Questions Congress Should Ask About the OECD Two‐Pillar Plan
Congress should reinsert itself into the international tax debate. It should understanding how the OECD plan will affect U.S. taxpayers.
Earlier this week, I wrote about how the OECD has lost its way by advocating for higher and more complicated taxes and leaving behind its historical mission of global free‐market economic development. The Biden Administration has also used the OECD to circumvent Congress’ role in developing tax rules and signed the United States on to the OECD’s Two-Pillar plan to increase taxes on large multinational companies.
As the European Union and other countries begin to adopt the OECD rules, Congress will face continued pressure to follow their lead. However, Congress should resist these pressures and work to keep domestic taxes low, rather than sign on to an international effort to reverse the economic gains from the last several decades of tax competition.
In addition to exercising its power of the purse by withholding funding for the OECD, Congress should reinsert itself into the international tax debate by asking Treasury and the Congressional Budget Office detailed questions about how the OECD plans will affect U.S. taxpayers and American sovereignty.
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The Two‐Pillar Approach
In October 2020, the OECD released an outline for a “Two‐Pillar” approach to changing the international tax system—nearly 140 countries have signed on, including the Biden administration. The proposals are intended to more comprehensively tax the profits of multinational businesses by raising effective tax rates and reallocating taxing rights away from some countries and toward others. Pillar One aims to change where companies pay taxes, moving toward a system based on customer location instead of business activities. Pillar Two includes a series of new rules that enforce a global minimum tax of 15 percent.
Pillar One would reallocate a portion of the profits of large multinational companies to countries where customers are located rather than based on where the firms are headquartered or have a physical presence. This is done using a formula based on a company’s sales, marketing, and distribution in each jurisdiction, with a series of thresholds so that the rules generally apply to the largest and most profitable companies. The full agreement on Pillar One is still being negotiated, and many specifics are subject to disagreements between countries.
Pillar Two is made up of five main new rules that work together to enforce a global minimum tax rate of 15 percent on businesses with more than €750 million in revenues.
The qualified domestic minimum top‐up tax (QDMTT) is an alternative minimum tax to allow countries first right to tax their domestic entities at a 15 percent rate on a novel tax base defined by the OECD. The income inclusion rule (IIR) requires parent companies to include in their taxable income the profits of their foreign subsidiaries that have not been taxed at the minimum 15 percent rate.
The under‐taxed profits rule (UTPR) allows countries to increase taxes on a business if a related entity in another jurisdiction pays a tax rate below 15 percent. The UTPR creates a backstop for the QDMTT by allowing foreign countries to tax firm profits in other countries if tax rates are lower than the OECD minimum rate. Taxing rights are distributed using a formula if multiple countries make assessments under the UTPR.
The final two components include denial of tax treaty benefits to companies in non‐compliant jurisdictions and anti‐base erosion reporting rules on corporate structure, county‐by‐county income, taxes paid, and around 150 other similar data points.
These rules are intended to stop multinationals from doing business in low‐tax jurisdictions and increase taxes on the largest and most profitable international firms. The in‐scope firms are largely U.S.-based businesses. Ultimately, the rules proposed by the OECD are a dramatic departure from the current international tax system, and for policymakers and businesses alike, they pose more questions than answers.
Congress Needs Answers
The Two Pillar framework faces a number of significant technical and economic questions that Congress must ask. Some of these unanswered questions include the impact of the proposal on small and developing countries that may want to use their tax systems to attract new foreign direct investment, potential conflicts with existing tax treaties, and the compliance costs associated with new expansive reporting requirements that could open firms up to extensive audits across the world. The proposal could also lead to multiple taxation of the same business income, decreased business investment, and less international trade. The OECD has acknowledged many of these problems; however, the effectiveness of their solutions remains uncertain and untested.
It is also unclear how UTPR will affect the U.S. tax revenue, domestic business interests, and future efforts at domestic pro‐growth tax reform. The OECD’s own analysis of its proposal is based on data that is as much as five years old and does not clearly account for compliance costs.
