The U.S. and Pillar Two, in 2025 and Beyond

Democrats swung and missed when it came to enacting the 15% global minimum tax last year, but they’re hoping it won’t be their last time at bat.

(Those are baseball metaphors, by the way, for my foreign readers.)

The United States is currently out of compliance with the Organization for Economic Cooperation and Development’s Pillar Two model rules, even though President Biden and his Department of the Treasury took a leading role in negotiating them during the final months. While Democrats in Congress crafted a tax and spending bill in 2022 to advance many of the Biden Administration’s priorities, Sen. Joe Manchin (D-W.V.), the party’s most reluctant member, refused to consider international tax changes of any kind. (Confusingly, Congress enacted a different 15% minimum tax, the corporate alternative minimum tax, that’s outside of the Pillar Two system. More on that in a bit.)

The U.S. noncompliance could mean increased tax liability for U.S. companies, due to provisions in Pillar Two that work as an enforcement mechanism to encourage countries to comply.

At the time, Democrats only held the 50-50 Senate through the vice president’s tiebreaker vote, and Manchin’s opposition was enough to kill hopes of Pillar Two enactment for the rest of that Congress. Now Democrats have one more senator, but lost the House and haven’t been able to pass much of anything this year. They may win back some seats in 2024 but it could be a while before the stars are aligned for them to pass large-scale changes to the international tax system.

The best chance is likely 2025, when many important provisions in the 2017 Tax Cuts and Jobs Act expire. Congress will likely act to extend them, or make them permanent. But doing so will require some kind of bipartisan agreement, no matter who’s in charge. Many observers and ex-Treasury officials say this could be the chance to enact Pillar Two and bring the United States onboard, relieving much of the OECD’s current political stress.

Democrats may get the chance to pass something. But what will they pass? That question is more complicated than it sounds, and it could determine the future of Pillar Two.

It’s often claimed that Sen. Manchin killed Pillar Two participation by nixing it as part of the 2022 Inflation Reduction Act. (His reason was that the U.S. should wait until other countries have begun enacting it–has his position changed?)

Technically, though, full participation was never on the table. The Biden Administration included Pillar Two implementation language in his 2023 annual budget request to Congress, but it was never added to any version of the IRA. Unlike in a parliamentary system, budget requests to the Congress are mostly a rhetorical exercise, and the proposals rarely go anywhere.

What did have a chance to be included last year were individual proposals that would bring the U.S. much closer to alignment with the OECD. These include changing the existing tax on global intangible low-taxed income to apply on a country-by-country basis, and to raise its rate from 10.5% to 15%. These were all in the Build Back Better Act, the precursor to the IRA that passed the House. Not so coincidentally, what was needed to bring the U.S. system closer to Pillar Two were also things that Democrats supported anyways, and which President Biden ran on in his 2020 campaign.

If Congress enacted those changes, it may (or may not) stem further corporate tax avoidance. But it wouldn't bring the U.S. into OECD compliance–GILTI’s definition of income is different, and potentially less generous to taxpayers than Pillar Two’s.

The assumption, at least back in 2022, is that if Congress acted, other countries would agree to some kind of exemption for the U.S. This would deem GILTI as a compliant regime despite the remaining differences, recognizing that it was the first global minimum tax, enacted before Pillar Two was designed. (OECD officials stopped calling this “grandfathering” a few years ago, due to the connection with Jim Crow segregation.)

Now that we’re back to the drawing board, would this still be the game plan? Or is the expectation that the U.S. would pass the new OECD standards, in full?

Personally, I think the latter scenario would be unlikely, even if Democrats are in the driver’s seat. It would move beyond mere tweaks, to a comprehensive overhaul, and at a time when Congress would be juggling many different priorities in a legislative package. And Treasury, still finishing up the complex TCJA and IRA implementations, would hardly be enthusiastic about creating yet another whole new regime. In these kinds of situations, things tend to get pared down to what’s absolutely necessary, with “like-to-haves” and “nice-to-haves” cast to the side.

This is a point that I find often confuses people, even tax experts who follow this closely. When officials from Treasury or the OECD talk about U.S. compliance, many assume they’ll be talking about full compliance. Maybe they are–but are they thinking of how high a hurdle that could be?

On the other hand, how close will the U.S. need to be for OECD partners to consider special treatment? The back-and-forth over the under-taxed profit rule’s application to U.S. companies, along with the political fireworks and fiery condemnations from Republican lawmakers, may have muddied the diplomatic waters over the past 12 months. The OECD has already issued technical guidance to reduce the tax impact on specific credits, in response to U.S. lobbying–that may lead some negotiators to feel they’ve given the U.S. enough.

