Impact on global implementation of Pillar 2 if the US fails to adopt it

Despite the Biden Administration’s vocal support for the Organisation for Economic Co-operation and Development (OECD) Pillar 2 Global Minimum Tax (Pillar 2) deal, it is uncertain whether or not the US will be able to adopt the necessary changes to its tax rules in order to become compliant with the Pillar 2 standards set by the OECD.

In particular, the necessary changes to the US global intangible low-taxed income (GILTI) regime have become front and center. At a minimum, the US would need to adopt a country-by-country GILTI regime in order to become a compliant Income Inclusion Rule per the Pillar 2 rules.

With last week’s announcement that West Virginia Senator Joe Manchin will not support the Build Back Better Act (BBBA), the chances of the US adopting said changes to the GILTI regime, by means of a reconciliation bill before the November elections, have decreased substantially. At this point, it is unclear whether or not these necessary changes may be implemented anytime in the near future.

Although it is impossible to predict the ramifications of these latest developments, there is no sign yet that the rest of the world, including the OECD and the EU, will slow down their efforts to implement Pillar 2 by the currently set deadline of January 1, 2024.

In fact, the UK issued its draft Pillar 2 legislation on July 20, including detailed explanatory notes. The country is on track for implementation by January 1, 2024.  In the UK authorities’ responses to the public consultation, they expressly stated that they expect the US GILTI rules will be considered a qualifying controlled foreign corporation (CFC) regime for the purposes of their Pillar 2 rules.  How exactly the GILTI tax will be allocated to the CFCs is an open point in the comments from the UK authorities.

One may assume that these developments, including the UK comments, will put more pressure on the OECD to provide anticipated clarity on how to deal with CFC-type taxes – and the US GILTI rules in particular – in the context of Pillar 2. Based on the current version of the Pillar 2 Model Rules, CFC taxes levied by a jurisdiction, in principle, qualify as so-called Covered Taxes for Pillar 2 purposes. This implies that these CFC taxes are allocated to the (often low-taxed) CFCs for Pillar 2 purposes.

The result of this allocation is that the amount of possible Pillar 2 top-up tax that may be levied over such low-taxed income is reduced by the amount of allocated CFC tax to the low-taxed subsidiary.

The OECD has not yet taken a position on whether or not the US GILTI rules are a qualifying CFC tax for Pillar 2 purposes. It may be expected that, based on these updates, there is increased pressure to provide more clarity on the Pillar 2 implications of CFC rules and the US GILTI rules especially. Moreover, there have been some indications that the OECD is also already seeking to determine how US GILTI tax should be allocated to subsidiaries for the purpose of Pillar 2.