Updated October 13, 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. On July 10, the G20 endorsed the plan. Some
aspects might require legislative changes. The OECD
The Pillar 1 blueprint would allow market countries a s hare
reported on October 8 that 136 out of 140 countries
of 25% of the residual profits (defined as profits after a
participating have joined the framework.
10% margin for marketing and distribution services) of
large multinational companies. It would apply to companies
The agreement does not mention a specific revenue
with global revenue turnover of more than $20 billion and
threshold, but the OECD in another initiative had proposed
apply to market countries that provide at least $1 million in
a threshold for country-by-country reporting of €750
revenue. As noted earlier, this agreement does not have
million. The next two sections discuss the two pillars as
force of law and is viewed as a first step. The proposal
outlined in the OECD/G20 blueprints.
would allocate the residual share based on revenues (such
as sales of advertising) and the location of the user or
Pillar 1
viewer for an array of digital services and split the residual
The standard international agreements historically have
share 50:50 between the location of the purchaser and seller
allocated the first right of taxation of profits to the country
for online markets. The OECD/G20 blueprint provides a
where the asset is located. This location may be where the
positive list of the businesses covered: “sale or other
asset is created (e.g., from investment in buildings,
alienation of user data; online search engines; social media
equipment, or research) or where the rights to the asset have
platforms; online intermediation platforms; digital content
been purchased, which may happen easily with intangible
services; online gaming; standardized online teaching
assets, such as drug formulas or search algorithms. Many
services; and cloud computing services,” as well as online
U.S. multinationals have sold the rights to intangible assets
market places.
to affiliates in other countries to serve the foreign market.
This system allocates profits between related parties on the
This agreement is viewed as a fundamental departure from
basis of arm’s-length prices (i.e., the price upon which a
the traditional allocation of the first right of taxation to the
willing buyer and a willing unrelated seller would agree to
owner of the asset, which is consistent with the economic
transact), although true arms-length prices often are
concept of profits as a return to the investor and not to the
difficult to determine.
consumer.
With the advent of companies providing digital services
Although the Pillar 1 proposal does not conform to the
that are often free services to consumers (such as search
traditional framework, it could serve the purpose—if
engines, online market places, and sites for social
agreement is reached—of heading off unilateral action, as
networking), an argument has been made that the country
has developed with the digital services taxes. From the
where the users reside should have a right to tax some of
viewpoint of the United States, which has large
the profits of these companies because the users create
multinational digital firms (e.g., Google and Facebook), the
value. Advocates also argue that these companies escape
arrangement could be costly. The excise taxes that would be
taxes on some of their profits by locating assets in tax
eliminated are borne largely by the customers; that is, an
havens. Several countries have imposed digital services
advertising tax decreases the net price from sales and would
taxes, although generally in the form of excise taxes (such
lead to higher prices to advertisers, which would in turn be
as taxes on advertising revenues, digital sales of goods and
reflected in higher product prices to customers who are
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International Tax Proposals Addressing Profit Shifting: Pil ars 1 and 2
largely in the country imposing the excise tax. Were
Donald J. Marples for a discussion of GILTI and other tax
countries unilaterally to impose taxes that are tied to profits
provisions enacted in 2017.)
without an agreement, under proposed regulations, U.S.
multinationals would not receive a U.S. foreign tax credit,
GILTI is similar in some ways to the minimum tax that
and the burden would fall largely on the profits of these
would be imposed by GLoBE under the IIR. It imposes a
firms. With a multinational agreement such as in Pillar 1,
tax at a lower rate (currently half the U.S. rate, or 10.5 %)
the U.S. foreign tax credit presumably would be allowed for
to income in excess of a deemed return of 10% of tangible
these taxes (unless Congress intervenes), which would
assets. The rate is scheduled to rise to 13.125% after 2025.
reduce revenues for the U.S. government, and the burden
In addition to the lower rate, three other features of GILTI
would fall on U.S. persons in general.
differ from the IIR. First, GLoBE would allow an exclusion
for a broader range of spending that includes payroll as well
U.S. companies may prefer this substitution of Pillar 1 for
as tangible assets, although at a lower rate of 5%. (During a
the digital services taxes, as they likely would not see a tax
transition period the percentage would be 8% for tangible
effect (since the taxes collected by the market countries
assets and 10% of payroll, phased out over 10 years .)
would be largely offset by foreign tax credits), and they
Second, GILTI achieves the “top-up” tax by imposing the
would be freed from the uncertainty and complexity of
full tax and then allowing credits against the GILTI tax for
digital services taxes.
80% of foreign taxes paid, up to the amount of U.S. tax due.
This limit is imposed on a global basis so that unused
Also, the United States may have an interest in maintaining
credits in high-tax countries can offset U.S. tax due in low-
harmonious relationships with the rest of the world, which
tax countries; the IIR would apply on a country-by-country
may justify the loss of revenues. The acceptance of Pillar 1
basis. Finally, the IIR would allow carryforwards of losses
also has been tied to establishing a global minimum tax
and excess taxes, which is not allowed under GILTI.
under Pillar 2, which would discourage the so-called “race-
to-the-bottom” as countries lower tax rates to attract capital.
The Administration budget proposals and several
congressional proposals, including the Build Back Better
Pillar 1 probably can be adopted without changing the tax
Act (H.R. 5376), would raise the GILTI rate, eliminate or
code, although it could require changes in treaties.
reduce the deduction for tangible assets, limit the credit on
a country-by-country basis, and increase the share of taxes
Pillar 2
credited in some cases. (See CRS In Focus IF11809, Trends
Pillar 2 would impose a global minimum income tax to
and Proposals for Corporate Tax Revenue, by Donald J.
address base erosion, or GLoBE. It includes an income
Marples and Jane G. Gravelle for a summary.)
inclusion rule (IIR) to raise the effective tax rate on a
country-by-country basis to 15% on profits in excess of a
The OECD blueprint recognizes the coexistence of GILTI
fixed return for substantive activities (including tangible
and certain problems that may arise and concerns if GILTI
assets and payroll). This rule is termed a top-up tax. The
were to be limited by future legislation.
income base is financial profits. These taxes would be
imposed by the parent company. In cases where the IIR
An advantage of a global minimum tax is that it could
does not apply, there is a subsidiary rule to tax payments to
reduce the race-to-the bottom as countries lower their taxes
low-tax countries (the undertaxed payment rule, or UTPR)
to attract capital investment. A global minimum tax would
at 9%.
allow countries with higher tax rates to attract more capital.
Most countries do not tax profits earned by their firms’
Adoption of the GLoBE provisions to replace GILTI, or
foreign subsidiaries in other countries (or tax them in a
modifying GILTI to be more consistent with GLoBE,
limited way under anti-abuse rules). The United States
would require legislative action to change the tax code as
currently has a minimum tax on foreign source income of
well as revising treaties.
subsidiaries of U.S. multinationals, the tax on global
intangible low-taxed income, or GILTI. (See CRS Report
Jane G. Gravelle, Senior Specialist in Economic Policy
R45186, Issues in International Corporate Taxation: The
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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