International Tax Reform and the Two-Pillar Solution

A significant transformation is underway in international taxation, driven by a global effort to address the challenges of a digitalized economy. For years, corporate tax strategies have exploited gaps in existing rules, allowing large multinational enterprises (MNEs) to shift profits to low-tax jurisdictions, a practice known as base erosion and profit shifting (BEPS). The reform movement, led by the Organisation for Economic Co-operation and Development (OECD) and the G20, aims to ensure corporations pay a fair share of tax where they conduct business and generate profits. This initiative recognizes that traditional tax rules based on physical presence are inadequate, as companies can now earn significant income from a market without a substantial physical footprint, creating a disconnect between where value is created and where taxes are paid.

Pillar One Re-allocation of Taxing Rights

Pillar One represents a fundamental shift in international tax principles, designed to re-allocate a portion of taxing rights to market jurisdictions. This means countries where a company’s customers are located will have a right to tax a share of that company’s profits, irrespective of whether the company has a physical presence there. The goal is to create a more equitable distribution of tax revenues, reflecting the contributions of market jurisdictions to the value creation of large MNEs.

The scope of Pillar One targets only the largest MNEs with a global turnover exceeding €20 billion and a profitability margin over 10%. A central component is “Amount A,” which applies to 25% of the profit that exceeds this 10% profitability threshold. This portion of the profit is then distributed among the market jurisdictions where the company generates its revenue using a revenue-based key.

Pillar One also includes “Amount B,” which aims to simplify and standardize the remuneration for baseline marketing and distribution activities. In early 2025, guidance on Amount B was incorporated into the OECD’s Transfer Pricing Guidelines. Jurisdictions may choose to apply this simplified approach for fiscal years beginning on or after January 1, 2025, providing a more predictable process for both MNEs and tax authorities.

Pillar Two Global Minimum Tax Framework

Pillar Two introduces a global minimum tax framework, an initiative designed to ensure that large MNEs pay a minimum level of tax on their income. The core of this framework is the establishment of a 15% global minimum corporate tax rate, which puts a floor on tax competition among countries. The rules apply to MNEs with annual consolidated revenues of €750 million or more, a threshold that is broader than that of Pillar One.

The primary mechanism for enforcing the global minimum tax is the Income Inclusion Rule (IIR). The IIR operates by imposing a top-up tax on the ultimate parent entity of an MNE group with respect to the low-taxed income of its foreign subsidiaries. If a subsidiary located in a jurisdiction is taxed at an effective rate below the 15% minimum, the IIR requires the parent company’s home jurisdiction to collect the difference.

A backstop to the IIR is the Undertaxed Payments Rule (UTPR), which comes into play if the IIR cannot be applied. The UTPR works by denying tax deductions or requiring an equivalent adjustment for payments made to a low-taxed entity within the MNE group. This rule ensures that even if the parent company’s jurisdiction has not implemented the IIR, other countries in which the MNE operates can still collect the top-up tax.

A complementary component of the Pillar Two framework is the Subject to Tax Rule (STTR). The STTR is a treaty-based rule that allows source jurisdictions, often developing countries, to impose a withholding tax on certain intra-group payments subject to a nominal tax rate below a minimum rate in the recipient’s jurisdiction. This rule is important for protecting the tax base of developing countries from outbound payments for services and royalties.

Interaction with United States Tax Provisions

The Pillar Two framework has significant implications for the United States and its existing international tax provisions. A key area of interaction is with the U.S. Global Intangible Low-Taxed Income (GILTI) regime. The GILTI rules, enacted as part of the 2017 tax reform, function as a type of minimum tax on the foreign earnings of U.S. multinational corporations.

There are notable differences between the GILTI regime and the Pillar Two Global Anti-Base Erosion (GloBE) rules. GILTI is calculated on a global blending basis, meaning a company can use excess foreign tax credits from high-tax countries to offset its GILTI liability on income from low-tax countries. In contrast, the GloBE rules apply on a jurisdictional basis, requiring the 15% minimum tax to be met in each country where an MNE operates.

Another concept is the Qualified Domestic Minimum Top-up Tax (QDMTT), a domestic tax that allows a country to collect the first right of taxation on low-taxed profits of MNEs within its borders. In the U.S., the Corporate Alternative Minimum Tax (CAMT) is being analyzed for its potential to function as a QDMTT. If the CAMT, which imposes a 15% minimum tax on adjusted financial statement income, is deemed qualified, the U.S. would collect the top-up tax on U.S. profits that would otherwise be subject to the GloBE rules.

A critical issue for U.S. companies is whether the GILTI regime will be considered a “qualified” IIR under the Pillar Two framework. If GILTI is not deemed qualified, U.S. MNEs could be subject to the UTPR in other countries, potentially leading to double taxation and increased compliance costs. The outcome of this analysis will significantly impact U.S. corporations.

Global Implementation Status

The global adoption of the two-pillar solution is progressing, with many countries incorporating the new rules into their domestic laws. The European Union has been a key driver, adopting a directive requiring member states to enact legislation consistent with the Pillar Two GloBE rules. For many countries, including the United Kingdom, Japan, and South Korea, the IIR became effective at the beginning of 2024, with the UTPR generally scheduled to follow in 2025.

The implementation of Pillar One is on a slower and more complex track. Because Pillar One requires a fundamental change to the allocation of taxing rights, it necessitates the development and ratification of a multilateral convention by a critical mass of countries. Achieving the necessary political consensus for this convention makes the timeline for Pillar One’s implementation less certain than that of Pillar Two.

The international tax framework is not static and is subject to ongoing refinement. The OECD continues to release administrative guidance and clarifications to ensure the rules are applied consistently across all implementing jurisdictions. This ongoing work is necessary to address the complexities of the new system and provide greater certainty for businesses.