Nations Can Fight, But There’s No Flight From Global Minimum Tax

While more than 140 countries have signed on to the global minimum tax agreement known as Pillar Two, these efforts don’t always have the backing of domestic legislative bodies, some of which have done little to adopt laws that would make Pillar Two effective.

For three of the world’s largest economies—the US, China, and India—the question of Pillar Two adoption remains a source of uncertainty for multinational enterprises. Many outcomes are possible, but they can be divided roughly into three categories: comply with Pillar Two, fight Pillar Two, or muddle through without either compliance or retaliation.

Each option is a realistic possibility, and each presents a different risk profile for businesses.

Compliance would involve adopting three taxes that comport with the Pillar Two goal of a 15% tax rate on corporate income. The first, known as a qualified domestic minimum top-up tax, or QDMTT, would apply to domestic income. Under a QDMTT, countries calculate the effective corporate tax rate using definitions set forth by Pillar Two rules, and “top up” the tax until the 15% target is reached.

The second, known as the income inclusion rule, or IIR, applies to the international income of companies headquartered in the IIR’s jurisdiction. Under an IIR, income not subject to a QDMTT can be topped up to a 15% tax rate by the home country of the company earning the income.

The third is an extraterritorial enforcement mechanism called the undertaxed profits rule, or UTPR. If a multinational enterprise has income that’s not subject to a 15% tax, then any country where the enterprise has a footprint can, through the UTPR, try to collect top-up tax for the whole multinational group. The countries can attempt this even if they are neither the home country of the company nor the place where the income was earned.

No instances of UTPR have been assessed yet, and guidance last year from the Organization for Economic Cooperation and Development has delayed implementing UTPR until 2026 in many places. Implementing the UTPR would provide a strong incentive for the countries to adopt QDMTT and IIR—if a jurisdiction doesn’t collect the tax, somebody else will.

The UTPR could incentivize the US, India, and China to adopt QDMTTs and IIRs. Unfortunately, adoption would lead to overlap in many cases. These large economies already have corporate income taxes and, in some cases, minimum taxes on top of those corporate income taxes. A QDMTT would add yet another set of accounting books to corporate compliance costs.

While the US and China already have international taxes that in some respects resemble IIRs, an IIR’s country-by-country requirements would require more accounting calculations than a single blended pool of all international income. Companies could see their actual tax bills rise because compliance with Pillar Two rules may curb certain tax incentives—particularly the current US approach to research and development tax credits.

The UTPR could backfire if lawmakers of large economies take it as an affront, or a tariff, rather than an amicable transition to a new tax system. A country assessing UTPR is, in effect, treating certain foreign firms (those with sub-15% tax rates somewhere else in their enterprise) differently from domestic firms, which typically would evoke a trade complaint and perhaps retaliation.

This approach—to fight the UTPR—is embodied in the Defending American Jobs and Investment Act, a US bill set forth by House Ways and Means Committee Chairman Jason Smith (R-Mo.).

A trade war would be disruptive and costly for multinational businesses of all kinds. But if large economies manage to use threats to secure a permanent safe harbor from UTPR, rather than a delay, multinationals may be able to avoid some compliance costs of Pillar Two adoption on their domestic income.

A third possibility lies between full compliance and retaliation. These large economies could mostly ignore Pillar Two and persist with their current set of laws. In many cases, little or no change is necessary.

The US, China, and India already have corporate income tax rates that exceed the minimum rate. The US and China also have international rules in place that approximate an IIR. Many of their businesses are likely to comply with Pillar Two even with no change in policy.

However, tax credits, incentives, or mismatches between domestic and Pillar Two definitions of income or tax can result in sub-15% rates for some businesses. If laws don’t change, businesses may need to fend for themselves and engage in tax planning to protect themselves from UTPR liability.

Each potential future—comply, fight, ignore—has significant downsides and introduces some complications for businesses hoping to plan for a post-Pillar Two world. The world’s largest countries are mostly compliant with Pillar Two already, but mismatches are bound to create headaches for corporations in any case.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Alan Cole is a senior economist at the Tax Foundation, with focus on business taxes, cross-border taxes, and macroeconomics.

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