It’s pencils-down time. After years of hard work, wrangling, and arm-twisting on the part of the OECD, the G7, the G20, and treasury secretaries and lawmakers around the world, the first major component of global tax reform is going live in 2024. Thirty-six countries (including all 27 member states of the EU, plus the UK, Japan, and Korea) have signed on to enshrine the so-called Global Minimum Tax into their tax legislation, and many more are expected to follow suit in 2025 and beyond.
The longstanding global architecture of corporate taxation, built on a century-old, non-global—and decidedly non-virtual—business ecosystem, is headed for a major update for the digital age. And while major countries like the United States have not joined the parade, and much technical work remains to be done, there is a sense that this time it’s for real: the creaky old taxation system has begun to shift on its axis, and there will be no going back.
For tax departments of qualifying multinational enterprises (MNEs), this shift demands a no-less dramatic shift of perspective and focus. Transfer pricing, tax provision/planning, and even R&D tax credit schemes will undergo significant transformations. In this paper, we look at the ins, outs, certainties, and doubts around the seismic shift known as “Pillar Two.”
So Many Pillars, So Little Time
For more than a decade, the OECD has been working on strategies to put an end to the practice of base erosion and profit-shifting (BEPS) and stop the global “race to the bottom” for corporate tax rates—a reality that became more glaring as the global economy digitized and economic power crystallized into a small cohort of IP-heavy corporate giants.
The negotiators advanced a two-track approach aimed at addressing the two sides (or “Pillars”) of the problem: that large, highly profitable digital companies aren’t paying enough (or any) tax in the places where they are actually reaping profits, and that these digital empires have been successfully (and legally) gaming the global system to minimize their total tax obligation.
Pillar One is focused on ensuring that taxing rights are allocated fairly among jurisdictions: the OECD estimates it would impact about $200 billion in profits. Pillar Two is aimed at reducing the incentives for MNEs to shift profits to low-tax jurisdictions by setting a global minimum effective income tax rate (ETR) of 15 percent, no matter where they do business. Globally, the OECD estimates that Pillar Two will yield an additional $155-192 billion per year in corporate tax income for governments.
The bifurcation of the BEPS project (now known as BEPS 2.0) into a two-track approach was a practical necessity—but it has yielded an uneven process and a highly uncertain outcome. That’s because while Pillar Two is a template that countries would voluntarily adapt into domestic legislation, so long as they follow a “common process,” Pillar One is unitary: it would require all countries to agree on the applicable profit allocation mechanisms, overriding their existing tax treaties, in order to provide the clarity and consistency companies would need to comply.
A tall order, indeed, and probably wildly unrealistic as presently envisioned. We will discuss the ins and outs of this controversial plan in a separate white paper.
How Did We Get Here? Where Are We Going?
To get a sense of the trajectory of the massive Global Minimum Tax project, it makes sense to look at the rocky road traveled to date.
In October 2021, nearly 140 OECD members signed a landmark deal that would eliminate the tax havens in the world and enact a global minimum tax—with the so-called Model Rules of Global anti-Base Erosion (GloBE) intended to go into in effect in 2023. The plan would increase taxes substantially on many large corporations, while ending an international fight over how technology companies are taxed.
It turned out that getting to yes was the easy part.
The hard part is right now: the country-by-country work of enshrining the airy ideals of BEPS 2.0 into the rough-and-tumble of tax legislation. By summer 2022, the plan had already run into a buzzsaw of political intrigues—including domestic political concerns in the US (more on that below), and tensions among member states of the EU, specifically Poland and Hungary. Squabbles on technical issues including how to reallocate taxing rights among nations led the OECD to announce the proposed rules would not even be announced until mid-2023. Eventually Hungary and Poland were persuaded to drop their objections, and the first round of Pillar Two enactments (36 countries in all, with a handful of short-term deferrals) were in place in January 2024.
Because immediate domestic concerns tend to outweigh international agreements, and governments rarely walk in lockstep, the OECD has provided for Safe Harbors and other measures to smooth the way toward implementation of some of the rules. And those rules haven’t even all been set down: plenty of thorny technical details remain to be hashed out on the road to some kind of tax certainty. The OECD said it will issue updated guidance later in 2024.
But at least Pillar Two is on track, and the flurry of activity we have seen in the EU and UK especially bodes well for the staying power of the global minimum tax. It’s hard to see the genie of widespread profit-shifting strategies going back in the bottle.
How Pillar Two Works
Pillar Two, when enshrined in domestic legislation, will apply to MNEs and domestic companies with over €750 million in revenue. Companies who once used old-school profit-shifting strategies to achieve a tax bill lower than 15 percent will now be required to cough up (in polite economic parlance, “top up”) the difference in each jurisdiction where the taxpayer falls short, thus theoretically removing the incentive.
So how does it work exactly? The domestic minimum tax enables countries to assert the first right to tax profits presently taxed below the minimum effective rate of 15 percent. The global minimum tax package encompasses two interlocking rules, plus a third rule for tax treaties.
- The Income Inclusion Rule (or IIR) determines when a company’s foreign income should be included in the taxable income of the parent company. Should that income fall short of the minimum effective tax rate of 15 percent, additional taxes would be owed in the company’s home jurisdiction. Most jurisdictions have implemented this rule first. Many have implemented (or soon will) a Qualified Domestic Minimum Top-up Tax (QDMTT), alongside the IIR.
- The Undertaxed Profits Rule (or UTPR) is essentially a backstop to the IIR. It allows a country to increase taxes on a company if a related entity in a different jurisdiction is being taxed below the 15 percent ETR. In cases where multiple countries are applying a similar top-up tax, the taxable profit is divided based on the location of tangible assets and employees.
