Updated July 20, 2023
International Tax Proposals Addressing Profit Shifting:
Pillars 1 and 2
On June 5, 2021, finance ministers of the Group of 7 (G7)
Pillar 1 would allocate some rights to market countries to
countries, including the United States, agreed in a
tax profits of digitalized firms (and countries would
communiqué to two proposals addressing global profit
eliminate their digital services taxes).
shifting. They agreed to Pillar 1, allocating rights of
taxation of residual profits to market countries for certain
The Pillar 1 blueprint would allow market countries a share
digital services for large profitable multinationals while
of 25% of the residual profits (defined as profits after a
eliminating digital services taxes. They also agreed to Pillar
10% margin for marketing and distribution services) of
2, imposing a global minimum tax of at least 15%.
large multinational companies. It would apply to companies
with global revenue turnover of more than $20 billion and
These proposals were developed in Organisation for
apply to market countries that provide at least $1 million in
Economic Co-operation and Development (OECD)/Group
revenue. As noted earlier, this agreement does not have the
of 20 (G20) blueprints for addressing profit shifting and
force of law. The proposal would allocate the residual share
base erosion, which involved participation by 139
based on revenues (such as sales of advertising) and the
countries. The OECD has provided extensive guidance on
location of the user or viewer for an array of digital services
the proposals. Implementation of the proposals would
and split the residual share 50:50 between the location of
require changes in domestic law.
the purchaser and seller for online markets. The OECD/G20
blueprint provides a positive list of the businesses covered:
Pillar 1
“sale or other alienation of user data; online search engines;
The standard international agreements historically have
social media platforms; online intermediation platforms;
allocated the first right of taxation of profits to the country
digital content services; online gaming; standardized online
where the asset is located. This location may be where the
teaching services; and cloud computing services,” as well
asset is created (e.g., from investment in buildings,
as online market places.
equipment, or research) or where the rights to the asset have
been purchased, which may happen easily with intangible
This agreement is a departure from the traditional allocation
assets, such as drug formulas or search algorithms. Many
of the first right of taxation to the owner of the asset, which
U.S. multinationals have sold the rights to intangible assets
is consistent with the economic concept of profits as a
to affiliates in other countries to serve the foreign market.
return to the investor and not to the consumer.
This system allocates profits between related parties on the
basis of arm’s-length prices (i.e., the price upon which a
Although the Pillar 1 proposal does not conform to the
willing buyer and a willing unrelated seller would agree to
traditional framework, it could serve the purpose—if
transact), although true arms-length prices often are
agreement is reached—of heading off unilateral action, as
difficult to determine.
has developed with the digital services taxes. From the
viewpoint of the United States, which has large
With the advent of companies providing digital services
multinational digital firms (e.g., Google and Facebook), the
that are often free services to consumers (such as search
arrangement could be costly. The excise taxes that would be
engines, online market places, and sites for social
eliminated are borne largely by the customers; that is, an
networking), an argument has been made that the country
advertising tax decreases the net price from sales and would
where the users reside should have a right to tax some of
lead to higher prices to advertisers, which would in turn be
the profits of these companies because the users create
reflected in higher product prices to customers who are
value. Advocates also argue that these companies escape
largely in the country imposing the excise tax. Were
taxes on some of their profits by locating assets in tax
countries unilaterally to impose taxes that are tied to profits
havens. Several countries have imposed digital services
without an agreement, under proposed regulations, U.S.
taxes, although generally in the form of excise taxes (such
multinationals would not receive a U.S. foreign tax credit,
as taxes on advertising revenues, digital sales of goods and
and the burden would fall largely on the profits of these
services, or sales of data), while proposed changes in the
firms. With a multinational agreement such as in Pillar 1,
taxation of profits are being discussed. The United
the U.S. foreign tax credit presumably would be allowed for
Kingdom (UK) enacted a diverted profits tax with a similar
these taxes (unless Congress intervenes), which would
objective. The United States had decided to impose tariffs
reduce revenues for the U.S. government, and the burden
against seven countries that imposed digital excise taxes—
would fall on U.S. persons in general.
France, Austria, India, Italy, Spain, Turkey, and the UK.
These tariffs were suspended while Pillar 1 was under
U.S. companies may prefer this substitution of Pillar 1 for
consideration.
the digital services taxes, as they likely would not see a tax
effect (since the taxes collected by the market countries
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International Tax Proposals Addressing Profit Shifting: Pillars 1 and 2
would be largely offset by foreign tax credits), and they
basis. Finally, the IIR would allow carryforwards of losses
would be freed from the uncertainty and complexity of
and excess taxes, which is not allowed under GILTI.
digital services taxes.
The proposal also calls for a revision to allow source
Pillar 1 would likely require changes in tax law and treaties
companies to tax items such as royalties and interests when
or other forms of congressional-executive agreements.
the recipient countries have low tax rates, the “subject to
Pillar 1 may not be implemented if any major countries do
tax rule” (STTR).
not agree to it.
