International Tax Proposals Addressing Profit Shifting: Pillars 1 and 2

International Tax Proposals Addressing Profit Shifting: Pillars 1 and 2

Updated January 31, 2024
International Tax Proposals Addressing Profit Shifting:
Pillars 1 and 2
On June 5, 2021, finance ministers of the Group of 7 (G7)
Pillar 1 was originally to allocate some rights to market
countries, including the United States, agreed in a
countries to tax profits of digitalized firms (and countries
communiqué to two proposals addressing global profit
would eliminate their digital services taxes). The proposal
shifting. They agreed to Pillar 1, allocating rights of
was expanded to include all firms except those in the
taxation of residual profits to market countries for large
financial and extractive industries. The Pillar 1 blueprint
profitable multinationals while eliminating digital services
would allow market countries a share of 25% of the
taxes. They also agreed to Pillar 2, imposing a global
residual profits (defined as profits after a 10% margin for
minimum tax of at least 15%.
marketing and distribution services) of large multinational
companies. It would apply to companies with global
These proposals were developed in Organisation for
revenue turnover of more than $20 billion and apply to
Economic Co-operation and Development (OECD)/Group
market countries that provide at least $1 million in revenue.
of 20 (G20) blueprints for addressing profit shifting and
The proposal would allocate the residual share based on
base erosion, which involved participation by 139
revenues (such as sales of advertising) and the location of
countries. The OECD has provided extensive guidance on
the user or viewer for an array of digital services, split the
the proposals. Implementation of the proposals would
residual share 50:50 between the location of the purchaser
require changes in domestic law.
and seller for online markets, and generally allocate the
profit to the final consumer’s country.
Pillar 1
The standard international agreements historically have
This agreement is a departure from the traditional allocation
allocated the first right of taxation of profits to the country
of the first right of taxation to the owner of the asset, which
where the asset is located. This location may be where the
is consistent with the economic concept of profits as a
asset is created (e.g., from investment in buildings,
return to the investor and not to the consumer.
equipment, or research) or where the rights to the asset have
been purchased, which may happen easily with intangible
Although the Pillar 1 proposal does not conform to the
assets, such as drug formulas or search algorithms. Many
traditional framework, it could serve the purpose—if
U.S. multinationals have sold the rights to intangible assets
agreement is reached—of heading off unilateral action, as
to affiliates in other countries to serve the foreign market.
has developed with the digital services taxes. From the
This system allocates profits between related parties on the
viewpoint of the United States, which has large
basis of arm’s-length prices (i.e., the price upon which a
multinational digital firms (e.g., Google and Facebook), the
willing buyer and a willing unrelated seller would agree to
arrangement could be costly. The excise taxes that would be
transact), although true arms-length prices often are
eliminated are borne largely by the customers; that is, an
difficult to determine.
advertising tax decreases the net price from sales and would
lead to higher prices to advertisers, which would in turn be
With the advent of companies providing digital services
reflected in higher product prices to customers who are
that are often free services to consumers (such as search
largely in the country imposing the excise tax. Were
engines, online market places, and sites for social
countries unilaterally to impose taxes that are tied to profits
networking), an argument has been made that the country
without an agreement, under proposed regulations, U.S.
where the users reside should have a right to tax some of
multinationals would not receive a U.S. foreign tax credit,
the profits of these companies because the users create
and the burden would fall largely on the profits of these
value. Advocates also argue that these companies escape
firms. With a multinational agreement such as in Pillar 1,
taxes on some of their profits by locating assets in tax
the U.S. foreign tax credit presumably would be allowed for
havens. Several countries have imposed digital services
these taxes (unless Congress intervenes), which would
taxes, although generally in the form of excise taxes (such
reduce revenues for the U.S. government.
as taxes on advertising revenues, digital sales of goods and
services, or sales of data), while proposed changes in the
U.S. companies may prefer this substitution of Pillar 1 for
taxation of profits are being discussed. The United
the digital services taxes, as they likely would not see a tax
Kingdom (UK) enacted a diverted profits tax with a similar
effect (since the taxes collected by the market countries
objective. The United States had decided to impose tariffs
would be largely offset by foreign tax credits), and they
against seven countries that imposed digital excise taxes—
would be freed from the uncertainty and complexity of
France, Austria, India, Italy, Spain, Turkey, and the UK.
digital services taxes.
These tariffs were suspended while Pillar 1 was under
consideration.
Pillar 1 would likely require changes in tax law and treaties
or other forms of congressional-executive agreements.
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International Tax Proposals Addressing Profit Shifting: Pillars 1 and 2
