In recent years, countries have been debating significant changes to international tax rules that apply to multinational companies. This week there was a breakthrough in discussions, and an outline for the new rules was released by the Organisation for Economic Co-operation and Development (OECD). If today’s global tax agreement is fully implemented, large U.S. companies would pay less to the U.S. government and more to overseas governments while the foreign earnings of companies would face higher taxes.
Large companies would pay more taxes in countries where they have customers and a bit less in countries where their headquarters, employees, and operations are. Additionally, the agreement sets up the adoption of a global minimum tax of at least 15 percent, which would increase taxes on companies with earnings in low-tax jurisdictions.
Of the 139 countries engaged in the negotiations, 130 signed on to the new outline. Holdouts include Ireland with its 12.5 percent corporate tax rate and Estonia which applies tax only on distributed profits of companies.
The proposal follows a general outline that has been under discussion since 2019. There are two “pillars” of the reform: Pillar 1 is focused on changing where large companies pay taxes; Pillar 2 includes the global minimum tax. Both pillars include multiple elements.
Pillar 1 contains “Amount A” which would apply to companies with more than €20 billion in revenues and a profit margin above 10 percent. For those companies, a portion of their profits would be taxed in jurisdictions where they have sales; between 20 percent and 30 percent of profits above a 10 percent margin may be taxed. After a review period of seven years, the €20 billion threshold may fall to €10 billion.
Companies in the extractives sector (like oil, gas, and other mining companies) and financial services companies would be excluded from the policy.
Amount A is a partial redistribution of tax revenue from countries that currently tax large multinationals based on the location of their headquarters and operations to countries where those companies have their sales. U.S. companies are likely to be a large share of the companies in scope of this policy.
There is potential for the U.S. to lose some tax revenue because of this approach. However, U.S. Treasury Secretary Yellen has previously written that she believes Amount A would be roughly revenue neutral for the U.S. For this to be true, the U.S. would need to collect significant revenue from foreign companies or from U.S. companies that sell to U.S. customers from foreign offices.
Pillar 1 also contains “Amount B” which would provide a simpler method for companies to calculate the taxes they owe on foreign operations such as marketing and distribution. The outline does not provide any new details on this approach.
Pillar 2 is the global minimum tax. It includes two main rules and then a third rule for tax treaties. These rules are meant to apply to companies with more than €750 million in revenues.
The first rule is an “income inclusion rule,” which determines when the foreign income of a company should be included in the taxable income of the parent company. The effective tax rate should be “at least 15 percent,” otherwise additional taxes would be owed in a company’s home jurisdiction.
The income inclusion rule would apply to foreign profits after a deduction for 7.5 percent of the value of tangible assets (like equipment and facilities) and payroll costs. After a five-year transition period, the deduction would be lowered to 5 percent.
Like other rules that tax foreign earnings, the income inclusion rule will increase the tax costs of cross-border investment and impact business decisions on where to hire and invest around the world—including in domestic operations.
The second rule in Pillar 2 is the “under-taxed payments rule,” which would allow a country to deny a deduction for or place a withholding tax on cross-border payments. If a company in one country is making payments back to its parent entity (which is in a low-tax jurisdiction), then the under-taxed payments rule could apply.
Paired together, these two rules create a minimum tax both on companies that are investing abroad and on foreign companies that are investing domestically. They are both tied to the minimum effective rate of at least 15 percent, and they would apply for each jurisdiction where a company operates.
The outline also mentions that companies “in the initial phase of their international activity” could be exempt from the global minimum tax, but that has not yet been agreed to.
The third Pillar 2 rule is the “subject to tax rule,” meant to be used in a tax treaty framework to give countries the ability to tax payments that might otherwise only face a low rate of tax. The tax rate for this rule would be set between 7.5 percent and 9 percent.
Both Pillar 1 and Pillar 2 represent major changes to international tax rules, and the outline suggests that the changes should be put in place by 2023. Countries would have to write new laws, adopt new tax treaty language, and repeal some policies that conflict with the new rules.
The outline specifically states that digital services taxes and similar policies will need to be removed as part of implementing Pillar 1.
The Biden administration has released a statement with warm approval of the agreement, although it may be challenging to get Congress to follow through on implementing these policies.
There are three reasons for this. First, the priorities that President Biden has set for taxes on the foreign earnings of U.S. companies follow a different approach than what was agreed to today. Second, the current tax on Global Intangible Low-Tax Income (GILTI) and the Base Erosion and Anti-abuse Tax (BEAT) are only roughly aligned to the new agreement, but GILTI may get special treatment according to the outline. Third, a tax treaty change requires 67 votes in the Senate, and that will prove challenging if there is not broad bipartisan support for the new rules.
For Pillar 1 to work well, it would be simpler if all countries adopt the rules in the same fashion. This would avoid companies having to deal with multiple approaches across the globe. The outline mentions a streamlined system that might require a sort of clearinghouse for Amount A payments and credits alongside a dispute resolution mechanism.
Pillar 2 is more optional. The outlined version of Pillar 2 is more like a template rather than a requirement for countries to adopt exactly what is described. If enough countries adopt the rules, though, then much of corporate profits across the globe would face at least a 15 percent tax rate.
Today’s agreement represents a major blow to tax competition, and it is unsurprising that a country like Estonia (a champion of good tax policy) was unwilling to sign up to it. Policymakers across the globe should be careful in designing measures to implement this and be aware of the various new distortions these rules will create.
Launch U.S. International Tax Reform Resource Center