Decoding Pillar Two: GLoBE Rules and GILTI

Executive summary

Administrative Guidance on the Pillar Two GLoBE Rules released in February 2023 provides the much-awaited clarification on co-existence of US GILTI tax regime with the GLoBE rules.

What is GILTI?

Global Intangible Low-Taxed Income (GILTI) refers to foreign income earned by controlled foreign corporations (CFCs) of US companies, from intangible assets such as patents, trademarks, and copyrights.

The US Tax Cut and Jobs Act (TCJA) in 2017 introduced a 10.5% minimum tax on GILTI in order to discourage business owners from moving intangible asset profits from US corporations to CFCs.

In simplified terms, if the foreign tax rate is zero, the effective US tax rate on GILTI will be 10.5% (half of the regular 21 percent corporate rate because of the 50 percent deduction). If the foreign tax rate is 13.125% or higher, there will be no US tax after the 80% credit for foreign taxes.

GLoBE Rules and GILTI

Once the Global Anti-Base Erosion (GloBE) rules were proposed by OECD, the focus of MNEs with US intermediary parents was on how the GloBE Rules will interact with GILTI (viz. interaction of the different minimum tax rules) to mitigate the risk of double taxation. The February 2023 Administrative Guidance released by OECD/ G20 Inclusive Framework has thrown some light on the above.

1. Treatment of GILTI as blended controlled foreign corporation (CFC) tax regime

GILTI (in its current form) did not appear to meet the requirements to be considered a qualified IIR for Pillar Two purposes. Hence, GILTI is proposed to be considered as a qualifying blended CFC tax regime for the purpose of Pillar 2.

Globe rules requires CFC taxes to be allocated to the constituent entity that earned the income subject to the CFC tax, rather than to the parent entity that pays the CFC tax. As a result, GILTI taxes may be allocated, fully or partially, to the relevant foreign jurisdictions rather than to the United States. The Administrative Guidance proposes a simplified methodology to allocate GILTI taxes. The prescribed formula allocates GILTI taxes to the relevant low tax jurisdiction (viz. effective tax rate is below 15%) based on a ratio of income to the entity’s effective tax rate in the jurisdiction. The simplified methodology is intended to sunset and be revisited in 2027.

This guidance also gives the US an opportunity to amend its GILTI rules to allow them to be treated as a qualified IIR for purposes of Pillar Two rather than a Blended CFC Tax Regime.

The Administrative Guidance includes two practical examples demonstrating how GILTI taxes will be allocated under the GloBE rules.

Qualified Domestic Minimum Top-up Tax (QDMTT) and GILTI

To be a QDMTT under the GLoBE Rules, the regime must exclude tax paid or accrued by domestic constituent entities (CEs) with respect to the income of foreign CEs under its own CFC regime. QDMTTs must also generally exclude cross-border taxes paid by a CE owner under a CFC regime that are allocable to a domestic CE, as well as taxes paid by a main entity that are allocable to a permanent establishment located in the QDMTT jurisdiction

In practice, this means that a QDMTT will apply first (i.e., before CFC allocations and application of the IIR or Undertaxed Payment Rule (UTPR). For countries that adopt a QDMTT, any allocation of taxes paid under GILTI will not be considered when determining the local QDMTT liability.

A more detailed analysis of the QDMTT as well as other relevant updates from the Administrative Guidance will follow shortly. Stay tuned to this space!