Since the start of the new year, the U.S. and other countries have taken several steps forward regarding implementation of the international tax agreement brokered by the Organisation for Economic Co-operation and Development (OECD) and agreed to by 137 countries last October. As the Treasury Department works to implement both pillars of this agreement in 2022, we encourage Treasury officials and the Biden administration to work with Members of Congress, especially on aspects of Pillar One that should be subject to the Senate’s treaty process.
NTU has offered its research and analysis on the international tax agreement several times in the past few months, and we remain concerned that both the Biden administration and the Democratic majority in Congress may rush Pillar One (P1) and Pillar Two (P2) changes that undermine America’s tax sovereignty and its competitiveness with other economic powerhouse countries in Europe and elsewhere.
Below is a brief summary of the two-pillar agreement, activities of the Biden administration and Congress thus far, and a review of how recent developments and research should inform the U.S. government’s work in the months ahead.
A Brief Summary of the Two-Pillar Agreement
The first prong of the 137-country October agreement, P1, would reallocate a portion of the profits earned by large multinational tech companies on the digital goods and services they provide, with profits directed to potentially dozens of countries where those companies earn a minimum amount of revenue. The OECD and countries that are party to the agreement still need to sort out numerous technical details in regards to P1. The second prong, P2, would require multinational companies to pay a minimum amount of tax on their foreign earnings, with countries where those companies are headquartered having the right to levy a ‘top-up’ tax where the effective tax rate falls below the minimum.
The October agreement asks countries to make P1 and most of P2 effective by the beginning of 2023, which gives these countries extremely limited time to debate and agree to key implementation questions affecting both pillars. We pointed out last year that the agreement may not give countries any time at all to implement P2, given the OECD expects an “implementation framework” for P2 “[a]t the latest by the end of 2022.”
Activities of the Biden Administration and Congress in 2021
The bulk of P1 changes in the U.S. will be led by the Biden administration (though their possible end-run around Congress regarding implementation of P1 is not without controversy; more below). The bulk of P2 changes in the U.S. will need to be enacted through legislation passed into law by Congress.
Though the U.S. enacted a P2-like minimum tax on U.S.-based companies’ foreign profits (i.e., Global Intangible Low-Taxed Income, or GILTI) well before the October OECD agreements – in 2017, under the Republican-supported Tax Cuts and Jobs Act (TCJA) – the Biden administration negotiated P2 in such a way that the current version of GILTI will not be compliant with what the U.S. agreed to under P2. Therefore, President Biden has tried to secure legislative action on P2 through his Build Back Better legislation. Democrats are largely in agreement on doing something to make GILTI compliant with P2 through Build Back Better, but there are minor and important disagreements between the Biden administration, the House, and the Senate over how to design GILTI changes. We summarized the GILTI proposals in the House-passed version of Build Back Better a few weeks ago; read more here.
P1 implementation in the U.S. has been somewhat more quiet than the matter of P2 compliance and GILTI, but NTU expressed concern back in October that the Biden administration may attempt an “executive agreement” to implement P1 as opposed to a tax treaty reviewed and ratified by the Senate. It’s no secret that Senate Republicans have expressed significant concerns with P1 and its implementation in the U.S., but that is no excuse for the Biden administration to act against tax treaty precedent and work around – rather than with – Congress on P1 implementation. On the plus side, President Biden’s Treasury Department has negotiated deals with five European countries, Turkey, and India to end their unilateral and punitive digital services taxes (DSTs) upon implementation of P1 around the world. We had some critiques on the Biden administration’s DST agreements with individual countries, but appreciate their commitment to ending these unfair taxes.
2022 Developments and the Work Ahead
A major potential wrinkle in the U.S. and global implementation of P1 is Canada’s intention to move ahead with its DST. According to MNE Tax, Canada introduced their draft DST legislation in mid-December and proposed that it “would be imposed in 2024 with retroactive application to 2022.”
Since Canada’s announcement, U.S. policymakers across the ideological spectrum have registered their opposition to the Canada DST proposal. A spokesperson for the U.S. Trade Representative (USTR), Ambassador Katherine Tai, criticized the proposal and pledged to “examine all options” for the U.S. to respond should Canada go forward with a DST. Reps. Suzan DelBene (D-WA) and Darin LaHood (R-IL), who are members of the House Ways and Means Committee and Co-Chairs of the Congressional Digital Trade Caucus, urged Canada to abandon its DST. Senate Finance Committee Chair Ron Wyden (D-OR) and Ranking Member Mike Crapo (R-ID) published a joint letter to USTR Ambassador Tai in which they noted Canada’s DST affects not only the global tax agreement but also the U.S.-Mexico-Canada (USMCA) trade agreement that has been signed by all three countries. And Reuters reported that Deputy USTR Jayme White expressed concern over the DST matter in a recent meeting with his Canadian counterpart, David Morrison, on January 12.
