U.S. Against the World: An Analysis of How the U.S. Could React to a Global Minimum Tax

by Ross Chambers, Associate Member, University of Cincinnati Law Review Vol. 92

I. Introduction

The digitalization and globalization of the world economy has brought both immense benefits and challenges as companies try to expand their international markets. As large multinational enterprises (“MNEs”) expand their global presence, their ability to avoid taxation is expanding. For example, one of the most prominent companies expanding on a global scale is Amazon. In 2021, Amazon’s international sales accounted for 31% of net sales, or roughly 1.3 billion dollars.¹ In that same year, Amazon had an effective tax rate of roughly 12.5%, a rate much lower than the corporate tax rate of the United States and most European countries.² To combat the growing public concern regarding international tax avoidance, the Organization for Economic Co-operation and Development (“OECD”) developed an Inclusive Framework (“IF”) to address tax avoidance by MNEs.³

This article discusses the potential impact of the IF on the economy on the United States and the routes United States policy makers may take in retaliation to countries passing certain provisions of the IF. Part II explores the background of the IF and breaks down relevant tax policies proposed in the IF and relevant United States tax statutes that could be impacted. Part III discusses the impact the IF could have on the United States economy and the potential policies the United States adopts to address the IF.

II. Background

Tax avoidance is the lawful activity of someone reducing their taxes owed.⁴ MNEs have developed a variety of different ways to lower their tax liability. One of the most well-known techniques is a strategy called the Double Irish arrangement. Under this strategy, a United States company will set up one Irish company with its principal place of business in a pure tax haven.⁵ The United States company will then license its intellectual property (“IP”) to the first Irish subsidiary.⁶ The first Irish subsidiary then sub-licenses the IP rights to a Dutch shell company.⁷ The Dutch entity then sub-licenses the IP rights to a second Irish company who finally sub-leases the rights to the U.S. company.⁸ This allowed MNEs to significantly reduce their effective tax rate on income earned outside the United States. This scheme was used by large MNEs to avoid both United States income tax and European Union withholding tax on large sums of earnings.⁹

For example, in 2018, Google used the scheme to move $24.5 billion effectively tax-free.¹⁰ To address the growing public concerns about tax avoidance by MNEs the OECD drafted a Two-Pillar Solution.¹¹ The goal of the solution is to reduce global tax avoidance by implementing a global minimum 15% corporate tax rate.¹² Currently, 140 countries, including most major economies, have nominally agreed to adopt and implement the IF within a set timeframe.¹³ The OECD recommends that countries adopt most of the provisions of Pillar Two between 2023 and 2024.¹⁴

Several major economies, including several of the United States’ economic allies, have passed or introduced legislation that would apply the rules found in Pillar Two.¹⁵ For example, both South Korea and Germany have introduced legislation to implement key provisions of Pillar Two by the end of 2024.¹⁶ Congress is currently debating how and if Pillar Two should be adopted by the United States. The Treasury Department has signaled a willingness to reform the United States tax system to be consistent with Pillar Two.¹⁷ However, Republicans on the Ways and Means Committee have opposed Pillar Two adoption,¹⁸ and take issue with the Treasury Department engaging in tax reform debate with other countries without the approval of Congress.¹⁹

The IF is broken out into two Pillars. Pillar One of the OECD Plan attempts to change the international tax system through changes in the profit allocation of businesses.²⁰ The key provisions of Pillar One only apply to companies whose revenue exceeds €20 billion and has a profit margin greater than 10%.²¹ Under Pillar One, a market jurisdiction would have the right to be tax based on their sales made in that jurisdiction, even if the company had no physical presence.²² The most novel aspect of Pillar One is called Amount A, which is the amount of residual profits that a market jurisdiction may tax.²³ The amount of residual profits that are taxable would be determined by a complex formula established by the OECD.²⁴

The main way that the OECD hopes to reduce tax avoidance by MNEs is through Pillar Two. The primary goal of Pillar Two is to establish a global minimum 15% corporate tax rate.²⁵ Under Pillar Two, a company with at least €750 million in revenue must calculate its Global Anti-Base Erosion Rules effective tax rate (“GETR”) in each jurisdiction it operates in.²⁶ Pillar Two achieves this by implementing a number of different tax provisions to ensure MNEs pay a 15% effective tax rate.²⁷

The first method is through a qualified domestic minimum top-up tax (“QDMTT”).²⁸ A QDMTT is a top-up tax that would be applied to a country’s domestic companies that fall under the scope of Pillar Two.²⁹ The goal of the QDMTT is to keep the taxes within their relevant jurisdiction.³⁰ For example, if a company within the scope of Pillar Two is not subject to a 15% effective tax rate, the country where that tax revenue is due has the right to impose additional taxes. If a country does not impose a QDMTT that achieves the proper effective tax rate, the next applicable provision is the Income Inclusion Rule (“IIR”)³¹ Under the IIR, if a parent company has a foreign subsidiary in a low-tax jurisdiction, they would be subject to a top-up tax on that portion.³² Finally, if a MNE still does not achieve a 15% effective tax rate, countries may implement the undertaxed profits rule (“UTPR”).³³ The UTPR is also the provision receiving.³⁴ The UTPR imposes a top-up on companies if their parent company does not have to pay a 15%.³⁵ The UTPR is intended to act as a final measure if a country where a parent company is located.³⁶ Under the UTPR, if a MNE’s profits are not subject to either a QDMTT or IIR and are not taxed at 15%, any company within the umbrella of the MNE can be taxed by their appropriate jurisdiction until a 15%.³⁷ Under the UTPR, because a MNE is not subject to certain taxes in one jurisdiction, they could be subject to an increase in taxes in another jurisdiction.

