Hercules was famous for holding 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.
Recently, US President Joe Biden 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. The OECD proposal is called “Pillar 2” (see below). So, Biden effectively held the world on his shoulders, moving the OECD to adapt Pillar 2 to fit in with existing US tax law. The impact on the Treasury will be much more than three golden apples, and it will impact us all.
On February 1, the OECD approved “administrative guidance” that bridged some yawning gaps between the OECD Pillar 2 proposals and US law. The result will be a 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 it is floundering. It proposes to shift some offshore profits back onshore, but developing countries want a bigger slice of profits.
All eyes are on Pillar 2. Does it matter if a multinational enterprise pays a minimum of 15% income tax in Africa or Europe? It does to Biden; he wants to see the US pick up some of that 15% minimum tax.
Understanding the US-OECD tax debacle
The US nearly lost out due to some tricky rules in Pillar 2. The OECD Pillar 2 rules include a 15% top-up tax. Suppose Firm a in Country A owns subsidiary Firm b in Country B. If the tax rate in B is only 12.5% (as in Ireland and Cyprus), then A can collect a top-up tax of 2.5% from a to top up the tax on b’s profits to the 15% minimum.
But suppose 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 Under Taxed Profits Rule.
If A is the US, will Countries B to Z soon clobber it with those 15% UTPR taxes? The US 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 olim who have an Israeli company.
Under GILTI, profits of non-US affiliated companies are apparently “blended” into one combined pot for US tax purposes to determine 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 and not one blended pot that can shelter offshore profits against onshore profits. Both Pillar 2 and GILTI apply to active foreign profits and not only passive investment profits.
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% in the US.
So, the OECD “administrative guidance” solves the double minimum-tax issue in all 141 OECD-aligned states by recognizing the US GILTI tax regime – provided US groups make a few tweaks to modify GILTI when reporting in other states.
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.
Example: If a US group derives profits from a preferred enterprise in Jerusalem or Sderot that is taxed at only 7.5%, then some of the Israeli tax shortfall of 5.625% (13.125% minus 7.5%) should be reflected in the tweaked US GILTI tax calculation for OECD Pillar 2 purposes.
What does a medium-low tax country such as Israel do? It might soon consider raising privileged enterprise tax rates to 13.125% or 15%. The government is formulating an international tax reform. Right now, Israel has other things on its plate.
Many countries seem likely to adopt Pillar 2 in 2024. Pillar 2 will apply internationally to groups with global annual revenues above €750 million, but individual countries are free to adopt a lower threshold. There isn’t much time to prepare.
As always, consult experienced advisers in each country at an early stage in specific cases.
leon@h2cat.com
The writer is a certified public accountant and tax specialist at Harris Consulting & Tax Ltd.