Prior Administration budget proposals and several
Pillar 2
congressional proposals, including versions of the Build
Pillar 2 would impose a global minimum income tax to
Back Better Act (H.R. 5376) that were not enacted, would
address base erosion, or GLoBE. It includes an income
have raised the GILTI rate, eliminated or reduced the
inclusion rule (IIR) to be applied by the country where the
deduction for tangible assets, limited the credit on a
parent is located (or the country where an intermediate
country-by-country basis, and increased the share of taxes
company in the chain is located in the absence of a parent
credited in some cases.
company IIR) to raise the effective tax rate on a country-by-
country basis to 15% on profits in excess of a fixed return
The OECD blueprint recognizes the coexistence of GILTI,
for substantive activities (including tangible assets and
and allows it as an IIR even though it does not conform to
payroll). This rule is termed a top-up tax. The income base
GLoBE.
is financial profits. Tax credits are not allowed. In cases
where the IIR does not apply, there is a subsidiary rule to
Under the UTPR, other countries could tax domestic
tax payments to low-tax countries (the undertaxed payment
income earned by U.S. corporations, In some cases,
rule, or UTPR) at 9%, which can be imposed by any
effective tax rates could fall below 15% because of
country with a related firm. (The UTPR is sometimes
deductions and credits, so that Pillar 2 could reduce the
referred to as the undertaxed profits rule.) Countries where
incentives of credits such as the research credit. See CRS
the business is located have the first right to impose a top-
Report R47174, The Pillar 2 Global Minimum Tax:
up tax through a qualified domestic minimum top-up tax
Implications for U.S. Tax Policy, by Jane G. Gravelle and
(QDMTT). Pillar 2 applies to firms with €750 million in
Mark P. Keightley for a discussion. The United States could
revenue.
collect this revenue by enacting a QDMTT, but the
incentives would still be reduced. Alternatively, the United
A number of countries have already taken steps to enact
States could make tax credits refundable, which would lead
GLoBE, including members of the European Union,
them to be treated as income increases and significantly
Canada, Japan, the UK, and South Korea. The OECD has
mitigate the impact on the effective tax rate. The OECD
issued a transition rule so that the UTPR will not apply to
recently announced that transferable credits, such as the
any country with a corporate tax rate of at least 20% until
recently enacted energy credits, would be treated as
2026.
refundable credits.
The United States currently has its own minimum tax on
The Joint Committee on Taxation (JCT) has estimated that
foreign source income of subsidiaries of U.S.
the United States could lose $175 billion in revenue over
multinationals, the tax on global intangible low-taxed
nine years if the countries that have already taken steps to
income, or GILTI. (See CRS Report R45186, Issues in
enact Pillar 2 do so. This revenue loss is due to the loss of
International Corporate Taxation: The 2017 Revision (P.L.
revenue on foreign source income of U.S. multinationals if
115-97), by Jane G. Gravelle and Donald J. Marples for a
the localities adopt a QDMTT or countries in the chain of
discussion of GILTI and other tax provisions enacted in
ownership enact an IIR. This number could be reduced or
2017.)
reversed in sign given profit shifting assumptions. Using
intermediate profit shifting assumptions, U.S. revenues
GILTI is similar in some ways to the minimum tax that
would fall by $122 billion over nine years if the rest of the
would be imposed by GLoBE under the IIR. It imposes a
world enacts GLoBe and the United States does not. If the
tax at a lower rate (currently half the U.S. rate, or 10.5 %)
United States also enacts GLoBE, revenues would be
to income in excess of a deemed return of 10% of tangible
increased by $237 billion.
assets. The rate is scheduled to rise to 13.125% after 2025.
In addition to the lower rate, three other features of GILTI
An advantage of a global minimum tax is that it could
differ from the IIR. First, GLoBE would allow an exclusion
reduce the race-to-the bottom as countries lower their taxes
for a broader range of spending that includes payroll as well
to attract capital investment. A global minimum tax would
as tangible assets, although at a lower rate of 5%. (During a
allow countries with higher tax rates to attract more capital.
transition period the percentage would be 8% for tangible
assets and 10% of payroll, phased down over 10 years.)
Adopting the GLoBE provisions to replace GILTI, or
Second, GILTI achieves the “top-up” tax by imposing the
modifying GILTI to be more consistent with GLoBE,
full tax and then allowing credits against the GILTI tax for
would require legislative action to change the tax code.
80% of foreign taxes paid, up to the amount of U.S. tax due.
Adopting GLoBE would also require action by Congress.
This limit is imposed on a global basis so that unused
credits in high-tax countries can offset U.S. tax due in low-
Jane G. Gravelle, Senior Specialist in Economic Policy
tax countries; the IIR would apply on a country-by-country
IF11874
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International Tax Proposals Addressing Profit Shifting: Pillars 1 and 2


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https://crsreports.congress.gov | IF11874 · VERSION 6 · UPDATED

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