The surprising 26 June announcement by the G7 of an "understanding" that would exclude US parented groups from the IIR and UTPR, two of the main mechanisms of the global minimum tax Pillar Two rules, brought about relief for some and uncertainty for many. With more questions than there are answers, we will seek in this Orbitax analysis to shed light on the potential application modalities and implications of this understanding. The analysis comes in two flavors: a long answer for the patient, and a short answer. With today's level of knowledge, neither answer will lift all mist, but both will attempt to chart the road ahead. Regardless of the final outcome, irrespective of whether this "understanding" will deliver a sustainable side-by-side arrangement or turns out to be the proverbial "two dreams in one bed", the ORBITAX first of class Global Minimum Tax Solution has you covered.

Introduction

The United States affirmed its opposition to the adoption of the Pillar Two framework in a presidential proclamation immediately following the inauguration of the new Administration. In parallel, the US Treasury was instructed to identify extra-territorial or discriminatory foreign taxes that affect US companies, and recommend retaliatory measures. Extra-territorial and discriminatory taxes were quasi-universally understood to mean, in this context, the Pillar Two Undertaxed Profits Rule (UTPR), digital services taxes (DSTs) and diverted profit taxes (DPTs). During the intervening period, US Treasury officials clarified that they seek a full exclusion of US entities from the Pillar Two rules, and that such exclusion concerns both their US-source and foreign-source profits. Schematically, the outcome sought is a side-by-side coexistence between the US domestic system and the Pillar Two system, much as is the case with the co-existence in the area of exchange of tax information between the US FATCA and the OECD/Global Forum CRS. The US position is grounded on the proposition that US tax laws provide for a robust minimum tax framework predating and, in fact, inspiring the Pillar Two system.

A proposed Section 899 inserted in the One Big, Beautiful Bill (OBBB), itself foremostly tabled to carry out the new Administration’s tax agenda, added urgency to the matter.  The proposed Section would impose higher withholding taxes on outflows of US-source income to jurisdictions applying extra-territorial or discriminatory taxes to US persons, as well as apply a "super-BEAT" to US entities controlled by residents of such jurisdictions.

To diffuse the escalation, the G7 meeting held in Canada on 26 June agreed to an "understanding", first announced in a tweet by the US Secretary of the Treasury and later confirmed by Canada (as the current holder of the G7 presidency), the US Treasury and, in a slightly modified form, the UK. The understanding would "exclude US-parented groups from the UTPR and IIR in respect of both their domestic and foreign profits". As a quid-pro-quo, the US would remove the proposed Section 899 from the OBBB (now OBBA). Furthermore, a monitoring system would be agreed to in view of concerns that the contemplated side-by-side system would facilitate profit-shifting or create structural disadvantages to European and other non-US parented groups. Finally, the understanding recognizes the fact that the Pillar Two framework hitherto operated under the ambit of the G20/OECD/Inclusive Framework and, therefore, involves more countries than the G7 members. It consequently confirms that the work would continue in the same format with a view to expeditiously delivering a side-by-side system that is acceptable to, and implementable by all. As importantly, the G7 understanding delivers a clean bill of health to the QDMTT, which appears, therefore, uncontested.

The G7 understanding clarifies two main principles and three commitments. Beyond this, it raises more questions than it provides answers so that any commentary on the potential final outcome -if there will be one at all- and its implications for taxpayers is, at this stage, by definition speculative. So what are so far the knowns and the unknowns?

The Knowns

The G7 understanding sets forth two broad principles within which any future arrangement would be worked out. These are:

     a. US parented groups must somehow be excluded from IIR and UTPR with respect to both their US and overseas profits; and

     b. The QDMTT is uncontested and continues to apply as provided for.

The work to deliver the stated side-by-side objective expeditiously -but without a definite deadline- would take place at the OECD/IF level and the outcome would need to be agreeable and implementable to all. The understanding suggests that this can be "undertaken alongside material simplifications being delivered to the overall Pillar Two administration and compliance framework", implying, but without clearly saying it, a permanent safe harbour approach.

