July 12, 2021
International Tax Proposals Addressing Profit Shifting: Pillars 1
and 2
On June 5, 2021, finance ministers of the G7 countries,
services, or sales of data), while proposed changes in the
including the United States, agreed in a communiqué to two
taxation of profits are being discussed. The United
proposals addressing global profit shifting. They agreed to
Kingdom (UK) enacted a diverted profits tax with a similar
Pillar 1, allocating rights of taxation of residual profits to
objective. The United States has decided to impose tariffs
market countries of at least 20% for certain digital services
against seven countries that imposed digital excise taxes:
for large profitable multinationals while eliminating digital
France, Austria, India, Italy, Spain, Turkey, and the UK,
services taxes. They also agreed to Pillar 2, imposing a
although these tariffs were temporarily suspended until
global minimum tax of at least 15%.
November 29, 2021, to allow time for further negotiations.
These proposals were developed in OECD/G20 blueprints
Pillar 1 would allocate some rights to market countries to
for addressing profit shifting and base erosion, which
tax profits of digitalized firms (and countries would
involved participation by 139 countries. The G7 agreement
eliminate their digital services taxes). In 2020, then-
is a general agreement and does not address the detail in
Secretary of the Treasury Steven Mnuchin signaled the U.S.
these blueprints. This G7 communiqué is a first step in the
position that negotiations over Pillar 1 were at an impasse.
process of reaching a multilateral agreement and is not
The G7 agreement reversed that position.
binding. Some aspects might require legislative changes.
The OECD reported on July 1, 2021, that 130 countries
The Pillar 1 blueprint would allow market countries a s hare
have joined the framework. On July 10, the G20 endorsed
of 20% of the residual profits (defined as profits after a
the plan.
10% margin for marketing and distribution services) of
large multinational companies. As noted earlier, this
The agreement does not mention a specific revenue
agreement does not have force of law and is viewed as a
threshold, but the OECD in another initiative had proposed
first step. The proposal would allocate the residual share
a threshold for country-by-country reporting of €750
based on revenues (such as sales of advertising) and the
million. The next two sections discuss the two pillars as
location of the user or viewer for an array of digital services
outlined in the OECD/G20 blueprints.
and split the residual share 50:50 between the location of
the purchaser and seller for online markets. The OECD/G20
Pillar 1
blueprint provides a positive list of the businesses covered:
The standard international agreements historically have
“sale or other alienation of user data; online search engines;
allocated the first right of taxation of profits to the country
social media platforms; online intermediation platforms;
where the asset is located. This location may be where the
digital content services; online gaming; standardized online
asset is created (e.g., from investment in buildings,
teaching services; and cloud computing services,” as well
equipment, or research) or where the rights to the asset have
as online market places.
been purchased, which may happen easily with intangible
assets, such as drug formulas or search algorithms. Many
This agreement is viewed as a fundamental departure from
U.S. multinationals have sold the rights to intangible assets
the traditional allocation of the first right of taxation to the
to affiliates in other countries to serve the foreign market.
owner of the asset, which is consistent with the economic
This system allocates profits between related parties on the
concept of profits as a return to the investor and not to the
basis of arm’s-length prices (i.e., the price upon which a
consumer.
willing buyer and a willing unrelated seller would agree to
transact), although true arms-length prices often are
Although the Pillar 1 proposal does not conform to the
difficult to determine.
traditional framework, it could serve the purpose—if
agreement is reached—of heading off unilateral action, as
With the advent of companies providing digital services
has developed with the digital services taxes. From the
that are often free services to consumers (such as search
viewpoint of the United States, which has large
engines, online market places, and sites for social
multinational digital firms (e.g., Google and Facebook), the
networking), an argument has been made that the country
arrangement could be costly. The excise taxes that would be
where the users reside should have a right to tax some of
eliminated are borne largely by the customers; that is, an
the profits of these companies because the users create
advertising tax decreases the net price from sales and would
value. Advocates also argue that these companies escape
lead to higher prices to advertisers, which would in turn be
taxes on some of their profits by locating assets in tax
reflected in higher product prices to customers who are
