At a time when inflation is running rampant, supply chain issues continue to plague Americans, and the economy is flailing, American multinationals now have tax increases to worry about. And it’s fair to ask how this is the case when there has been no significant legislation that would increase taxes on U.S. companies.
The Biden administration came to agreement in October with 137 countries led by the Organisation for Economic Cooperation and Development (OECD) and the G20 to establish a global minimum tax rate. Model rules for “Pillar 2” were released in December as part of a two-pillar solution pursued to address tax challenges of the digitalization of the global economy, and in response to recent unilateral digital service taxes (DSTs) imposed by a number of countries, affecting companies not physically located within their borders.
Pursuing an international agreement to address DSTs was commendable, but the proposed solution would be more harmful to U.S. companies than the original problem.
The Pillar 2 model rules establish a global minimum effective tax rate (ETR). Using ETR means that it matters how various credits, deductions, etc. are treated for the purposes of determining what the ETR is and whether a company’s income is “low-taxed.” If it is deemed to be low-taxed, a top-up tax can be applied by the country where the business is located.
While other countries successfully negotiated to protect their domestic tax laws, the U.S. Treasury did not. Generally, refundable tax credits are accommodated under the model rules and non-refundable tax credits — i.e., most U.S. business tax incentives — are not. Additionally, despite the United States having the world’s only global minimum tax, it is not recognized as being a qualified regime under Pillar 2. The OECD document, The Pillar Two Rules in a Nutshell, clearly states that “consideration will be given to the conditions under which the U.S. Global Intangible Low-Taxed Income (GILTI) regime will coexist with (these) rules.”
This means that U.S. tax credits for research and development, low-income housing, new markets, and clean energy could be nullified, thwarting congressional intent. In other words, a U.S. company with operations abroad might be able to lower its ETR below the global minimum (15 percent) through legal application of U.S. tax law and then lose that benefit to top-up taxes in a foreign jurisdiction.
The power to lay and collect taxes lies with Congress, and any executive branch negotiations over treaties or other international agreements are required to be undertaken with the advice and consent of the Senate. Tax treaties, like other treaties, must be approved by two-thirds of the Senate before they can be ratified. The OECD agreement is not a treaty, but the practical effect of the Pillar 2 model rules is that of a multilateral tax treaty that was concluded without the advice and consent of the Senate.
International law does not trump domestic law in the United States, and Congress must act to implement any changes. However, failure of Congress to act in this context could be more detrimental. The Treasury ceded significant taxing authority over U.S. multinationals to foreign authorities in the Pillar 2 agreement. If other countries implement Pillar 2 before we do, they will be able to start collecting top-up taxes on local affiliates of U.S. companies. The United States similarly would have to implement Pillar 2 in order to levy top-up taxes on foreign companies located here and to preserve its primary right of taxation over the income of American multinationals.
If this agreement is implemented, it will harm the global competitiveness of U.S. businesses and American jobs. However, options are limited now that the agreement is in the implementation phase.
Treasury officials recently acknowledged the concerns of Congress and the business community, and the assistant secretary for tax policy is trying to assure stakeholders that many tax incentives would be unaffected and that Treasury is working with the OECD to “clarify” how others would be handled. These issues were never part of earlier blueprints and appeared for the first time in the model rules.
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The United States should not have to rely on a tortured interpretation of the commentary to protect its interests, and this should provide little comfort to stakeholders. We should learn from the foreign sales corporation debacle and not rely on amorphous or ambiguous terms.
Meanwhile, the European Union has failed to reach the necessary unanimous agreement for implementation and other countries are running into similar roadblocks. It’s time to pause to ensure all parties and stakeholders understand with absolute clarity what is being agreed to prior to any implementation. It is essential to preserve the integrity and efficacy of tax incentives passed by Congress.
Kimberly J. Pinter, a tax policy attorney, was a Deputy Assistant Secretary for Legislative Affairs, Tax and Budget at the Treasury Department under President Trump. She is a visiting fellow with the Independent Women’s Forum, and has worked on Capitol Hill for the late Sen. Craig Thomas (R-Wyo.), the House Small Business Committee, and Sen. Ted Cruz (R-Texas).