President Biden’s 2023 budget would replace the current 10 percent base erosion anti-avoidance tax (BEAT) on US subsidiaries of foreign corporations with a 15 percent minimum tax called the undertaxed profit rule (UTPR). Together with global intangible low-tax income (GILTI) regime reforms proposed earlier, the UTPR would fully align the US corporate tax with the OECD’s Base Erosion and Profit Shifting (BEPS) plan.
The UTPR would implement the latest Pillar 2 innovation, introduced in last December’s updated model rules: a “top-up” tax on the domestic income of companies with undertaxed foreign affiliates. Under the provision, US subsidiaries of foreign multinationals could be denied domestic deductions sufficient to raise the effective tax rate on offshore affiliates to at least 15 percent.
How does the UTPR differ from BEAT?
The BEAT, enacted as part of the 2017 Tax Cuts and Jobs Act, also works by denying deductions to US affiliates for payments to offshore affiliates. The BEAT, however, is a 10 percent alternative minimum tax calculated by adding back to taxable income certain deductions, such as interest and royalties, made to related parties in offshore jurisdictions. The business must pay the higher of the 21 percent US corporate tax rate or the BEAT.
The UTPR denies deductions to US affiliates of large foreign multinationals that have offshore affiliates paying a less than 15 percent effective tax rate. For example, if a foreign affiliate of a US company has $100 million in net profits and pays no foreign income tax, the UTPR denies deduction of the US company until they yield $15 million in US tax liability. Since the US corporate tax rate is 21 percent, that limit is $71.4 million (= $15 million/21 percent).
The US UTPR would also apply pre-emptively whenever foreign jurisdictions applied a UTPR to US affiliates. This new provision of the Pillar 2 model rules allows countries to claim revenue that would otherwise flow to other governments.
How does the UTPR interact with the Income Inclusion Rule (IIR)?
The UTPR supplements the Pillar 2 income inclusion rule (IIR), which is a 15 percent minimum tax on the foreign income of multinational corporations imposed by their country of residence. Countries that implement Pillar 2 subject all foreign income of their resident multinationals to the IIR--a sharp departure from current practice outside the US, since most countries impose no income tax on the foreign earnings of their multinationals.
Under Pillar 2, the UTPR only applies when the home country of the parent corporation does not apply its own IIR. In that case, countries where subsidiaries operate may impose the UTPR on their outbound payments. The UTPR creates an incentive for all countries to implement their own IIR. If they do not, their corporations will bear the same tax burden, but the revenues will go to other jurisdictions.
Biden would give Treasury the authority to determine whether a foreign jurisdiction has an IIR or UTPR in place.
Which corporations would be affected?
Foreign multinational companies with US operations and at least $850 million in global revenue in at least two of the previous four years would be subject to the UTPR. The proposal includes several exceptions, including smaller countries where a multinational does little relatively little business, smaller firms that operate in a relatively few countries, and new firms.
US multinationals domestic affiliates would not be subject to the UTPR, if a GILTI reform similar to that in the Build Back Better Act (BBBA) is enacted. The reformed GILTI regime would constitute a 15 percent country-by-country IIR that would preempt application of the top-up tax.
How is the Pillar 2 effective tax rate determined?
Pillar 2 tax liability is based on profit reported in financial statements in each jurisdiction where the multinational operates. Similar to the US “qualified business asset investment” provision under GILTI, Pillar 2 allows an income “carveout” based on the book value of tangible assets and payroll in each jurisdiction. The deduction starts at 7.8 percent for tangible assets and 9.8 percent for payroll but declines over a period of nine years to reach 5 percent for both.
The proposed reforms would preserve the value of certain tax credits and investment incentives. Unused disallowances could be carried forward indefinitely.
The fate of US Pillar 2 adoption remains unclear, as the BBBA continues to languish in Congress. However, Biden’s 2023 budget proposal for full Pillar 2 implementation is consistent with his administration’s commitment to the BEPS process.