As a quid pro quo, the G7 understanding provides for one immediate and three potential future actions. The immediate action is the removal by the US of the contemplated Section 899 "revenge taxes". The potential future actions are a commitment to revisit the stalled Pillar 1 framework and the taxation of the digitized economy, and another to "ensure [that] any substantial risks that may be identified with respect to the level playing field, or risks of base erosion and profit shifting, are addressed" in order "to preserve the common policy objectives of the side-by-side system". The language used, while open to all interpretations, suggests that the solution to identified risks would not be a return to the status-quo ante.

The Unknowns

The G7 understanding merely sets out one main deliverable without clarifying how it must be reached and what its practical implications will be, thus leaving several unknowns.

Is it a done deal?

The first unknown is whether the understanding reached by 7 countries within the G7 would equally be embraced by the other 135 non-G7 Inclusive Framework member countries which supported the global tax deal. The modus operandi for the Pillar Two work has so far been that the higher-level policy orientations are taken at the level of the Inclusive Framework, while the technical work is carried out at the level of the OECD Secretariat CTPA and Committee on Fiscal Affairs Working Parties.

Obviously, the CTPA and relevant WPs have been involved in devising technical solutions for the US Pillar Two quagmire for some time. WP 11, which is heavily involved in Pillar Two work, has been meeting during the first week of July and cannot have overlooked the G7 development. There is, therefore, little doubt that the CTPA and relevant WPs are equipped to deliver on complex technical issues. Nevertheless, if it were only to preserve decorum, it is unlikely that whatever solution proposed would be nominatively ringfenced to the US. Instead, the solution would need to be theoretically open-ended and available to all, and yet somehow not applicable beyond US parented groups. Which is not evident.

The steering Committee of the IF will be meeting on 9 July.  Admittedly, all IF members are equal, but not all IF members carry the same weight, or have engaged in, or contributed to IF outcomes equally. Nevertheless, the IF functions by consensus, and, as evidenced by the slow death of Pillar One, holdouts can derail the process. Whether this will be the case this time is anyone’s guess. It would not be surprising, however, if geopolitical considerations or the perceived shifting of the level playing field in favour of US businesses would not find opponents to the G7 understanding within the IF. Even from within those IF members that have not themselves implemented Pillar Two yet.

Finally, the understanding reached within the G7 is not guaranteed to survive the tumults of trade and politics within the G7 itself. While the US seems to have shifted potential DST face-offs out of the tax area and to the trade and tariffs arena, there is no telling what impact, if any, such face-offs would have on the Pillar Two front.

In conclusion, the G7 understanding is an important milestone, but the path to delivering a workable and sustainable exclusion of US parented groups is fraught with technical, legal and political risks.

How would the exclusion be delivered?

The G7 understanding does not expressly spell out the delivery method but does imply that this would be achieved through permanent safe harbours. The most obvious route is a safe harbour which would equate GILTI with an IIR. The advantage of this option is that it is more easily implementable than others.

To date, 50+ jurisdictions have implemented Pillar Two, including EU Member States through the global minimum tax directive, and the GloBE rules as implemented are the law in those jurisdictions.  A substantive make-over of the GloBE rules as domestically enacted would require going through the legislative process again, save perhaps in the few jurisdictions with a direct reference in their domestic legislation to the Model Rules as amended from time to time. Within the EU, for example, substantive changes to the global minimum tax directive would require achieving consensus between all Member States, and revisiting the same procedure as for the initial adoption of the directive at the EU level and its initial implementation at the national levels. Based on a reading of a reference in the directive to safe harbours agreed under a “qualifying international agreement”, EU Commission representatives have suggested that delivering the G7 understanding through a permanent safe harbour could be adopted without the need to revisit the directive.  