Congress should understand how the OECD proposal will impact the U.S. government’s finances and American businesses. Accordingly, Congress should request that the Treasury and the Congressional Budget Office, in consultation with the Joint Committee on Taxation, complete independent evaluations of the OECD minimum tax preproposals. The following is a non‐exhaustive list of questions that still need complete answers.
If other countries implement a UTPR, how will American business tax liabilities change if U.S. law remains unchanged? How will this affect U.S. corporate tax revenue?
If other countries implement a QDMTT, how will American business tax liabilities change if U.S. law remains unchanged? How will this affect U.S. corporate tax revenue?
How do the Pillar Two rules interact with current‐law U.S. international tax rules in a way that could increase taxes paid? Are payments to other countries under QDMTT and UTPR creditable? Are there other potential avenues for double taxation of U.S. business profits?
Assuming no action from Congress, if other countries impose UTPR on U.S. businesses, how will Treasury respond? Does UTPR violate the permanent establishment clauses or any other portion of any existing U.S. tax treaty? If Congress adopted Pillar Two, what changes would be necessary to existing treaties? Has Treasury made clear to OECD signatories what U.S. law and treaties dictate if Congress chooses not to amend any tax treaties?
Assuming full global adoption of Pillar Two, how does U.S. revenue change if Congress also adopts Pillar Two? How does U.S. revenue change if Congress adopts Pillar One?
If Congress imposes a UTPR and there is a dispute between Treasury and another jurisdiction over profit allocation, how will OECD dispute determinations be enforced? How could enforcement problems undermine Pillar Two’s design? How could lack of credible enforcement undermine Pillar One’s design, particularly concerning the reimposition of domestic digital services taxes?
What are the potential audit risks and compliance costs of the Pillar Two anti‐base‐erosion reporting rules for U.S. businesses? Do the rules pose any risks to intellectual property theft or financial privacy? What will be the compliance costs of all the Pillar Two rules on American businesses?
Are there any existing tax credits or deductions, such as Opportunity Zones, 1031 Exchanges, Low‐Income Housing Tax Credit, or Advanced Manufacturing Investment Credit, that might be limited under the Pillar Two tax base?
How will the Pillar Two rules impact state corporate tax incentives and revenues?
What happens to compliance costs and effective tax rates if other countries do not implement the Pillar Two rules uniformly?
How would adopting the Pillar Two agreement constrain future efforts to change U.S. business taxes? What types of investment incentives, preferential rates, or tax credits would be clawed back by the minimum tax?
How might multination firms and low‐tax jurisdictions exploit the Pillar Two rules in technically compliant ways but counter to the spirit of the agreement, such as applying a QDMTT to in‐scope firms and using the revenue to provide non‐tax and otherwise compliant state subsidies to firms locating in their jurisdiction?
What are the potential economic consequences of the agreement, including its impact on investment, innovation, and job creation in the United States? How will these effects differ across industries and states?
Congress does not have to allow U.S. tax policy to be dictated by OECD bureaucrats in Paris. No tax system levied by hundreds of nations will ever be perfectly implemented or uniformly tax corporate profits equally across industries and countries. These gaps in the tax system have numerous economic benefits, but they will also continue to motivate additional consolidation and centralization of international tax rules. The Two‐Pillar approach will not solve the revenue problems of large European welfare states or convince everyone that multinational companies are finally paying their “fair share.” Instead, the current OECD proposal is another step toward undermining national sovereign taxing authority. The OECD is building the tools for future frameworks that will further strip individual countries of their ability to design tax systems to attract business and compete for global talent.
Congress should credibly commit to rejecting the OECD Two‐Pillar proposal, withdraw U.S. funding for the OECD, and pursue pro‐growth tax and spending reforms that attract multinational companies to invest in the U.S. At a minimum, Congress should understand how the changes being proposed will impact American taxpayers.