And, bear in mind, even if GILTI is deemed to be a compliant regime, that still won’t solve all of the problems. That’s because GILTI doesn’t apply to U.S. domestic income–so under the OECD rules it wouldn’t stop foreign countries from applying the UTPR on the U.S. income of U.S. taxpayers. In theory, Congress would need to enact a qualified domestic minimum top-up tax (QDMTT) to fully protect U.S. companies from UTPR taxes. (Which would be kind of a wash for U.S. companies, because all it means is that UTPR taxes are replaced by QDMTT taxes.)

The questions continue to abound. Would the OECD agree to some kind of expanded GILTI exemption that covers domestic income as well? Would they maybe consider the corporate alternative minimum tax a compliant QDMTT? CAMT has aspects of a QDMTT, but just about as many differences–it covers global income, and it carves out many of the credits that were left into Pillar Two, such as those for research and development.

And Congress may have to legislate in the blind, without a clear idea of how the OECD would respond.

So while a 2025 legislative resolution may seem like it would finally bring the Pillar Two discussion to a close, that would likely be a mirage. The diplomatic and political maneuvering would be far from over, and neither would the underlying policy debates over sovereignty, and how the international tax system should consider key incentives to bolster local economies.

DISCLAIMER: These views are the author's own, and do not reflect those of his current employer or any of its clients. Alex Parker is not an attorney or accountant, and none of this should be construed as tax advice.

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LITTLE CAESARS: NEWS BITES FROM THE PAST WEEK

• The tax world’s focus has shifted up north, as Canada forges ahead on its planned 3% digital services tax, despite strong pushback from seemingly everyone. The Canadian government proposed the tax, which targets revenue (instead of income) from select online activities, despite an agreement from 138 countries to hold off on DSTs for another year. Most recently, a bipartisan group of 41 members of the House Ways and Means Committee signed a letter blasting the levy. The open letter was sent not to Canada but to U.S. Treasury Secretary Janet Yellen, interim Ambassador to the OECD Karen Enstrom, and United States Trade Representative Katharine Tai. The letter also states that the tax “raises serious questions about its obligations under the United States-Mexico-Canada Agreement and the World Trade Organization Agreement”--a not-so-subtle hint that the U.S. should consider some kind of trade enforcement action. This is turning into quite the firestorm, eh?
• The U.S. Internal Revenue Service announced plans to hire 3,700 new agents who will focus on complex partnerships and large corporations. This is part of their stepped enforcement effort that is enabled by the Inflation Reduction Act’s $80 billion boost in funding, which through executive order cannot be used for audits of those earning less than $400,000 per year. This coincided with a commitment from IRS Commissioner Danny Werfel to reduce audits on commonly used credits like the Earned Income Tax Credit, in a letter to the Senate Finance Committee. These new agents will be spending a lot of their time on international issues, by definition–and last week the IRS outlined new priorities including compliance campaigns for digital assets (like cryptocurrencies) and enforcement of Foreign Bank and Financial Accounts (FBAR) requirements. All in all, there’s going to be a lot more agency focus on issues pertaining to multinational corporations and individuals with significant foreign assets, so it will be interesting to see how this affects global dynamics in the upcoming years.
• The OECD released public comments from stakeholders on “Amount B,” a proposal to simplify tax administration for baseline functions, in an effort to reduce compliance burdens for low-capacity jurisdictions. Many believe this could be one of the most enduring proposals in the Two-Pillar plan, because it’s relatively uncontroversial and addresses a clear need in the developing world. The corporate taxpayers who will be affected by this expressed a lot of support in comments–but they also urged that it be finalized as an elective safe harbor, and that more be done to ensure transparency and simplicity. Interestingly, many also pushed for the policy to include digital goods. It's unclear if the OECD will hold a public consultation over this, so stay tuned.

PUBLIC DOMAIN SUPERHERO OF THE WEEK

Every week, a new character from the Golden Age of Superheroes who's fallen out of use.

Atom Man, appearing first in Young Australian Comics #2 in 1946. Not to be confused with Atoman (who we've already used) or with the Atomic Thunderbolt, even though Atom Man's other nickname is The Human Thunderbolt. Rather than some nuclear accident, as is usually the case, Atom Man gets his powers--including "radar vision" and flight--from some contraption on his belt.

Contact the author at amparkerdc@gmail.com.