country’s domestic legislation is going to be interesting. That could just add to the controversy and uncertainty and the complexity of this whole system.”
