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OECD Agreement May Increase Global Effective Tax Rates for IP-Intensive Multinationals

Robert Scarborough


Partner, New York

Claude Stansbury


Partner, Washington, DC

Brendan Counihane


Associate, New York

In October 2021, OECD members agreed new two-pillar international tax rules that increase global effective tax rates. [J1] Pillar One works by allocating part of a multinational enterprise’s (MNE's) profits to market jurisdictions, which would tax this amount even if the business concerned does not have a physical presence in that jurisdiction.

Pillar One departs from long-established international tax principles, implemented by tax treaties, that tax profits earned in a jurisdiction only if attributable to a physical presence (or “permanent establishment”). This system has enabled IP-intensive MNEs to avoid significant tax in countries where they market their products by being present, if at all, only through a marketing subsidiary to which little profit is attributable. Some countries, including the UK and France, have responded with “digital services taxes” (DSTs) on revenues from sales there. Under the OECD agreement, countries that have enacted DSTs would generally be required to withdraw them. Pillar One would apply only to MNEs with global turnover above €20bn and profitability above 10 percent and would exclude regulated financial services. It would be implemented by a multilateral agreement, meaning US adoption of Pillar One may require approval by two-thirds of the Senate if it is viewed as subject to the Constitutional requirements for treaty ratification, and is therefore uncertain.

OECD’s Pillar Two requires changes to rules around taxation of foreign subsidiaries

Pillar Two would achieve the global minimum tax rate of 15 percent in part by requiring countries in which MNE parents are resident to impose a top-up tax on offshore subsidiaries taxed at locally lower rates. In addition, it would deny deductions or make other adjustments for payments to affiliates in low-tax jurisdictions. Each of these features would require changes in current rules that generally do not tax parent corporations on earnings of foreign subsidiaries (subject to “controlled foreign corporation” rules), permit deductions to arm’s length payments to foreign affiliates, and – by treaty – exempt those payments from taxation at source. The United States has already taken significant steps to address the resulting erosion of its tax base through changes effective in 2018, which include rules similar to Pillar Two. Those include the Global Intangible Low Tax Income (GILTI) rules – taxing a portion of the earnings of foreign subsidiaries at 10.5 percent) and the Base Erosion and Anti-Abuse Tax (BEAT) – preventing some US companies from using deductible payments to foreign affiliates to reduce tax rates below 10 percent. Pillar Two would exclude MNEs with total consolidated group revenue below €750m. US implementation of Pillar Two seems quite likely since the Rules Committee of the House has sent a revised version of H.R. 5376, the Build Back Better bill, as reported by the Budget Committee on November 5, to the House for consideration, which includes both an increase to the GILTI tax rate to over 16 percent and a 15 percent minimum tax on US corporations reporting financial statement income of at least $1bn.

Key takeaways for boards

  • Multinational corporate groups, particularly in tech and other IP-intensive industries, should prepare for changes in international tax rules that significantly increase global effective tax rates. These result from a plan that was agreed by OECD members, including the United States, and announced in October.

  • The first part of the plan (Pillar One) provides for taxation by market jurisdictions, where the products of a large multinational enterprise (MNE) are consumed, of part of its global profits, even if it does not have a physical presence in that jurisdiction.

  • The second (Pillar Two) provides for a global minimum tax rate on MNEs of 15 percent.