This is the first time in history when significant changes in US taxation are intertwined with a global tax reform effort.
The interconnection of national and international tax restructuring results in a very complex environment that creates a lot of uncertainty for businesses everywhere.
There is currently a global moment in proposed tax reform; the G7 is encouraging 140 countries to complete a project led by the OECD (The Organization for Economic Co-operation and Development) and G20 to overhaul tax laws impacting multi-national businesses.
In tandem with its participation in these global tax reform efforts, the Biden administration in the US is also working to enact new tax legislation.
140 nations are working together on two ideas that have been named Pillar One and Pillar Two.
Pillar One: The goal of Pillar One is to address the concerns of nations such as France and the UK where the very largest size (in dollars) companies have a significant number of customers.
The proposed plan currently applies to companies with revenue over $24B / €20B and states that if a company’s profit reaches 10% threshold, the nations where the customers are located are able to tax between 20% – 30% of the profits above the 10% level. This set of requirements results in only about 100 companies being impacted, a large share of which are likely to be US companies.
It is important to note that companies in sectors such as extraction (oil, gas, etc.) and financial services are exempt from the proposed policy.
Pillar Two: This is the most widely known initiative. This states that countries that have multinational companies’ headquarters could levy a minimum tax of 15% to “top up” the tax imposed in the nations where the company operates to ensure that profits wherever earned are subject to at least 15% tax. The purpose of this minimum global tax of 15% is to reduce tax competition among countries and limit the potential for companies to reduce their taxes by funneling profits or moving headquarters to low-tax jurisdictions.
In Summary: Pillar 1 looks at global profit and reassigns which country has taxing rights (which of course, inversely means if one country is gaining the ability to tax, another country is giving up that ability). This is a very globally involved undertaking and it will require a significant degree of coordination amongst tax authorities and result in multi-lateral tax disputes to manage. Pillar 2 gives countries the authority to impose additional tax above the local tax where the local tax is below the agreed minimum tax rate.
Most companies worry about Pillar 2, some focus on Pillar 1, a few very large companies must think deeply about both.
One of the biggest questions for board directors to understand is who is the regulatory entity is that is “in charge” of administering and enforcing the minimum tax that is being proposed? Should board members be asking management what international jurisdictions will be affected by this proposed minimum tax for 2022 and beyond?
There is no singular overarching global tax enforcing agency; it will be up to each individual country to implement and enforce the measures they agree to. Countries would need to enact new laws, repeal previous tax policies that conflict with new rules and would have to work with many other countries to resolve potential disputes.
While there are 140 countries participating in the OECD/G20 discussions, this does not automatically translate into every country being fully on board and swiftly enacting these laws. Participation as well as implementation is voluntary and there will likely be different rates and degrees of buy in making it all the more difficult for companies as they enter their tax planning cycles.
In conjunction with proposed OECD global tax reform, the US is currently in the midst of a national tax reform effort under the Biden administration.
The Jobs Act in 2017 established our current tax rate of 21%. Biden has proposed raising the current corporate rate to 28%. Biden has also proposed a 21% tax rate on foreign earnings of US companies which, when coupled with foreign tax credit limitation and expense allocation rules could result in a tax rate of over 26% on foreign earnings (much higher than the OECD proposed 15% global tax minimum).
It would seem that the US Tax proposals and discussions are moving faster and farther than the OECD global tax proposals and could potentially leave US businesses in a disadvantaged position if they will be subjected to increased taxes long before other countries enact similar tax policies that level the playing field.
However, it is important to note that while the Biden administration has released a tax policy proposal, moving any tax increases through Congress will be challenging and will require the use of the reconciliation process that allows legislation to pass with just a majority vote in the Senate.
Corporate boards have a duty of loyalty to their stakeholders to make financial decisions in the best interest of their stakeholders. The proposed US national tax policy changes coupled with international tax policy discussions may be an important strategic topic for the annual planning cycle for 2022 and beyond.
Board members both for US companies as well as international multinational companies may want to consider adding these topics to future board room discussions:
- Ask for a briefing on your current global tax status.
- Ask for a briefing on how the proposed Biden tax changes currently being considered in Congress will affect the company.
- Ask for a review of any future capital investment proposal and which jurisdiction is the optimal geography.
- Review and consider the tax implications of future international M&A targets.
- One way to handle gathering insights and recommendations for the board could be to set up an interim committee on a tax strategy and finance. This committee could lead with a special focus so this complex topic can be analyzed and reviewed beginning with the 4th quarter planning cycle.
The US and other international tax authorities have various mechanisms for helping companies getting tax certainty by reaching agreement up front. Perhaps boards may want to ask management for an update on their use of these mechanisms currently and their plans for future use.
It may be possible to secure advanced certainty that lasts for several years in the US, as well as bilaterally, with another country’s tax authority. This process is frequently used on transfer pricing. While this process can be time-consuming, it can be a cost savings option in the long run.
A key consideration is your corporation’s global competitiveness. Tax increases will require boards to examine where to cut capital spending. Typically, companies don’t cut dividends; R&D, new facilities, equipment and factories are often cut which impacts global competitiveness.
This is a critical window of time before the US tax bill is passed for boards to ask for a tax briefing and scenario modeling from management. Boards need to ask for a tax briefing and scenario planning and how management is thinking about models. There will be significantly less corporate profit available to reinvest in the company in the future if these large corporate tax increases are approved. For example, boards and management need to understand how the company will stay competitive if their R&D budget potentially takes a hit to accommodate for a larger tax bill.
The board would be well served to immerse itself in tax this season as this is a complex topic with far reaching impact; it is well worth allocating extra time and resources on all fronts for a thorough and robust planning.