Hercules was known for holding the world on his shoulders, but it seems he really held the sky on his shoulders instead of Atlas, in exchange for three golden apples.
Recently, US President Joe Biden made a similar feat. He was unable to persuade Congress to change US tax law to 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, prompting the OECD to adapt Pillar 2 to existing US tax law. The impact on the Treasury will be much more than three golden apples, and it will affect us all.
On February 1, the OECD approved “administrative guidelines” that bridged some gaping gaps between the OECD Pillar 2 proposals and US legislation. The result will be a minimum corporate tax rate of 13.25% in the US and 15% in 140 other OECD member countries.
The OECD also has a Pillar 1 initiative, but it is floundering. It proposes to shift some offshore profits back to the country, but developing countries want a bigger share of the profits.
All eyes are on Pillar 2. Does it matter if a multinational company pays a minimum of 15% income tax in Africa or Europe? It does Biden; he wants the US to pick up some of that 15% minimum tax.
Illustrative image of doing taxes. (credit: PXHERE)
Understanding the US-OECD tax debacle
The US almost fell victim to some tricky Pillar 2 rules. The OECD Pillar 2 rules include an additional tax of 15%. Suppose company a in country A owns subsidiary company b in country B. If the tax rate in B is only 12.5% (as in Ireland and Cyprus), then A can collect an additional tax of 2.5% from a to tax the profit of b to the minimum of 15%.
But what if A does not actually collect the 2.5% under Pillar 2 rules? Then it seems that Countries C to Z will soon be able to collect up to 15% tax by refusing expense reimbursements. This falls under an Under Taxed Profits Rule.
If A is the US, will countries B to Z soon spoil 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 is already causing problems for US citizens who are olim and own an Israeli company.
Under GILTI, profits from non-U.S. affiliates are apparently “mixed” into one combined pot for U.S. tax purposes to determine whether the average tax rate exceeds a minimum rate of 13.125%. Pillar 2, on the other hand, will soon impose a global minimum tax rate of 15% per country and not one mixed pot that can protect offshore profits against onshore profits. Both Pillar 2 and GILTI apply to active foreign gains and not just passive investment gains.
If nothing had been done, payments from non-US companies to US companies would have been subject to double minimum taxes: 15% in the paying country and 13.125% in the US.
So, the OECD’s “administrative guidance” solves the double minimum tax problem in all 141 OECD-affiliated states by recognizing the US GILTI tax regime – provided US groups make a few adjustments to change GILTI when reporting in other states.
Essentially, the US groups must decouple global profits and allocate them to each country in proportion to: (1) profits in each country; and (2) the extent to which the tax rate in each country remains below 15%.
Example: If a US group derives profits from a preferential business in Jerusalem or Sderot that is taxed at only 7.5%, then part of Israel’s tax deficit of 5.625% (13.125% minus 7.5%) should be reflected in the adjusted US GILTI tax calculation for OECD Pillar 2 purposes.
What does a middle-low tax country like Israel do? It could soon consider raising preferential corporate tax rates to 13.125% or 15%. The government is formulating an international tax reform. Right now, Israel has other things on its plate.
It seems likely that many countries will adopt Pillar 2 in 2024. Pillar 2 will apply internationally to groups with global annual sales of more than €750 million, but individual countries are free to set a lower threshold. There is not much time to prepare.
In specific cases, as always, consult experienced advisors in each country at an early stage.
The writer is a chartered accountant and tax specialist with Harris Consulting & Tax Ltd.