All of these developments, especially the uncertainty regarding U.S. implementation of P1 and Canada’s forward movement on a DST, threaten the viability of P1 less than a year from the scheduled effective date. Unfortunately, a world without some kind of smooth P1 implementation may actually be worse off than a world with no P1. As Oxford’s Dr. Richard Collier, an advisor to the OECD on P1, recently pointed out – a likely alternative to P1 implementation is the resurrection and resurgence of unilateral DSTs around the world. Dr. Collier also correctly noted that P2 implementation would not likely “stall or reverse the momentum for a re-allocation of taxing rights” (i.e., either P1 or unilateral DSTs) because P2 fundamentally does not address the “digitalization debate” that P1 targets.
Going forward, it’s clear that the Biden administration must 1) continue to engage diplomatically with Canada in an effort to prevent our northern neighbors from enacting a DST; 2) beat back similar efforts that may crop up around the world, if nations decide to offer DSTs as a contingency plan upon the failure to implement P1; and 3) consult with Congress on the implementation of P1 in America, rather than conduct an end-run around Congressional advice and consent with an “executive agreement.”
The major development in P2 this winter has been the release of OECD model rules for P2 on December 14. The Biden administration is urging Congress to quickly implement P2 in the U.S. through legislation, with Treasury official Lily Batchelder claiming at a January 25 event that global P2 implementation would ensure the U.S. is no longer “the only country on earth that requires [multinational companies] to pay a minimum tax on their foreign earnings.” Republicans on the House Ways and Means Committee have pushed back, with Rep. Kevin Hern (R-OK) leading a letter charging the Biden administration with making “promises to the world without sufficient bipartisan, bicameral consultation.”
Across the pond, European Union members have all signed on to the October international tax agreement but have clear differences in preferred speed and style for P2 implementation. At a recent meeting, Hungary and Sweden pushed back on implementing P2 across Europe for 2023, while Hungary, Poland, and Estonia expressed discomfort with moving forward aggressively on P2 while key technical details regarding P1 remain unresolved. The EU may yet agree to move forward on P2 as early as March 15, with France (which runs the EU Council for the first six months of 2022) making P2 implementation a top priority.
An interesting wrinkle of the December OECD model rules is the introduction of a so-called qualified domestic minimum top-up tax (QDMTT). As Oxford’s John Vella, Michael P. Devereux, and Heydon Wardell-Burrus explain in a recent policy brief:
“…by introducing a QDMTT a country collects the revenue that would otherwise have been collected by another country under Pillar 2 through the Income Inclusion Rule (IIR) or the Undertaxed Payment Rule (UTPR). Critically, a country can introduce a QDMTT in the safe knowledge that this would not impinge on its competitive position because the top-up tax would be collected by another country if it is not collected through the QDMTT. Countries thus have a strong incentive to introduce a QDMTT, and in this Policy Brief we assume that they will.”
The QDMTTs might function similarly to the domestic minimum ‘book income’ tax introduced in the U.S. by Congressional Democrats as part of the Build Back Better package. Book tax advocates claim the levy leads to companies simply paying their “fair share,” but NTU has pointed out that book taxes can undermine important, bipartisan provisions of the tax code that encourage companies to invest, hire workers, conduct R&D, and more. A proliferation of domestic minimum taxes could also make tax compliance much more difficult for multinational companies around the world, leading to additional costs and additional work, and many of those companies are based here in the U.S.
Even the path forward for P2 implementation in the U.S. remains rocky and unclear, as noted above. NTU has encouraged Congress to delay implementation of P2-compliant GILTI changes until 2024, at minimum, so that companies and the IRS have time to adapt to the new law. We have also urged the Biden administration and Congressional Democrats to avoid handicapping U.S.-based companies relative to their peers – in Europe and other economically developed areas – by scaling back some of the proposed GILTI tax increases in BBB. Congress needs to fix how its proposal would interact with existing foreign tax credit (FTC) rules, ensure U.S. companies with foreign income and domestic loss carryforwards can access the preferential GILTI rate, eliminate the FTC haircut under GILTI, consider a more generous substance-based carve-out that matches P2 model rules, pursue simplification options that reduce compliance burdens for U.S. companies and administrative burdens for the IRS, and more.
We’re less than a year out from the official implementation date for P1 and P2, and multiple political, policy, technical, and diplomatic issues lack a clear resolution even after the release of model rules. NTU will continue sharing its perspective on behalf of American taxpayers.
 The agreement calls for multinational companies with revenue of more than €20 billion and profitability above 10 percent to reallocate 25 percent of their profit (in excess of 10 percent of revenue) to countries where the companies derive at least €1 million in revenue (€250,000 in countries with GDP less than €40 billion). The agreement is contingent on a multilateral conversation removing existing, unilateral digital service taxes (DSTs) and prohibiting new DSTs. Read more here.
 The minimum rate is 15 percent of profit, after allowing for a carve-out based on the value of a company’s tangible assets and payroll, determined on a country-by-country basis for multinational companies with annual revenue of more than €750 million. Read more here.
 In our critique, we noted that the withdrawal of DSTs are not immediate but contingent on the implementation of P1, which is far from a sure thing. On the plus side, upon implementation of P1 U.S. companies will receive credits against DST liabilities incurred in 2022 and 2023 that can be used to offset their P1 liability in 2024 and beyond.
 Members had specific concerns with current-law GILTI compliance with P2, potential repeal of the Foreign Derived Intangible Income (FDII) deduction, and the potential treaty workaround for P1.