Aligning GILTI With Pillar Two Is a Task the US Shouldn’t Delay – Bloomberg Tax

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One of the biggest questions about the global minimum tax agreement known as Pillar Two has been how different countries would implement it locally. Each nation has a different set of tax rules—and different ways to amend those rules—that have to line up to put into practice the 15% minimum tax on corporations.

In the US, Congress must consider the future of the domestic minimum tax on which Pillar Two is based—the Global Intangible Low Taxed Income regime, commonly known as GILTI—before the transition period to adopt the 15% tax ends in 2026.

Many thought GILTI would be grandfathered in as a compliant tax minimum, given the similarities between pre-existing GILTI rules and the global minimum tax. As discussions progressed, there was greater focus on a key difference between the rules: GILTI is calculated on an aggregate or worldwide basis, while Pillar Two is computed country by country.

Moving the GILTI rules to a country-by-country basis is seen as a harsher result. Yet other differences would remain, many which produce more negative results to taxpayers than under the 15% tax.

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Foreign Tax Credits

Right now, GILTI includes a 20% haircut on foreign tax credits. This reduces the value of those credits and permits some double taxation. US companies must allocate and apportion expenses to determine their tax liability, which can increase the effective tax rate on GILTI well above the statutory rate. GILTI rules also prohibit foreign taxes or losses to be carried forward or back to offset taxes in other years.

However, Pillar Two rules have no foreign tax credit haircut and don’t allocate or apportion parent expenses. They allow losses to be carried forward and provide other mechanisms to smooth out timing differences between when income is earned and when tax is paid or accrued. This means the minimum tax imposed under Pillar Two rules generally can’t increase the effective tax rate above 15% as taxpayers receive a full “credit” for other taxes paid.

The US’ unique expense allocation rules can result in the effective tax rate on GILTI far exceeding 15%. Pillar Two’s rules allow losses to be carried forward to offset future profits, while GILTI losses evaporate into the ether. All these rules are more generous under Pillar Two.

The US executive branch, Congress, and Organization for Economic Cooperation and Development must reach an understanding on how GILTI and OECD model rules can coexist. It’s crucial for the US to comply with the emerging global system without putting US multinationals and the US economy at a disadvantage. In doing so, all differences between the two systems must be considered.

Qualified Tangible Assets

Although GILTI and Pillar Two rules each have a substance-based carve-out for a certain amount of routine profit, there are significant differences.

The GILTI calculation excludes a deemed return of 10% on qualified business asset investment. It includes buildings, machinery, and equipment. Only controlled foreign corporations with income are eligible for qualified business asset investment; entities with losses are excluded.

Pillar Two’s parallel calculation is the substance-based income exclusion. It has two components: one for the carrying value of tangible assets and a second for employee payroll costs in the jurisdiction. Substance-based income exclusion excludes 5% of each component but includes higher percentage under a transition rule for 10 years.

While the tangible assets component of qualified business asset investment and substance-based income exclusion are similar, some of that difference is made up for in the fact that GILTI only permits qualified business asset investment for entities with a profit and has no analogous rule for payroll.

Under GILTI, payroll for employees performing research and development work is amortized, further exacerbating the differences between the “benefits” of the two sets of rules. Congress must eventually contend with the fact that US research and development currently isn’t included at all under Pillar Two, as it’s not refundable.

With so many differences, it’s crucial that Congress and the OECD take time to consider how to blend these two systems, or the end result will be disastrous for US multinationals.

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

Anne Gordon is vice president for international tax policy at the National Foreign Trade Council. She has worked on international tax matters in the private and public sectors.

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