havens. Several countries have imposed digital services
largely in the country imposing the excise tax. Were
taxes, although generally in the form of excise taxes (such
countries unilaterally to impose taxes that are tied to profits
as taxes on advertising revenues, digital sales of goods and
without an agreement, under proposed regulations, U.S.
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International Tax Proposals Addressing Profit Shifting: Pil ars 1 and 2
multinationals would not receive a U.S. foreign tax credit,
Donald J. Marples for a discussion of GILTI and other tax
and the burden would fall largely on the profits of these
provisions enacted in 2017.)
firms. With a multinational agreement such as in Pillar 1,
the U.S. foreign tax credit presumably would be allowed for
GILTI is similar in some ways to the minimum tax that
these taxes (unless Congress intervenes), which would
would be imposed by GLoBE under the IIR. It imposes a
reduce revenues for the U.S. government, and the burden
tax at a lower rate (currently half the U.S. rate, or 10.5 %)
would fall on U.S. persons in general.
to income in excess of a deemed return of 10% of tangible
assets. The rate is scheduled to rise to 13.125% after 2025.
U.S. companies may prefer this substitution of Pillar 1 for
In addition to the lower rate, three other features of GILTI
the digital services taxes, as they likely would not see a tax
differ from the IIR. First, although the fixed return for
effect (since the taxes collected by the market countries
substantive assets in GLoBE has not been specified, it
would be largely offset by foreign tax credits), and they
applies to a broader range of spending that includes payroll
would be freed from the uncertainty and complexity of
as well as tangible assets. Second, GILTI achieves the “top-
digital services taxes.
up” tax by imposing the full tax and then allowing credits
against the GILTI tax for 80% of foreign taxes paid, up to
Also, the United States may have an interest in maintaining
the amount of U.S. tax due. This limit is imposed on a
harmonious relationships with the rest of the world, which
global basis so that unused credits in high-tax countries can
may justify the loss of revenues. The acceptance of Pillar 1
offset U.S. tax due in low-tax countries; the IIR would
also has been tied to establishing a global minimum tax
apply on a country-by-country basis. Finally, the IIR would
under Pillar 2, which would discourage the so-called “race-
allow carryforwards of losses and excess taxes, which is not
to-the-bottom” as countries lower tax rates to attract capital.
allowed under GILTI.
Pillar 1 probably can be adopted without changing the tax
The Administration budget proposals and several
code, although it would require changes in treaties.
congressional proposals would raise the GILTI rate,
eliminate the deduction for tangible assets, and limit the
Pillar 2
credit on a country-by-country basis. (See CRS In Focus
Pillar 2 would impose a global minimum income tax to
IF11809, Trends and Proposals for Corporate Tax
address base erosion, or GLoBE. It includes an income
Revenue, by Donald J. Marples and Jane G. Gravelle for a
inclusion rule (IIR) to raise the effective tax rate on a
summary.)
country-by-country basis to 15% on profits in excess of a
fixed return for substantive activities (including tangible
The OECD blueprint recognizes the coexistence of GILTI
assets and payroll). This rule is termed a top-up tax. The
and certain problems that may arise and concerns if GILTI
income base is financial profits. These taxes would be
were to be limited by future legislation.
imposed by the parent company. In cases where the IIR
does not apply, there is a subsidiary rule to tax payments to
An advantage of a global minimum tax is that it could
low-tax countries (the undertaxed payment rule, or UTPR)
reduce the race-to-the bottom as countries lower their taxes
at the same rate. Many details would need to be worked out.
to attract capital investment. A global minimum tax would
allow countries with higher tax rates to attract more capital.
Most countries do not tax profits earned by their firms’
foreign subsidiaries in other countries (or tax them in a
Adoption of the GLoBE provisions to replace GILTI, or
limited way under anti-abuse rules). The United States
modifying GILTI to be more consistent with GLoBE,
currently has a minimum tax on foreign source income of
would require legislative action to change the tax code as
subsidiaries of U.S. multinationals, the tax on global
well as revising treaties.
intangible low-taxed income, or GILTI. (See CRS Report
R45186, Issues in International Corporate Taxation: The
Jane G. Gravelle, Senior Specialist in Economic Policy
2017 Revision (P.L. 115-97), by Jane G. Gravelle and
IF11874


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International Tax Proposals Addressing Profit Shifting: Pil ars 1 and 2


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https://crsreports.congress.gov | IF11874 · VERSION 1 · NEW

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