Updated September 21, 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). The Pillar 1 blueprint
shifting. They agreed to Pillar 1, allocating rights of
would allow market countries a share of 25% of the
taxation of residual profits to market countries for certain
residual profits (defined as profits after a 10% margin for
digital services for large profitable multinationals while
marketing and distribution services) of large multinational
eliminating digital services taxes. They also agreed to Pillar
companies. It would apply to companies with global
2, imposing a global minimum tax of at least 15%.
revenue turnover of more than $20 billion and apply to
market countries that provide at least $1 million in revenue.
These proposals were developed in Organization for
The proposal would allocate the residual share based on
Economic Co-operation and Development (OECD)/Group
revenues (such as sales of advertising) and the location of
of 20 (G20) blueprints for addressing profit shifting and
the user or viewer for an array of digital services and split
base erosion, which involved participation by 139
the residual share 50:50 between the location of the
countries. The OECD has provided extensive guidance on
purchaser and seller for online markets. The OECD/G20
the proposals. Implementation of the proposals would
blueprint provides a positive list of the businesses covered:
require changes in domestic law.
“sale or other alienation of user data; online search engines;
social media platforms; online intermediation platforms;
Pillar 1
digital content services; online gaming; standardized online
The standard international agreements historically have
teaching services; and cloud computing services,” as well
allocated the first right of taxation of profits to the country
as online market places.
where the asset is located. This location may be where the
asset is created (e.g., from investment in buildings,
This agreement is a departure from the traditional allocation
equipment, or research) or where the rights to the asset have
of the first right of taxation to the owner of the asset, which
been purchased, which may happen easily with intangible
is consistent with the economic concept of profits as a
assets, such as drug formulas or search algorithms. Many
return to the investor and not to the consumer.
U.S. multinationals have sold the rights to intangible assets
to affiliates in other countries to serve the foreign market.
Although the Pillar 1 proposal does not conform to the
This system allocates profits between related parties on the
traditional framework, it could serve the purpose—if
basis of arm’s-length prices (i.e., the price upon which a
agreement is reached—of heading off unilateral action, as
willing buyer and a willing unrelated seller would agree to
has developed with the digital services taxes. From the
transact), although true arms-length prices often are
viewpoint of the United States, which has large
difficult to determine.
multinational digital firms (e.g., Google and Facebook), the
arrangement could be costly. The excise taxes that would be
With the advent of companies providing digital services
eliminated are borne largely by the customers; that is, an
that are often free services to consumers (such as search
advertising tax decreases the net price from sales and would
engines, online market places, and sites for social
lead to higher prices to advertisers, which would in turn be
networking), an argument has been made that the country
reflected in higher product prices to customers who are
where the users reside should have a right to tax some of
largely in the country imposing the excise tax. Were
the profits of these companies because the users create
countries unilaterally to impose taxes that are tied to profits
value. Advocates also argue that these companies escape
without an agreement, under proposed regulations, U.S.
taxes on some of their profits by locating assets in tax
multinationals would not receive a U.S. foreign tax credit,
havens. Several countries have imposed digital services
and the burden would fall largely on the profits of these
taxes, although generally in the form of excise taxes (such
firms. With a multinational agreement such as in Pillar 1,
as taxes on advertising revenues, digital sales of goods and
the U.S. foreign tax credit presumably would be allowed for
services, or sales of data), while proposed changes in the
these taxes (unless Congress intervenes), which would
taxation of profits are being discussed. The United
reduce revenues for the U.S. government.
Kingdom (UK) enacted a diverted profits tax with a similar
objective. The United States had decided to impose tariffs
U.S. companies may prefer this substitution of Pillar 1 for
against seven countries that imposed digital excise taxes—
the digital services taxes, as they likely would not see a tax
France, Austria, India, Italy, Spain, Turkey, and the UK.
effect (since the taxes collected by the market countries
These tariffs were suspended while Pillar 1 was under
would be largely offset by foreign tax credits), and they
consideration.
would be freed from the uncertainty and complexity of
digital services taxes.
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International Tax Proposals Addressing Profit Shifting: Pillars 1 and 2
Pillar 1 would likely require changes in tax law and treaties
Prior Administration budget proposals and several
or other forms of congressional-executive agreements.
congressional proposals, including versions of the Build
Pillar 1 may not be implemented if any major countries do
Back Better Act (H.R. 5376) that were not enacted, would
not agree to it.
have raised the GILTI rate, eliminated or reduced the
deduction for tangible assets, limited the credit on a
Pillar 2
country-by-country basis, and increased the share of taxes
Pillar 2 would impose a global minimum income tax to
credited in some cases.
