Widening the Pillar Two Exemptions

Donald Trump’s recent electoral victory is forcing everyone to reconsider the world, or at least what they thought they knew about it.

The biggest question on everyone’s mind in international taxes is, what does this mean for Pillar Two? Technically, the 15% global minimum tax agreed to at the Organization for Economic Cooperation and Development began in his first administration. But while he himself hasn’t said much about it since, Republicans have been vociferous in their opposition, and will no doubt look for ways to undermine or oppose the system as it begins its first few years.

Will this be the end of it? Normally, U.S. opposition is enough to kill or significantly diminish a project at the OECD. We’re the 800-pound gorilla that they’d prefer to keep inside the tent, no matter how much they have to water things down to do so. (To use a tortured but vivid mixed metaphor.)

But this isn’t just any OECD project, it’s one that was agreed to three years ago and has already been enacted into many countries’ laws. Those countries often have parliamentary systems where legislative changes are easier to enact than the glacial U.S. Congress–but they still can’t turn things around instantly. For that matter, many of those countries are already counting on new revenue from these tax tools. Even if they fear U.S. retaliation, they'll be reluctant to reverse course.

So while the OECD winning over a reinvigorated Trump administration seems like a longshot, it’s even less likely that Pillar Two will be gone for good. That presumably leaves some room for jockeying and negotiation. But it will be happening in a climate of increased U.S. unilateralism and heightened economic tension. Trump’s not necessarily against making a deal–it’s even part of his brand–but it’s going to have to be on his terms.

I’ve floated the idea that Trump’s win could increase the odds that other OECD nations will agree to some alterations that would make Pillar Two less onerous for U.S. businesses. This could even be something the Biden Administration tries to push through in its final days, although I have no idea if that is realistic or being considered. These alterations could include a safe harbor for applying the undertaxed profits rule that countries apply on companies based in jurisdictions that don’t comply with the Pillar Two standards. (As the U.S. currently doesn’t.) They could go even further and agree to tweaks that would treat expenditure-based tax incentives, such as the U.S. credit for research and development, more favorably.

This seems likelier to me, but I have no idea what the current odds are. One thing that’s important to remember, though, is that none of the changes currently under discussion would be able to give the U.S. some blanket exemption from the UTPR or Pillar Two. While they would soften the impact, they’d still leave some risk of increased taxes–as well as compliance requirements for companies to manage that risk, which could be the bigger cost.

So while the parties could reduce the grounds for a trade war, they couldn’t totally eliminate it–which could make a trade war all but inevitable.

One reason for hope is that the OECD has already agreed to tweaks in the Pillar Two formula which favored some U.S. policies. In February 2023 they granted better treatment for arrangements used for low-income housing credits, and in June 2023 they made a similar change for transferable tax credits, like the green energy credits enacted by the 2022 Inflation Reduction Act.

For simple conversational terms, especially among those who aren’t tax wonks, these will sometimes be referred to as “exemptions” for those activities. But they’re not. Both housing and green energy credits can still lower a company’s effective tax rate under Pillar Two’s formula for income, potentially triggering the UTPR or other tax rules in the system if the income tax rate drops below 15%.

What the OECD agreed to was to treat these credits as an increase in income, rather than a decrease in taxes. They could justify this as being part of “implementation,” rather than a policy change–it’s just “clarifying” how the income rules work in some ambiguous situations. (To be fair to the OECD, some of these questions were ambiguous, especially because the income measure was based on accounting rules which are often being revised.)

While the increased income/decreased taxes distinction may seem like semantics, it can be a significant alteration. I’ll spare you the math here, but just pick some random numbers and try it for a 20% reduction and you’ll see. Switching an increase in income to a decrease in taxes can increase the amount of Pillar Two liability exponentially.

It was a good break for those who invest in housing, or who want to begin production with green energy. And if the OECD extended similar treatment for the R&D credit–what’s been floated is to treat all expenditure-based (rather than income-based) credits this way–it would be a nice break for companies that do a lot of research and development.

But even with this break, and even with the substance-based carveout which would likely help companies in R&D-heavy industries, the risk isn’t totally gone. And since the amount of money being spent and the profits being derived could be astronomical in these industries, there almost certainly will be cases where Pillar Two still applies.

Perhaps more importantly, companies will have to prepare for this risk, which means tracking their Pillar Two numbers alongside all of their other tax and accounting systems. Many tax practitioners have said that this is the real cost of Pillar Two, even if they ultimately don’t have to pay more.

If it’s possible to institute more changes–a big if–that would only be the first step. It would take some creative design-work and negotiating to devise some kind of safe harbor or broader exemption to truly limit instances when Pillar Two applies to U.S. income to true cases of true profit-shifting. That was kind of the original idea–when first drawn up years ago, it was mainly supposed to stop inversions to clear tax havens that defy the OECD and refuse to implement any kind of minimum tax regime. But, a lot has changed since 2019.

Quite a lot.

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

• There’s been such a flurry of news in D.C. over the past week, it’s hard to know where to even start. The sweepstakes to be Janet Yellen’s replacement as U.S. Treasury secretary has taken some unexpected swings–Howard Lutnick, a leading contender, was announced as the Commerce secretary nominee yesterday, presumably a consolation prize after Trump ruled him out. As of this writing–although it could very well have changed by the time you’re reading–former Federal Reserve governor Kevin Warsh is the new name. It’s a surprisingly well-respected and establishment-friendly pick, and may be a bid to ease markets as Trump pursues his tariff agenda. (Technically, Treasury doesn’t control tariff policy, anyways.) But if appointed and confirmed, Warsh, who’s criticized tariffs in the past, could be a voice of moderation on Trump’s unilateral, protectionist impulses. And he’s not necessary against multilateralism either. Among his recent pieces is one calling for a new “economic and security commons,” led by the U.S., for global prosperity. He could well be a sign for hope at the OECD.
• Speaking of which, the G-20 finished its annual meeting in Brazil this week, issuing a communique which, as always, touched on tax policy. Aside from offering diplomatic support for both the OECD and the U.N. in their tax projects (while also warning against duplicative efforts), the document also urges cooperation to ensure that “ultra-high-net-worth individuals are effectively taxed.” That’s a little vague, as it could be read to just be supporting existing information exchanges to enforce rules against evasion or to call for a new Two-Pillars-like project on wealth taxation. But it garnered high praise from tax advocacy groups and comes as Brazil itself is pursuing a wealth tax. Of course, the chances of the U.S. pursuing new taxes on the ultra-wealthy or wealth itself have never looked longer.
• Continuing on its work in the climate policy space, the OECD issued a report last week on greenhouse gas emission pricing, which found that the taxation of carbon usage has declined somewhat while becoming more concentrated between 2021 and 2023. The OECD also notes increased focus on carbon border adjustments, addressing “leakage” and arbitrage of the vast differences in individual jurisdictions.

I mentioned this before, but since this summer I've been working as an independent consultant/freelancer on international tax issues. If you think I might be able to help you--with writing or advice on these topics, for instance--please let me know, you can reach me at amparkerdc@gmail.com.

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