The OECD introduced the framework for the Pillar Two global minimum tax in December 2021. The subsequent issuance of the Pillar Two model rules aims to guarantee that multinational enterprises (MNEs) with global revenues surpassing EUR 750 million ($800 million) are subject to a 15% minimum tax rate on their income from each jurisdiction in which they operate. This minimum tax can be applied either to the ultimate parent entity through the income inclusion rule (IIR) or to another operating entity in a jurisdiction that has adopted the rules through the undertaxed payments rule (UTPR). Moreover, various jurisdictions can impose a qualified domestic minimum top-up tax (QDMTT) on profits generated within their jurisdiction.
Some of the common planning arrangements and tax regimes likely to be impacted by these rules include:
- Structures that involve tax havens, low-tax jurisdictions, and jurisdictions with territorial regimes;
- Notional interest deduction regimes;
- Intellectual property (IP) boxes and other incentives regimes; and
- Low-taxed financing, IP, and global centralization arrangements.
Every global organization within the scope of the model rules should take into account the potential impact of Pillar Two. The situation will vary for each multinational enterprise (MNE) depending on their specific profile and presence in different jurisdictions. Even if an MNE is not subject to a top-up tax, it will still need to demonstrate that it falls below the threshold established by the model rules. As a result, large MNEs should anticipate a significant increase in their compliance responsibilities. This is because the rules necessitate the calculation of low-taxed income based on accounting income by constituent entities on a jurisdictional basis, as well as the reporting of the Pillar Two calculation to the tax authorities.
How a Tax Advisor Can Help
Impact assessments and modeling
- Explain, evaluate, and communicate appropriate Pillar Two responses;
- Model ETR and cash tax impact, supply chain, and broader organizational effects;
- Identify structuring options for the capital and operational supply chain;
- Identify data and compliance implications and a roadmap for Pillar Two readiness; and
- Assist with compliance.
Focusing on the Section 965 transition tax
The Supreme Court of the United States has agreed to review the constitutionality of the “transition tax” in IRC Section 965, which was added by the 2017 Tax Cuts and Jobs Act. Section 965 implemented a one-time tax on certain foreign corporations' unrepatriated earnings and profits.
The specific issue presented to the Court in the case of Moore v. United States is whether the tax imposed on the deemed repatriation of these earnings and profits under IRC Section 965 is constitutional. The taxpayers argue that because the tax is imposed on unrealized income, it violates the 16th Amendment to the U.S. Constitution. The taxpayers lost in the U.S. District Court for the Western District of Washington and again on appeal in the U.S. Court of Appeals for the Ninth Circuit. The taxpayers have now appealed to the Supreme Court, which granted certiorari on June 26, 2023.
Section 965 functions by increasing the subpart F income for the last taxable year of a "specified foreign corporation" that began before January 1, 2018, based on the greater of the accumulated post-1986 deferred foreign income of the corporation as of (1) November 2, 2017, or (2) December 31, 2017. The accumulated post-1986 deferred income generally refers to the earnings and profits of the corporation accumulated in taxable years starting after December 31, 2017.
Under Section 965, each U.S. shareholder (typically a U.S. person who owns 10% or more of the total combined voting power of a foreign corporation) of a specified foreign corporation was required to include in their income their pro rata share of the subpart F income in the year in which the taxable year of the foreign corporation ended and pay a tax on that income at reduced rates. For a U.S. shareholder with the calendar year as their taxable year, the inclusion year was 2017 for a specified foreign corporation with the calendar year as its taxable year, and 2018 for a specified foreign corporation with other taxable years. The transition tax could be reduced by net operating losses, foreign tax credits, and other credits. Taxpayers were allowed to choose to pay the transition tax over eight years.
You may be interested to read about the 2023 Year-End Guide – Tax Accounting Methods
How a Tax Advisor Can Help You
Filing Protective Refund Claims
- Assess statute of limitations matters, consider the best posture for the year(s) for filing refund claims, and assist in the preparation of the protective refund claims with appropriate disclosures.
Modeling and Analysis and Final Refund Claims
- Model implications of Section 965 being ruled unconstitutional (if this occurs) in later years because tax attributes would change;
- Address all items impacted by a ruling assuming a refund is claimed and issued; and
- Provide continued support in dealings with the IRS during the processing of the refund claims.
What actions you can take as a taxpayer
It is advisable to consider filing protective refund claims for any year affected by Section 965 to protect your potential right to a refund in case the Court declares the Section 965 tax unconstitutional.
Protective refund claims serve to safeguard a taxpayer's ability to claim a tax refund when that right is dependent on future events, such as a court decision, which may not occur until after the statute of limitations expires. Although the concept of protective claims is not explicitly mentioned in the Internal Revenue Code or Treasury regulations, it has been established through case law. The years impacted by Section 965 will include each inclusion year, each year in which an installment payment was made, and each year that is affected by adjustments made to tax attributes (such as net operating losses and foreign tax credits) used in an inclusion year.
International Tax Planning in a Distressed Economy
During times of economic distress, U.S. companies with foreign operations may face significant tax implications. However, it's important to note that in such challenging circumstances, these companies can explore various planning opportunities to access cash and potentially take advantage of specific tax benefits. Some of these planning opportunities may include:
- Accessing CFC cash by borrowing from a controlled foreign corporation (CFC) (or pledging CFC stock to secure third-party debt) without causing an inclusion under Section 956.
- Claiming an ordinary worthless stock loss on an insolvent CFC under Internal Revenue Code Section 165(g)(3).
- Importing built-in loss property through an inbound liquidation or reorganization of a CFC.
- Preserving net operating losses, foreign tax credits, and Section 250 deductions by deconsolidation.
- Repatriating previously taxed earnings and profits to trigger Section 986(c) foreign exchange losses.
- Restructuring so that CFCs are no longer directly or indirectly owned by U.S. entities.
- Accelerating foreign-source income to utilize foreign tax credits.
- Capitalizing interest expense into the cost of goods sold to minimize the base erosion and anti-avoidance tax (BEAT).
- Increasing adjusted taxable income for Section 163(j).
This list highlights just a few of the opportunities that a company operating in a distressed economy can explore. It is important to carefully evaluate each opportunity based on the specific facts and circumstances of the taxpayer.
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Final Foreign Tax Credit Regulations
The final foreign tax credit (FTC) regulations for 2021, which were released in December of that year, brought about significant changes to the previous regulations that had been in place since 1983. While the 2021 FTC regulations generally aligned with the proposed regulations from September 29, 2020, they also introduced several important modifications.
One particularly noteworthy change in the 2021 FTC regulations relates to the cost recovery element of the net gain requirement and the addition of a new attribution requirement. These changes impact how foreign levies are considered as creditable foreign income tax under Internal Revenue Code Sections 901 and 903, especially for U.S. taxpayers involved in cross-border activities. The new attribution rule stipulates that foreign taxes must adhere to source rules similar to those in U.S. federal income tax law.
To address taxpayers' concerns about the stringent requirements of the 2021 FTC regulations, the IRS released technical corrections to the cost recovery element of the net gain requirement. Additionally, they proposed regulations that establish safe harbors for both the cost recovery element of the net gain requirement and the royalty sourcing rule under the attribution requirement. Despite these efforts by the IRS, many concerns persisted.
How we can assist you
As a CPA Firm, we can help multinational companies review their international operations to identify opportunities, model potential tax benefits, analyze tax positions and risks, and assist in the preparation of supporting documentation.
Please don't hesitate to reach out to our team for assistance in navigating the complexities of taxes. We are here to help you overcome any challenges you may encounter.