This reasoning is based on Art. 32 of the global minimum tax directive which stipulates that "[….] Member States shall ensure that, at the election of the filing constituent entity, the top-up tax due by a group in a jurisdiction shall be deemed to be zero for a fiscal year if the effective level of taxation of the constituent entities located in that jurisdiction fulfils the conditions of a qualifying international agreement on safe harbours. For the purposes of the first paragraph, 'qualifying international agreement on safe harbours' means an international set of rules and conditions which all Member States have consented to and which grants groups in the scope of this Directive the possibility of electing to benefit from one or more safe harbours for a jurisdiction". The fact that this clause had already facilitated the acceptance of the transitional UTPR safe harbour within the EU is thought to also accommodate a permanent safe harbour excluding US parented groups from the IIR and UTPR. Whether this approach is legally full proof is disputed. Indeed, Art. 32 requires an international agreement to which all Member States consent, which is yet to happen. Secondly and most importantly, it refers to an effective level of taxation of the constituent entities in that jurisdiction.  Expanding that to facilitate a permanent blanket exclusion of US parented groups from IIR and UTPR might be an overreach. Nevertheless, the permanent safe harbour approach remains the least legally challenging option.

How broad is the exclusion?

The G7 understanding specifies that US parented groups would be excluded from the IIR and UTPR on both their US and overseas profits. In contrast, the QDMTT is uncontested, and there is no express reference to the Pillar Two related compliance and reporting requirements. This means:

• Foreign subsidiaries of US parents established in jurisdictions without a QDMTT are immune from the application of the UTPR by other jurisdictions. Whether they remain equally immune from top-up tax under the IIR where they are held by a non-US POPE is questionable;
• Overseas subsidiaries of US parents are not immune from top-up taxes imposed under the QDMTT in their country of residence; and
• US subsidiaries of foreign-parented groups are not immune from top-tax under the IIR in the UPE’s jurisdiction or UTPR elsewhere if their non-US parent is not an IIR jurisdiction.

The envisaged side-by-side system does not produce two parallel disconnected universes, with US parented groups operating in a universe where the Pillar Two compliance burden has magically disappeared. Indeed, registration, local tax (and possibly IIR in the case of POPEs) calculations and return filing remain in the best scenario unchanged. There is even a risk that local reporting could be expanded to fill the informational gap created by the US not participating in the GIR framework. Indeed, countries which do not receive through the GIR the information required for their domestic audit purposes, may expand the scope of information to be submitted locally. Also, if a solution is found in a permanent safe harbour and that solution is adopted in the EU by reference to Art. 32 of the directive, effective levels of taxation would still need to be calculated to adhere to the letter of the directive.

What is the timeline?

The G7 statement merely mentions that the envisaged side-by-side system should be delivered “expeditiously” but without setting a specific deadline. Clearly to pre-empt the effective application of the UTPR, US congressional leaders have demanded tangible results before year-end failing which they would consider a revival of the “revenge taxes” under the withdrawn Section 899. The same need for an expeditious resolution was expressed by the OECD, notably in relation to the nearing expiry of the transitional safe harbours. However, whether a sustainable side-by-side arrangement can be achieved within a short period of time depends on the dynamics within the Inclusive Framework and the shifting geo-political and trade sands.

Can we travel back in time?

The IIR and/or QDMTT components of Pillar Two are not only law, but actually became effective in dozens of jurisdictions. To quote an extreme example, the government of Hungary has already pocketed the first top-up tax prepayments by the end of last May. This begs the question of whether an exclusion of US parented groups say by the end of 2025 could have retroactive effects to 2024. There is no unequivocal answer to this question as it depends on the agreed method of delivering the side-by-side system and the procedural rules proper to each country. In the EU, one would be in unchartered territory. If the delivery method is through a partial repeal and replacement of the directive, there is little case law on whether the repeal and replacement could have a retroactive effect. This is compounded by the fact that the directive is not primary law; it has to be implemented at the national level. The most likely outcome is that there would be no retroactive effect.