Outstanding Issues for Congress on Pillars One and Two Following October Agreement

Nearly 140 countries just agreed to the next phase of a two-part global tax agreement, known as Pillars One and Two, following months of negotiations between countries. Some policymakers are eager to spike the football and celebrate the accord as if the hard work is done. U.S. officials must be aware, though, that Congress can and should have a lot more to say about the details and implementation of both pillars in this deal.

Pillar One would reallocate some of the profits of multinational technology companies to the countries where those companies have a minimum number of customers or users. A recent Oxford study found that nearly two-thirds of the revenue generated by Pillar One would be from U.S.-based companies and nearly half (45 percent) would be generated from five U.S. companies alone.^[1] Pillar Two would set a global minimum tax rate for all multinational companies, effectively requiring these companies to pay a minimum amount of taxes on their global profits.

Officials at the U.S. Treasury Department, who helped negotiate the deal, are expressing confidence that the U.S. will fully and expeditiously implement both pillars of the agreement, and have even suggested that the U.S. is a mere few policymaking steps away from implementation.

Not so fast.

There are many aspects of both Pillar One and Pillar Two that Congress must weigh in on. This agreement is, in some respects, the most significant global tax accord in decades. It would significantly impact the business operations of numerous American companies and scores of American workers. Below is a partial list of outstanding issues that lawmakers must resolve in the months ahead.

Pillar One

Eliminating Digital Services Taxes (DSTs)

For years, NTU has called for the elimination of discriminatory and punitive DSTs, pointing out that 1) DSTs are a tax on revenues rather than profits, 2) DSTs could lead to positive tax liabilities for money-losing firms, 3) DSTs could result in double taxation, and 4) DSTs are more distortive than profit-based taxes, and they lead to higher prices, lower quantities, and less investment in the affected sectors.

The October Pillar One agreement takes a major and welcome step forward in effectively suspending the imposition of new DSTs through 2023 (and on a permanent basis if Pillar One is implemented).

However, the October agreement lacks sufficient and necessary information on how countries will handle existing DSTs. A gradual drawdown of DSTs or a carve-out for DSTs levied on companies and activities not fully in scope of Pillar One, as suggested by some commenters, is hardly a comfort for U.S. companies and workers. U.S. policymakers and taxpayers must have certainty that existing DSTs in Austria, Frace, India, Italy, Spain, Turkey, the UK, and elsewhere do not stick around if and after the U.S. ratifies Pillar One.

A recent Bloomberg report (paywall) indicates that the U.S. may be close to securing agreements with some countries to end their DSTs, but the Biden administration has (as of this writing) declined to share further details:

“The Biden administration said it’s close to securing agreements from a number of countries on withdrawing their so-called digital service taxes, further clearing the path to a new global tax regime and avoiding a potentially damaging set of trade spats.

U.S. Treasury Department officials, speaking on a call with reporters Monday, said they were hopeful the deals would be struck in time for the Oct. 30-31 Group of 20 summit in Rome where world leaders are expected to endorse a new global tax agreement.”

Withdrawal of DSTs would be a major win for American companies, workers, and taxpayers, but the devil may be in the details here. NTU eagerly awaits further news from the administration.

Senate Ratification of Pillar One

More concerningly, the Biden administration is suggesting that they may be able to bypass Senate approval of the changes in Pillar One. They should not do so, given that the U.S. Constitution provides the Senate with the responsibility of advising and consenting on treaties. Or, as Senate Finance, Foreign Relations, and Banking Committee Ranking Members Mike Crapo (R-ID), Jim Risch (R-ID), and Pat Toomey (R-PA) recently argued:

“As you know, under the U.S. Constitution, a bilateral or multilateral tax treaty would require the advice and consent of the Senate, with a two-thirds vote of approval. Further, we are unaware of any existing congressional authorization that would permit the Administration to conclude a lesser international agreement, such as a congressional-executive agreement. As described, the nature of changes required to implement Pillar One necessitates the conclusion of a treaty, not a congressional-executive agreement or other legislative override.”

