After years of work, major US trading partners are moving forward with enacting a global minimum tax. Unfortunately for the Biden administration, not all in Congress are on board with the Organization for Economic Cooperation and Development’s plan for a 15% global minimum corporate tax that’s known as Pillar Two.
Since all US tax legislation must begin in the House, that’s a problem for Pillar Two proponents. It’s an even bigger problem for major US employers who soon will face an exponentially more complex and incongruent international tax system.
Refundability Problem
Because of an unnecessary distinction in its design, Pillar Two favors refundable tax credits over non-refundable tax credits. The first type, rarely used in the US, generally is treated as economically equal to a government grant under Pillar Two. These “good” Pillar Two credits increase a company’s income under the relevant accounting rules. Non-refundable tax credits, such as the US research and development credit, however, are treated as a corporate tax reduction.
Most countries aren’t that concerned about this outcome, as they distribute their incentives in the form of refundable tax credits. In fact, they could even see a revenue boost if they implement the full Pillar Two framework before other OECD members. US employers easily could end up with US effective tax rates below the OECD’s 15% minimum rate because of this distinction.
For example, let’s say a US manufacturing company earns $100 of US net income. The company’s federal income tax in the US would be based on the statutory rate of 21%, so its tax obligation would be $21. Now, let’s suppose the company receives a refundable tax credit of $10, which means that, regardless of how much tax it actually pays, the government is going to give the company $10.
The OECD framework treats this as if the government gave the company a $10 grant instead of a reduction in tax, so it calculates the company’s effective tax rate using $21 of tax (ignoring refundable credits) divided by $110 of income ($100 plus the $10 “grant”), meaning the company’s effective tax rate is 19%. That exceeds the global minimum tax rate of 15%, so the company is in the clear.
But if that same company, with the same amount of net income, received a $10 non-refundable tax credit—which is how most US general business credits are structured—its effective tax rate for OECD Pillar Two purposes would be 11% ($21 minus the $10 tax credit, divided by the $100 in net income).
In reality, the company is still paying $11 to Uncle Sam in both examples ($21 tax rate minus the $10 tax credit). But because of this refundability quirk in the OECD calculation, the company’s effective rate drops from 19% to 11%, prompting the OECD to ask for an additional 4% in tax. That’s where the challenge really begins.
Global Complexity Problem
Remember that the OECD just facilitates discussion for its 145 members that have signed onto the deal. A US company’s OECD tax bill will come due in up to 144 other countries where it has operations—assuming other countries fully implement the Pillar Two framework. So, as a US company computes its effective tax rate in each country where it operates, every one of those countries will get to independently decide if it agrees with those calculations.
As of now, there is no hierarchy in terms of how Pillar Two interacts with other tax agreements and no dispute resolution mechanism to address differences. So the race is on to implement, except in the US.
Both Democrats and Republicans in Congress have indicated they want US R&D tax credits (and presumably other non-refundable tax credits) to receive more favorable treatment under Pillar Two. Republicans on the Ways and Means Committee are dissatisfied with the lack of communication from the Treasury Department during the Pillar Two negotiation process.
Some Republicans have expressed that frustration by introducing two bills that would hike taxes even further on certain US companies already feeling the full brunt of the OECD Pillar Two taxes. To punish Paris, France, their plans would raise taxes on manufacturers in Peoria, Ill., in the name of “retaliation.”
Long-Term Implications
It’s unlikely countries will stop implementing the full Pillar Two framework or that Congress will make all tax credits refundable. It’s also doubtful that other countries will be willing to seriously accommodate requests to fix the tax credit issue.
If that assessment holds, the unfavorable Pillar Two treatment of R&D credits and the lack of immediate deductibility of common and routine business R&D expenses will create a discouraging environment for long-term US R&D investment.
To find mutually beneficial solutions, Congress and the administration must work together. The US should seek solutions within the agreed-upon Pillar Two design.
For example, could OECD members accept a stipulation that non-refundable tax credits actually utilized within a five-year period be treated as equivalent to a refundable credit? Since Pillar Two is based upon accounting standards, could the accounting treatment of certain non-refundable tax credits be reassessed?
These sorts of questions might spur a constructive bipartisan dialog among US policymakers and trading partners. Major US employers hope some resolution can be found soon, because the alternative is precarious.
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
Jonathan Samford is executive vice president of the Global Business Alliance, a nonprofit business association that represents international companies with significant operations in the US.
We’d love to hear your smart, original take: Write for us.