The US played a key role in encouraging 136 countries to sign a global tax accord unveiled by the OECD last October and hailed as the most important tax reform in more than a century.
But it has become clear in recent days that the way Washington intends to implement one of the two parts of the proposals, a corporate tax floor of 15 percent, is at odds with how the agreement works in other places.
The simplified version of Joe Biden’s tax plans that were contained in the Inflation Reduction Act, the White House’s flagship economic legislation that narrowly passed the Senate last week and is expected to pass the House of Representatives this week, misses key elements of the agreement signed in Paris.
This has raised concerns that multinationals will face a web of complexity that will see them struggle to comply with a set of rules designed to ensure they pay a fairer amount of tax. “Every company wants that alignment that they’ve been working towards, but now it’s not what they thought it would be,” said Kate Barton, global vice president of tax at accountancy firm EY. “Now are all countries going to do their own thing?”
Where does the Inflation Reduction Act fall short?
Global minimum tax rules, as set out by the OECD, require multinational companies with annual revenues of more than €750 million to pay an additional tax at an effective rate of 15 percent in all countries where they operate.
That part of the deal, known in tax circles as “Pillar Two,” is designed to “stop what has been a decades-long race to the bottom in corporate taxation,” as the U.S. Treasury secretary put it. United, Janet Yellen, when the agreement was signed.
In order to align the US with pillar two, the Biden administration originally proposed reforms to the US’s low-tax intangible global income (or Gilti) regime. Under Gilti, an additional tax of approximately 10.5 percent currently applies to the profits of subsidiaries of US companies located in low-tax jurisdictions.
Gilti was introduced in the U.S. in 2017 to prevent American companies from shifting profits overseas, and Biden’s original proposal was to raise the Gilti rate to 15 percent to bring the U.S. into line with the deal. OECD.
These proposals failed to pass the Senate, however, with Joe Manchin, the West Virginia Democrat who was crucial to the passage of the Act, calling for its removal.
Instead, a minimum corporation tax of 15 percent will only apply to the “accounting income” (the amount shown in the financial accounts) of companies with revenues of more than $1 billion. It will also only apply at group level, rather than country by country, failing to achieve the agreement’s aim of eliminating the practice of setting up subsidiaries in tax havens.
It is “doubtful” that what is in the act will be considered compatible with the global minimum tax, said Ross Robertson, international tax partner at accountancy firm BDO.
“Ultimately, it could increase the complexity for international companies in applying the rules once they come into force, or worse, it could increase the risk of double taxation,” Robertson added.
How can other signatories respond?
Peter Barnes, a tax specialist at the Washington law firm Caplin & Drysdale, called Congress’s alteration of Biden’s tax proposals “disappointing” but “certainly not fatal” to the deal.
One reason is that if the US implements the 15 percent floor rate as detailed in the act and not in the agreement, other taxing authorities could extract more revenue from US companies for them same This is because the agreement includes a complex mechanism that allows other countries to effectively impose a tax of up to 15 percent on the income of a subsidiary located there if, as is the case in the US, the country of ‘origin of the parent company does not. impose an additional tax.
“The[4.5 percentage point]The difference between Gilti’s 10.5% rate and 15% will be captured by other jurisdictions,” explains Reuven Avi-Yonah, a law professor at the University of Michigan.
Pascal Saint-Amans, director of tax administration at the OECD, said: “When you think seriously about [the design of] Pilar Segon you realize it will happen anyway.”
Barnes agrees and believes that US multinationals can push Congress to apply the second pillar in a way closer to that agreed upon in the OECD.
However, progress towards the implementation of the global minimum tax has lagged across the board, with not all countries having yet passed its legislation, despite initially pledging to do so by the end of 2022.
What is causing the delays elsewhere?
The EU issued a draft directive to implement Pillar Two in December, but political divisions have failed to secure unanimous approval from member states. Hungary, a member state often at odds with Brussels, is currently blocking progress.
The remaining 26 European countries can implement the second pillar without Hungary, however, enshrining it in their own domestic legislation.
“There is a lot of political will in Europe to push forward,” Robertson said, adding that he expected most of Europe to implement the second pillar from January 2024.
Once the EU moves forward, other countries will likely follow suit to avoid losing the extra taxes.
The other part of the agreement, Pillar One, which aims to make the world’s largest multinationals pay more taxes in the countries where they sell, lags even further.
While the delays and setbacks have proven frustrating for those desperate to see companies pay their fair share, professionals stress how critical the deal reform is.
“We actually need to design a whole new global tax base,” said Heydon Wardell-Burrus, a researcher at the Oxford Center for Business Taxation.