- Finally, the Subject to Tax Rule (STTR) is designed for use within a tax treaty framework. It empowers countries to tax payments that might otherwise face only a low rate of tax, at the specified rate of 9 percent.
How “Inclusive” Is the Framework… if the US Doesn’t Play Along?
Let’s face it: The OECD’s BEPS “Inclusive Framework” was primarily negotiated by and for the wealthiest and most powerful nations in the world. They have historically dominated international tax policy. Yet, while the United States (and in particular, Treasury Secretary Janet Yellen) played a leading role in driving the implementation of the Global Minimum Tax, the US itself hasn’t been able to implement the deal—and it may not, anytime soon, depending on the prevailing political temperature.
Despite the Biden administration’s strong backing, Congress was unable to conform the Global Intangible Low-Tax Income (GILTI) to Pillar Two’s global minimum tax in the landmark 2022 Inflation Reduction Act bill (IRA). Now, with the GOP in charge of the US House, outright hostility to BEPS 2.0—which they characterize as a “surrender” of tax authority “to foreign nations” and a revenue-loser for the US—is the rule of the day. The House Ways and Means Committee recently introduced retaliatory legislation that would counter laws adopted by foreign countries applying minimum tax rules to US companies, taking square aim at both Pillars.
So where does this leave US MNEs? Absent a change of heart (or effective control of Congress in 2025), they will be swimming in an alphabet soup of different, often overlapping, minimum taxes: from GILTI to the Base Erosion and Anti-Abuse Tax (BEAT) to the Inflation Reduction Act’s new Corporate Alternative Minimum Tax (CAMT)—all of which will have to be reconciled, jurisdiction by jurisdiction, with at least some of the global minimum tax rules.
Implementing Pillar Two in Tax Departments: What Could Possibly Go Wrong?
The introduction of Pillar Two may seem straightforward, comparing local jurisdictional tax rates to the global minimum ETR of 15 percent. But in reality, the GloBE framework is a complex set of rules that will demand not only a new approach from tax departments, but also a plethora of new data points, some of which could result in unforeseen outcomes.
For example, even though a US MNE may have an effective tax rate of 21 percent, once a taxpayer has followed the Pillar Two approach, its actual effective tax rate could end up well below the prescribed 15 percent minimum. And that could mean the company might be on the hook for additional taxes—either to the IRS or a foreign government.
Here’s a look at how the global minimum tax could touch three critical areas for your tax department.
Pillar Two will add fire to the long-standing transformation of transfer pricing: from a straightforward compliance exercise into a strategic necessity.
Since different jurisdictions may interpret Pillar Two rules differently, uncertainty will remain a challenge—and, absent a crystal ball, that requires both finesse and foresight. Many companies will need to carefully reconsider the potential benefits of their Advance Pricing Agreements (APAs). They’ll also need to address issues around profit allocation and tax incentives, with a constant focus on economic substance: ensuring transfer pricing arrangements always reflect operational realities. They also need to navigate timing misalignments in post-year-end transfer pricing adjustments.
Above all, prepare to think through (and—given the ever-evolving list of countries adopting Pillar Two principles into law—probably rethink) how you structure your intercompany transactions to avoid triggering the top-up tax. Uncertainty imposes a tax of its own, and this one may not go away on any kind of schedule. Hopefully, the “further guidance” promised by OECD in 2024 will clarify some of these tricky areas.
US companies determine their tax obligations—and pay their taxes to the IRS—based on regulations established by Congress. In parallel, they follow GAAP rules to report their assets, liabilities, equity, and net income (and taxes) to shareholders.
In parallel, but not in unison. Financial accounting mandates reporting when financial events occur, not solely when payments are made. Because recognition criteria for certain income and expenses vary under the two systems, the tax expense reported in the financial statements will be different than the tax paid to the IRS. A classic example: tax regulations that allow companies to deduct expenses for depreciation at a faster rate than permitted by accounting rules.
These timing variations give rise to deferred tax assets and liabilities on financial statements. What’s important here is that Pillar Two’s IIR rules rely primarily on financial (book) accounting data, and address timing differences through deferred tax assets valued at the 15 percent minimum tax rate.
MNEs preparing for Pillar Two will have to establish processes to track elections and deferred tax liability recaptures. With certain exceptions, timing differences that only reverse over a long period of time may be treated as permanent differences.
R&D Tax Credits
Pillar Two’s rules require enormous adjustments in order to perform the modeling required for compliance. That could lead to a few surprises.
Take the treatment of nonrefundable R&D tax credits: they could lead to lower tax in countries where the headline corporate tax rate is above 15 percent (the US, at 21 percent, being a prime example). Those otherwise salutary credits and other incentives could get caught in the crossfire of Pillar Two rules, potentially making those credits much less valuable. This new reality will make it crucial for companies (and governments) to reassess the true value of these credits. When the dust settles, the changes will likely be profound for both.
For the Tax Department, a New Strategic Spotlight
The global minimum tax will strongly reduce the incentive to move profits to tax havens. And there will be little room to hide: the rules are designed to impact the operations of large MNEs even in countries (like the US) that don’t incorporate the rules in domestic legislation. Every international corporation with worldwide revenues exceeding €750 million—including companies approaching this threshold—should already be focused on compliance.
As tax departments brace for Pillar Two, the key will be proactive preparation, meticulous compliance work, and a strategic approach to navigate the complexities introduced by this transformative global tax framework. Without a doubt, the rules will make cross-border investment more costly, impacting business decisions on where to hire and invest around the world—both overseas and at home.
There’s plenty of uncertainty ahead, but one thing is sure: Pillar Two will bring plenty of new attention to the tax department—from complex new calculations and data points to a significant uptick in compliance work—along with a well-earned higher profile.