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. The OECD blueprint recognizes the
address base erosion, or GLoBE. It includes an income
coexistence of GILTI, and allows it as an IIR even though it
inclusion rule (IIR) to be applied by the country where the
does not conform to GLoBE.
parent is located (or the country where an intermediate
company in the chain is located in the absence of a parent
Under the UTPR, other countries could tax domestic
company IIR) to raise the effective tax rate on a country-by-
income earned by U.S. corporations, In some cases,
country basis to 15% on profits in excess of a fixed return
effective tax rates could fall below 15% because of
for substantive activities (including tangible assets and
deductions and credits, so that Pillar 2 could reduce the
payroll). This rule is termed a top-up tax. The income base
incentives of credits such as the research credit. See CRS
is financial profits. Tax credits are not allowed. In cases
Report R47174, The Pillar 2 Global Minimum Tax:
where the IIR does not apply, there is a subsidiary rule to
Implications for U.S. Tax Policy, by Jane G. Gravelle and
tax payments to low-tax countries (the undertaxed payment
Mark P. Keightley for a discussion. The United States could
rule, or UTPR) at 9%, which can be imposed by any
collect this revenue by enacting a QDMTT, but the
country with a related firm. (The current UTPR is referred
incentives would still be reduced. Alternatively, the United
to as the undertaxed profits rule.) Countries where the
States could make tax credits refundable, which would lead
business is located have the first right to impose a top-up
them to be treated as income increases and significantly
tax through a qualified domestic minimum top-up tax
mitigate the impact on the effective tax rate. The OECD
(QDMTT). Pillar 2 applies to firms with €750 million in
recently announced that transferable credits, such as the
revenue.
recently enacted energy credits, would be treated as
refundable credits.
As of early 2024, a number of countries have already taken
steps to enact GLoBE, including members of the European
The Joint Committee on Taxation (JCT) has estimated that
Union, Canada, Japan, the UK, and South Korea. The
the United States could lose $175 billion in revenue over
UTPR is delayed until 2025. The OECD has issued a
nine years if the countries that have already taken steps to
transition rule so that the UTPR will not apply to any
enact Pillar 2 do so. This revenue loss is due to the loss of
country with a corporate tax rate of at least 20% until 2026.
revenue on foreign source income of U.S. multinationals if
the localities adopt a QDMTT or countries in the chain of
The United States currently has its own minimum tax on
ownership enact an IIR. This number could be reduced or
foreign source income of subsidiaries of U.S.
reversed in sign given profit shifting assumptions. Using
multinationals, the tax on global intangible low-taxed
intermediate profit shifting assumptions, U.S. revenues
income, or GILTI. (See CRS Report R45186, Issues in
would fall by $122 billion over nine years if the rest of the
International Corporate Taxation: The 2017 Revision (P.L.
world enacts GLoBE and the United States does not. If the
115-97), by Jane G. Gravelle and Donald J. Marples for a
United States also enacts GLoBE, revenues would be
discussion of GILTI and other tax provisions enacted in
increased by $237 billion.
2017.)
An advantage of a global minimum tax is that it could
GILTI is similar in some ways to the minimum tax that
reduce the race-to-the bottom as countries lower their taxes
would be imposed by GLoBE under the IIR. It imposes a
to attract capital investment. A global minimum tax would
tax at a lower rate (currently half the U.S. rate, or 10.5 %)
allow countries with higher tax rates to attract more capital.
to income in excess of a deemed return of 10% of tangible
assets. The rate is scheduled to rise to 13.125% after 2025.
Adopting the GLoBE provisions to replace GILTI, or
In addition to the lower rate, three other features of GILTI
modifying GILTI to be more consistent with GLoBE,
differ from the IIR. First, GLoBE would allow an exclusion
would require legislative action to change the tax code.
for a broader range of spending that includes payroll as well
Adopting GLoBE would also require action by Congress.
as tangible assets, although at a lower rate of 5%. (During a
transition period the percentage would be 8% for tangible
Some Members of Congress have proposed retaliatory taxes
assets and 10% of payroll, phased down over 10 years.)
for countries imposing the UTPR. H.R. 3665 (Smith (MO))
Second, GILTI achieves the “top-up” tax by imposing the
would increase the tax rate of U.S.-source income, and H.R.
full tax and then allowing credits against the GILTI tax for
4695 (Estes) would increase the base of the alternative base
80% of foreign taxes paid, up to the amount of U.S. tax due.
erosion and anti-abuse tax. Some members of the Ways and
This limit is imposed on a global basis so that unused
Means Committee have urged countries to adopt their own
credits in high-tax countries can offset U.S. tax due in low-
version of GILTI to address base erosion.
tax countries; the IIR would apply on a country-by-country
basis. Finally, the IIR would allow carryforwards of losses
Jane G. Gravelle, Senior Specialist in Economic Policy
and excess taxes, which is not allowed under GILTI.
IF11874
Prior Administration budget proposals and several
congressional proposals, including versions of the Build

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International Tax Proposals Addressing Profit Shifting: Pillars 1 and 2

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https://crsreports.congress.gov | IF11874 · VERSION 10 · UPDATED