In Greek mythology, Hercules was famous for holding the weight of the world on his shoulders, but it seems he really held the sky on his shoulders instead of Atlas, in return for three golden apples.
More recently, US President Biden may have pulled off a similar feat. He couldn’t persuade Congress to adapt US tax law to fit in with a 15% global minimum tax proposed by the OECD and accepted by 140 countries outside the USA. The OECD proposal is called “Pillar 2” (see below). So Biden effectively held the rest of the world on his shoulders, moving the OECD to adapt Pillar 2 to fit in with existing US tax law. The impact on the US Treasury will be much more than three golden apples. And it will impact us all.
OECD global minimum tax:
On February 1, 2023 the OECD approved “administrative guidance” which bridged some yawning gaps between the OECD Pillar 2 proposals and US law. The result will soon be minimum corporate income tax of 13.25% in the US and 15% in 140 other countries aligned with the OECD.
The OECD also has a Pillar 1 initiative, but this is floundering. It proposes to shift some offshore profits back onshore, but developing countries want a bigger slice of profits.
So, all eyes are on Pillar 2. Does it matter if a multinational enterprise (MNE) pays a minimum of 15% income tax in Africa or Europe? Yes, it does to Biden, he wants to see the US pick up some of that 15% minimum tax.
The US nearly lost out due to some tricky rules in Pillar 2 (some apparently say it did lose out). The OECD Pillar 2 rules include a 15% top-up tax. Suppose Company A in Country A owns subsidiary Company B in Country B. If the tax rate in Country B is only 12.5% (as in Ireland, Cyprus), then Country A can collect a top-up tax of 2.5% from Company A, to top up the tax on Company B’s profits to the 15% minimum.
But suppose Country A doesn’t actually collect the 2.5% under Pillar 2 rules? Then it seems Countries C to Z can soon collect up to 15% tax by denying expense deductions. This is under a UTPR rule (=Under Taxed Profits Rule).
The USA:
If Country A is America, will Countries B to Z soon clobber America with those 15% UTPR taxes? America is not an offshore tax haven. But it has a different minimum tax regime known as GILTI (=Global Intangible Low-Taxed Income).
GILTI already causes issues for US citizens who are Israeli Olim that have an Israeli company.
Under GILTI, profits of non-US affiliated companies are apparently “blended” into one combined pot for US tax purposes, to see if the average tax rate exceeds a minimum rate of 13.125%.
By contrast, Pillar 2 will soon impose a global 15% minimum tax rate on a country by country basis, not one blended pot that can shelter offshore profits against onshore profits. Both Pillar 2 and GILTI apply to active foreign profits, not only passive investment profits.
OECD Administrative Guidance:
If nothing was done, payments by non-US companies to US companies might have been subject to double minimum taxes – 15% in the payor country and 13.125% tax in the US.
So the OECD “administrative guidance” is intended to solve the double minimum tax issue in all 141 OECD-aligned countries by recognizing the US GILTI tax regime – provided US groups make a few tweaks to modify GILTI when reporting in other countries.
Basically, the US groups must un-blend global profits and allocate them to each country pro rata to: (1) profits in each country, and (2) the extent to which the tax rate falls short of 15% in each country.
For example, if a US group derives some of its profits from an Cypriot company taxed at only 2.5% (12.5% but reduced by a Cyprus “Notional Interest Deduction”), then some of the Cyprus tax shortfall of 10.625% (=13.125% – 2.5%) should be reflected in the tweaked US GILTI tax calculation for OECD Pillar 2 purposes.
What will medium-low tax countries do?
What does a medium-low tax country like Cyprus do? Such countries may perhaps consider raising tax rates to 13.125% or 15% for larger groups affected by Pillar 2 i.e. with annual revenues above EUR 750 million.
Some countries may also consider a digital service tax (DST) which is really a second VAT/Sales Tax – especially if the OECD’s Pillar 1 proposals continue to flounder….
Timing:
Many countries seem likely to adopt Pillar 2 in 2024 or 2025. As mentioned, Pillar 2 will apply internationally to groups with global annual revenues above EUR 750 million, but individual countries are free to adopt a lower threshold. There isn’t much time to prepare.
As always, consult experienced advisors in each country at an early stage in specific cases.
Next Steps:
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(c) Leon Harris 28.5.2023