address base erosion, or GLoBE. It includes an income
inclusion rule (IIR) to be applied by the country where the
The OECD blueprint recognizes the coexistence of GILTI,
parent is located (or the country where an intermediate
and allows it as an IIR even though it does not conform to
company in the chain is located in the absence of a parent
GLoBE.
company IIR) to raise the effective tax rate on a country-by-
country basis to 15% on profits in excess of a fixed return
Under the UTPR, other countries could tax domestic
for substantive activities (including tangible assets and
income earned by U.S. corporations, In some cases,
payroll). This rule is termed a top-up tax. The income base
effective tax rates could fall below 15% because of
is financial profits. Tax credits are not allowed. In cases
deductions and credits, so that Pillar 2 could reduce the
where the IIR does not apply, there is a subsidiary rule to
incentives of credits such as the research credit. See CRS
tax payments to low-tax countries (the undertaxed payment
Report R47174, The Pillar 2 Global Minimum Tax:
rule, or UTPR) at 9%, which can be imposed by any
Implications for U.S. Tax Policy, by Jane G. Gravelle and
country with a related firm. (The UTPR is sometimes
Mark P. Keightley for a discussion. The United States could
referred to as the undertaxed profits rule.) Countries where
collect this revenue by enacting a QDMTT, but the
the business is located have the first right to impose a top-
incentives would still be reduced. Alternatively, the United
up tax through a qualified domestic minimum top-up tax
States could make tax credits refundable, which would lead
(QDMTT). Pillar 2 applies to firms with €750 million in
them to be treated as income increases and significantly
revenue.
mitigate the impact on the effective tax rate. The OECD
recently announced that transferable credits, such as the
A number of countries have already taken steps to enact
recently enacted energy credits, would be treated as
GLoBE, including members of the European Union,
refundable credits.
Canada, Japan, the UK, and South Korea. The OECD has
issued a transition rule so that the UTPR will not apply to
The Joint Committee on Taxation (JCT) has estimated that
any country with a corporate tax rate of at least 20% until
the United States could lose $175 billion in revenue over
2026.
nine years if the countries that have already taken steps to
enact Pillar 2 do so. This revenue loss is due to the loss of
The United States currently has its own minimum tax on
revenue on foreign source income of U.S. multinationals if
foreign source income of subsidiaries of U.S.
the localities adopt a QDMTT or countries in the chain of
multinationals, the tax on global intangible low-taxed
ownership enact an IIR. This number could be reduced or
income, or GILTI. (See CRS Report R45186, Issues in
reversed in sign given profit shifting assumptions. Using
International Corporate Taxation: The 2017 Revision (P.L.
intermediate profit shifting assumptions, U.S. revenues
115-97), by Jane G. Gravelle and Donald J. Marples for a
would fall by $122 billion over nine years if the rest of the
discussion of GILTI and other tax provisions enacted in
world enacts GLoBe and the United States does not. If the
2017.)
United States also enacts GLoBE, revenues would be
increased by $237 billion.
GILTI is similar in some ways to the minimum tax that
would be imposed by GLoBE under the IIR. It imposes a
An advantage of a global minimum tax is that it could
tax at a lower rate (currently half the U.S. rate, or 10.5 %)
reduce the race-to-the bottom as countries lower their taxes
to income in excess of a deemed return of 10% of tangible
to attract capital investment. A global minimum tax would
assets. The rate is scheduled to rise to 13.125% after 2025.
allow countries with higher tax rates to attract more capital.
In addition to the lower rate, three other features of GILTI
differ from the IIR. First, GLoBE would allow an exclusion
Adopting the GLoBE provisions to replace GILTI, or
for a broader range of spending that includes payroll as well
modifying GILTI to be more consistent with GLoBE,
as tangible assets, although at a lower rate of 5%. (During a
would require legislative action to change the tax code.
transition period the percentage would be 8% for tangible
Adopting GLoBE would also require action by Congress.
assets and 10% of payroll, phased down over 10 years.)
Second, GILTI achieves the “top-up” tax by imposing the
Members of Congress have proposed retaliatory taxes for
full tax and then allowing credits against the GILTI tax for
countries imposing the UTPR. H.R. 3665 (Smith) would
80% of foreign taxes paid, up to the amount of U.S. tax due.
increase the tax rate of U.S.-source income, and H.R. 4695
This limit is imposed on a global basis so that unused
(Estes) would increase the base of the alternative base
credits in high-tax countries can offset U.S. tax due in low-
erosion and anti-abuse tax. Some members of the Ways and
tax countries; the IIR would apply on a country-by-country
Means Committee have urged countries to adopt their own
basis. Finally, the IIR would allow carryforwards of losses
version of GILTI to address base erosion.
and excess taxes, which is not allowed under GILTI.
Jane G. Gravelle, Senior Specialist in Economic Policy
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 8 · UPDATED

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