III. Discussion

With many of the provisions of the Tax Cuts and Jobs Act (“TCJA”) set to expire in 2025, tax reform will be on the minds of Congress in the coming years. Pillar Two, and the impact it will have on United States MNEs will likely drive many of the policy decisions made by Congress. Changing United States tax law to account for an increase in global taxes could mitigate some of the consequences of an increase in tax rates. One of the primary ways Congress could achieve this is by reforming the tax provisions related to global intangible low-taxed income (“GILTI”). GILTI applies an effective tax between 10.5% to 13.125% on income generated from intellectual property held in foreign jurisdictions.³⁸ Currently, under GILTI, United States MNEs are allowed to take a tax credit on taxes paid to foreign jurisdictions.³⁹ However, the tax credit is limited to 80% of the foreign taxes paid.⁴⁰ This 80% limit is often called the GILTI haircut. Eliminating the GILTI haircut and allowing companies to take the full tax credit on foreign taxes paid would have positive and negative consequences. If the United States does not adopt Pillar Two legislation, it would allow MNEs to offset more of their tax liability. Additionally, eliminating the GILTI haircut would eliminate double taxation of a company’s profits. Under the current GILTI regime, because a MNE is only able to take a tax credit on 80% of their foreign taxes, there is still 20% of income taxed in a foreign jurisdiction then subject to United States taxation. However, eliminating the GILTI haircut could lead to reduced United States tax income if MNEs are able to take larger credits.

Some United States policy makers, including the Chairman of the House Ways and Means Committee, Jason Smith, have pushed back against countries that plan to adopt Pillar Two.⁴¹ These policy makers have two primary issues with adopting Pillar Two. First, they are concerned about the impact the UTPR would have on the United States economy and job market.⁴² Second, they argue the United States Treasury Department does not have the ability to negotiate tax policy on behalf of Congress and all tax policies should be dictated by Congress.⁴³ These policy makers have announced various steps they might take in retaliation to adoption of Pillar Two by various countries.⁴⁴ However, passing these measures would likely require one party to control the House, Senate, and Presidency.⁴⁵

The first piece of potential retaliatory action is the Defending American Jobs and Investment Act (H.R. 3665).⁴⁶ This legislation, proposed by Jason Smith, attempts to address concerns regarding the UTPR.⁴⁷ Under this proposed legislation, the Treasury Department would be required to make a list of countries that impose extraterritorial taxes, such as the UTPR.⁴⁸ The legislation would then institute an escalating tax rate on corporations whose home country implements, and does not repeal, such a tax.⁴⁹ This would cause a dramatic increase in corporate tax rate on subsidiaries of a foreign corporation that are based in the United States.⁵⁰ For example, after four years, a United States subsidiary would be subject to a 41% corporate tax rate.⁵¹ This policy response is unlikely to gain the necessary votes to pass, even if Republicans control the House, Senate, and Presidency.⁵² Democrats would likely prefer to pursue the path of Pillar Two and many Republicans would likely be wary of increasing the corporate tax rate by 20%.⁵³

Retaliatory tariffs against countries who impose a policy similar to the UTPR are also being discussed. For example, the Trump administration attempted to impose a tariff on France in relation to a proposed digital services tax.⁵⁴ The proposal would have imposed a 25% tariff on $1.3 billion French goods.⁵⁵ At the time, the French Finance Minister indicated that the European Union could impose tariffs in retaliation to United States tariffs.⁵⁶ Instituting tariffs on countries that adopt the UTPR, or a similar law, would likely not be effective. Most counties in the European Union have signaled they plan to adopt Pillar Two, meaning the tariffs would need to be imposed against all EU member states.⁵⁷ As a result, the companies will likely pass down the cost of the tariff to the consumer.⁵⁸ Additionally, as the United States attempts to maintain its position as the leading economic power, it would be unwise to start a trade war with its largest trading partners. Initiating a trade war with the European Union could further strengthen the relationship between the European Union and China.

IV. Conclusion

With growing globalization, the question of who gets to tax certain income is becoming a more prevalent issue. The provisions in Pillar Two that address global tax issues could have a negative impact on multinational enterprises in the United States. As more countries adopt the provisions of Pillar Two, the greater the risk that the United States takes retaliatory measures leading to potential trade wars and costing the United States economy billions of dollars.

Cover Photo by Alan Cleaver on Flickr

Ross Chambers

Ross Chambers is a 2L at the University of Cincinnati College of Law. Ross received a Bachelor of Science in both Accounting and Finance from the University of Tennessee at Chattanooga. He spent two years working in corporate income tax for an insurance company. Ross joined the Law Review to write about issues in tax and corporate law.

References

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I. Introduction

II. Background

III. Discussion

IV. Conclusion

Author

References