G7 statement on application of Pillar Two to US

The G7 has released a statement (published on the US Treasury website) confirming that agreement has been reached concerning the operation of a side-by-side solution to the application of Pillar Two to US parented groups. The statement notes that this side-by-side system will fully “exclude US parented groups from the UTPR and the IIR in respect of both their domestic and foreign profits”. As a result, it appears that the US will remove from the progress of the One Big Beautiful Bill the section 899 provision, which threatened to impose additional taxes on residents of jurisdictions which were deemed to have in place tax measures discriminating against the US and US companies.

The statement will come as a relief to international businesses generally, which had been concerned over the prospect of US retaliation against jurisdictions introducing (what the US viewed) as discriminatory tax measures, including the widely implemented Pillar Two proposal. However, it is clear that the G7 statement represents a broad understanding of the way ahead at this stage and much work will still be needed to finalise the terms of the agreement.

Background

The Pillar 1 and Pillar 2 approaches were designed by the OECD Inclusive Framework to deal with problems created for the international tax landscape by the digital economy and involve: revised profit allocation and nexus rules (Pillar One); and a global anti-base erosion rule involving a minimum level of taxation of 15% (Pillar Two).

The overall design of Pillar Two includes two domestic rules (together the Global anti-Base Erosion Rules (GloBE) rules):

• an Income Inclusion Rule (IIR), which imposes top-up tax on a parent entity in respect of the low taxed income of a subsidiary entity; and
• an Undertaxed Payment Rule (UTPR), which denies deductions or requires an equivalent adjustment to the extent the low tax income of a subsidiary entity is not subject to tax under an IIR.

Earlier this year, the Trump administration indicated that it would no longer implement the OECD Pillars. With regard to Pillar Two in particular, the US objected to its extension to include the UTPR. Whilst the basic GloBE rules largely work in a way similar to CFC rules to top up taxes of subsidiaries to 15%, the UTPR will go much further. This will allow jurisdictions to impose additional taxes on members of an MNE group that pay less that the global minimum of 15% in another jurisdiction, including where the ultimate parent company fails to pay 15%. As such, with the US not implementing the GloBE rules domestically, then other jurisdictions would potentially be in a position to charge domestic group companies additional taxes on the basis that their US parent was subject to tax at a rate less than 15%.

The UTPR proposal falls squarely within the scope of the discriminatory tax measures President Trump has taken aim at, including the recent inclusion of Section 899 in the One Big Beautiful Bill which would have levied additional taxes on the income earned from US assets held by individuals or businesses in other countries with taxes the US perceived as discriminatory to US businesses. With at least thirty countries planning to adopt the UTPR by the end of 2025, including the UK, Australia, Canada and certain EU member states, retaliatory action under the section 899 proposal was a source of major concern.

The G7 announcement

The US Treasury had put forward a ‘side-by-side’ solution under which US parented groups would be exempt from IIR and UTPR in recognition of the existing US minimum tax rules to which they are subject (including the existing BEAT (Base erosion and anti-abuse tax) and GILTI (Global intangible low-taxed income) regimes). However, uncertainty remained as to whether this proposal would be acceptable to other members of the OECD given significant differences in the way the regimes work compared to Pillar Two (for example, GILTI is not aligned with Pillar Two as it is calculated based on a global average rather than a jurisdiction by jurisdiction minimum tax). However, such an approach is not unprecedented, with a similar arrangement being reached with regard to the implementation of the Common Reporting Standard and the US FATCA reporting rules.

Following discussions on this issue, the G7 statement notes that there is now “a shared understanding that a side-by-side system could preserve important gains made by jurisdictions in the Inclusive Framework in tackling base erosion and profit shifting and provide greater stability and certainty in the international tax system moving forward”. A side-by-side system would fully exclude US parented groups from the UTPR and the IIR in respect of both their domestic and foreign profits. As a result, it appears that the US administration has agreed to remove the threat of section 899 which had been hanging over jurisdictions implementing the UTPR aspects of Pillar Two. The importance of the removal of the threat of section 899 is also expressly recognised in the statement when it says that “removal of section 899 is crucial to this overall understanding and to providing a more stable environment for discussions to take place in the Inclusive Framework”.

It is worth noting, however, that the statement, as it currently stands, represents a broad commitment to move forward on this basis and there are still issues to be worked through and hurdles to overcome. The statement further notes that the understand reached by the G7 is based on the following accepted principles:

• A side-by-side system would include a commitment to ensure any substantial risks that may be identified with respect to the level playing field, or risks of base erosion and profit shifting, are addressed to preserve the common policy objectives of the side-by-side system.
• Work to deliver a side-by-side system would be undertaken alongside material simplifications being delivered to the overall Pillar 2 administration and compliance framework.
• Work to deliver a side-by-side system would be undertaken alongside considering changes to the Pillar 2 treatment of substance-based non-refundable tax credits that would ensure greater alignment with the treatment of refundable tax credits.

The current Pillar One and Two proposals have been agreed not just by the G7, of course, but by the many more jurisdictions in the OECD Inclusive Framework (which numbers over 130 jurisdictions). The statement recognises that work therefore remains to push through this agreement with the remainder of the members of the Inclusive Framework, saying: “We recognize that these issues have relevance to a wider group of jurisdictions and look forward to discussing and developing this understanding, and the principles upon which it is based, within the Inclusive Framework with a view to expeditiously reaching a solution that is acceptable and implementable to all.

What of digital taxes (DSTs)?

It is perhaps surprising that the US appears to have agreed to remove the section 899 proposal without also agreeing a deal on the various DSTs implemented (or announced) in over 20 jurisdictions, including the UK, France, Italy, Spain, Canada, and India. DSTs were generally introduced as a reaction to a perceived failure of the international tax rules to keep pace with modern business practices and the ability of many businesses, especially those operating in the digital space, to derive value from jurisdictions without having any presence there (which is required for the recognition of a permanent establishment (PE) giving taxing rights to the host jurisdiction). Proposals to recognise a virtual PE in some cases were eventually replaced with the current OECD Pillar One proposals. The US and various European jurisdictions (including the UK and France) signed a transitional agreement on the withdrawal of these DSTs, dependent on entry into force of the OECD Pillar One proposal. This transitional agreement was designed to forestall the threatened trade action by the US against jurisdictions imposing DSTs. With the US withdrawing from the OECD process, there is no longer an agreed basis for the removal of these DSTs. However, since DSTs tend to disproportionately affect large US based multinational tech giants, they are also known to be a target for the US administration’s action against perceived discriminatory taxes. Most recently, Canada appears to have agreed to drop the implementation of its DST in order to progress broader trade talks with the US.

The G7 statement glosses over this issue for the time being, simply noting that “Delivery of a side-by-side system will facilitate further progress to stabilize the international tax system, including a constructive dialogue on the taxation of the digital economy and on preserving the tax sovereignty of all countries”.

Comment

The G7 statement is a hugely significant and extremely welcome development, as far as it goes. It represents an important understanding as to how to take forward a solution, but it seems clear that there is much detail to be worked through before this broad understanding can be turned into a full agreement. The G7 will also need to take the remainder of the OECD Inclusive Framework forward with it.

The statement also contains no suggesting timing on the implementation of the solution, but it would be surprising if the US expectation were not that those countries that implement the UTPR will do so based on the existence of this solution from the outset, whether or not it has been finalised.

Finally, the G7 statement does not address the future of DSTs and it seems unlikely that we have heard the last of this issue, which President Trump has referred to as “a direct and blatant attack” on the US.