International tax matters affecting U.S. taxpayers have long been considered under the treaty process. Alternative “executive agreements” -- whether solely agreed to by the executive branch or a congressional-executive agreement that bypasses the treaty process -- would cut against tradition and amount to an end-run around the Senate’s rightful advise and consent role on Pillar One.

Pillar Two

Biden administration officials also recently expressed confidence that implementing Pillar Two would require minimal updates to existing law. As Politico’s Morning Tax reported:

“A senior Treasury official told reporters on Monday that, essentially, only two updates to the so-called levy on Global Intangible Low-Taxed Income, or GILTI — bumping up the rate to 15 percent (or higher) and applying it on a country-by-country basis.

As the official noted, both the tax package that has passed the House Ways and Means Committee and the international draft released by the Senate Finance Committee would check those boxes.”

This is a significant oversimplification of the work Congress would be required to do on Pillar Two. Besides a rate change and a move to country-by-country tax reporting -- and NTU has significant concerns with both proposals -- lawmakers must settle the following questions and issues with Pillar Two:

• The substance-based carve-out: Pillar Two does not subject all of a multinational’s foreign earnings to taxation; instead, it carves out eight percent of the value of tangible assets plus 10 percent of payroll in the first year (2023), with a gradual transition over 10 years down to five percent of tangible assets plus five percent of payroll after the tenth year (2032). This is much more generous than the carve-out in the U.S. global tax regime (on Global Intangible Low-Taxed Income, or GILTI), which is just five percent of tangible assets. Will lawmakers adjust the carve-out so it matches the generous transition period in Pillar Two? This could reduce some (but not all) of the sting from a transition to a higher GILTI rate (from 10.5 percent to 15 percent or higher).
• The FTC haircut: The current U.S. GILTI regime limits the amount of foreign taxes a company can use to reduce their GILTI liability, to only 80 percent of foreign taxes paid. The so-called “FTC haircut” raises effective GILTI rates to above the statutory minimum of 10.5 percent. The House proposal for GILTI changes reduces the FTC haircut to five percent. Will the Senate follow suit, or eliminate the FTC haircut altogether? Eliminating the FTC haircut could ensure that, in many cases, U.S. companies do not pay more than the statutory GILTI rate on their foreign earnings in certain countries.
• Simplification: The U.S. and global tax negotiators have yet to figure out simplification options that could reduce compliance burdens for U.S. companies and workers -- and administrative burdens for the IRS -- under Pillar Two. NTU has regularly called on Congress and the Treasury Department to include a safe harbor threshold for companies paying above a set effective tax rate, or a de minimis profits threshold, for calculating tax liability under Pillar Two.
• Loss and FTC carryforwards: The House proposal for GILTI changes makes a few positive changes, such as fixing the international tax rules for U.S.-based companies experiencing domestic losses and expanding FTC carryforwards to GILTI income. The Senate’s treatment of loss and FTC carryforwards is to be determined.
• The Foreign Derived Intangible Income (FDII) rate: FDII has been described as the carrot to GILTI’s stick, incentivizing U.S.-based multinational companies to keep valuable, highly-profitable, and highly-mobile intangible assets like intellectual property in the U.S. instead of in low-tax countries abroad. The House proposal for international tax reform would raise the FDII rate from its current 13.125 percent to 20.7 percent, a major increase that also diverges significantly from the proposed GILTI rate (16.6 percent). President Biden envisions scrapping the FDII deduction under current law, effectively raising the rate from 13.125 percent to as much as 28 percent. Lawmakers must retain a competitive FDII rate, or else risk “increas[ing] the incentive to shift intangible investments and profits recorded by U.S. firms to other countries” with lower tax rates, according to the Penn Wharton Budget Model.

These are just a few of the Pillar Two issues Congress must resolve. In other words, fulfilling America’s Pillar Two obligations involves a lot more than just increasing the minimum rate and moving to country by country tax reporting for multinational companies.

Lawmakers can and should assert their role in tax policymaking in the months ahead, rather than cede significant chunks of tax policy over to the Biden administration and other countries.