New Regulation: Statutes, Pillars and the Build Back Better Act

Episode Summary

In this episode of the “GILTI Conscience” podcast, Skadden international tax attorney Paul Oosterhuis and associate Huzefa Mun join our hosts Nate Carden and David Farhat to discuss legislation, new regulations and the Build Back Better Act. They examine possible outcomes if the Build Back Better Act is not adopted, including changes in other tax regulations that could arise, as well as the potential impact of the “Two-Pillar Solution” on global taxation.

The Build Back Better Act has received a great deal of recent attention, but it doesn’t look like we’re going to see any movement on it in the near future. Many analysts therefore are focusing on what is likely to happen on the regulatory and pillars front were the bill not to pass. Paul suggests there would be a fair amount that the Treasury Department would want to consider with respect to the treatment of interest expense for U.S. multinationals. Possible changes include increased foreign tax rates, new check-the-box regulations and alterations in foreign tax credit regulations.

Next, the guests discuss whether the OECD’s two-pillar method will shift taxation away from standard international tax rules and bring about a global minimum level of taxation. Pillar One requires a physical presence in a country before that country can tax, and Pillar Two sets a minimum tax at a 15% rate. However, what happens if these pillars are enacted by other countries but not the U.S.? Paul and Hufeza expect that Pillar Two will not be difficult to enact in the EU, the U.K., Japan, Australia and many of the other major countries with multinationals. However, without Pillar Two, the U.S. would likely encounter problems for several years, unless major reform takes place. In addition, absent Pillar One, the U.S. is likely to face a period of chaos, unless it can “beta test” and see if a large group will adopt the pillar.

Finally, the group discusses a few other statutes and regulations you should be aware of relating to the Build Back Better Act and international taxation.

Key Takeaways

• The Build Back Better Act on the regulatory front and pillars front: Paul explores the Treasury Department’s potential considerations if Build Back Better is not enacted, from foreign tax rates to check-the-box regulations. He also shares predictions on whether Treasury will try to leverage certain regulations to conform to international rules or whether they’ll back down on some of the provisions in the existing regulations.
• The OECD’s Pillar One: Motivated by internet transactions and a desire to centralize functions, Pillar One is all about allocating more income to the market. Ultimately, Pillar One aims to avoid double taxation issues and restructure the framework on a multinational scope.
• Breaking Down Pillar Two: Pillar Two refers to the adoption of an IIR regime that is based on financial statements but a country-by-country minimum tax of 15%. If this pillar is enacted, we may see foreign countries with traditionally lower rates raise those rates. If the U.S. doesn’t adopt Pillar Two and maintains a rate below 15%, anyone with an international deal could run into challenges.

Voiceover (00:02):
This is GILTI Conscience, casual discussions on transfer pricing, tax tradies, and related topics. A podcast from Skadden that invites thought leaders and industry experts to discuss pressing transfer pricing issues, international tax reform efforts, and tax administration trends. We also dig into the innovative approaches companies are using to navigate the international tax environment and address the obligation everyone loves to hate. Now your hosts, Skadden partners, David Farhat and Nate Carden.

Nate Carden (00:36):
Hey everybody. This is Nate Carden, David Farhat, Eman Cuyler, Stefane Victor, and once again you're here at GILTI Conscience. Like an old band, a lot of times we're trying to do new, narrow, avant guard stuff, but sometimes the crowd demands the greatest hits. Today we're going to do the hits and we're going to do legislation, regulation, and the pillars. We're joined today by a couple of our colleagues, Paul Oosterhuis and Huzefa Mun, both from our DC office. Let them introduce themselves and then we'll jump into everyone's favorite topic, new regulation, Paul.

Paul Oosterhuis (01:12):
Thanks, Nate. I thought you were referring to old hits because I'm an old man, but that's okay. Paul Oosterhuis, I'm of council at Skadden. I've been with Skadden since 1989 and have done a lot of international tax over the years. These days I do a lot of tax policy. Huzefa, you want to introduce yourself.

Huzefa Mun (01:32):
Yeah. Hi, I'm Huzefa Mun. I'm in my a year as an associate at Skadden and work on operational tax planning, including transfer pricings.

Nate Carden (01:42):
So the saga around Build Back Better has made Joe Manchin the most famous United States Senator in the world. It doesn't look like we're going to see anything, at least in the near future. One of the things that's making a lot of us wonder about is what happens if that doesn't pass both on the regulatory front and on the pillars front? Paul, I wonder if you can kick us off.

Paul Oosterhuis (02:06):
Let's start out with regulations. As you know, the BBB proposes a section 163N that limits interest deductions basically in proportion to worldwide EBITDA or in the Senate bill worldwide assets if you're elected. But if BBB's not enacted there's a fair amount that we suspect this Treasury Department will want to consider, with respect to the treatment of interest expense particularly for US multinationals. Some of the members of the Treasury Department have been quite critical of things that were done during the Trump administration and the green book that Treasury proposed back in the spring of last year included a proposal to disallow interest deductions in a novel application of section 265. They include that as a legislative proposal. But they did say no inference should be drawn from that proposal as to whether, as an administrative matter, they could do it by regulations.

Paul Oosterhuis (03:19):
My impression is that they will give some significant consideration to doing a disallowance by regulations. Now, what would that mean? The idea, and a lot of this comes from an article that Steve Shay wrote that was in Tax Notes last fall if I remember, is that if you have interest expense that is not allocated for foreign tax credit purposes because of the section 250 deduction, or because of section allocated to income that is otherwise sheltered by the 250 deduction or the 245A deduction, you should have that interest expense disallowed rather than treated as it is today under our section 861-8 regulations. The theory is that the 250 deduction is the equivalent of a partial exemption, and the 245A deduction is the equivalent of partial exemption. Now, I disagree with that with the 250 deduction because it's limited to taxable income and so it's not automatically an amount of gross income that is exempt from tax by means of the deduction. With respect to [crosstalk 00:04:33]-

David Farhat (04:32):
Paul, if I could interrupt.

Paul Oosterhuis (04:34):
Yeah, sure.

David Farhat (04:34):
If I can interrupt and ask, if I'm in house right now and I'm listening to this, what should have me worried? What should I be thinking about with the proposal of these new rules?

Paul Oosterhuis (04:46):
It's simply that a certain amount of your interest expense that today it doesn't adversely affect you, you're getting a full deduction and it's not hurting you from a foreign tax credit point of view, would be disallowed. It's more are the portion that is under our 861 principles today attributable to the exempt assets that you have that are exempt by reason of the 250 deduction. You really have to get into the weeds, David, of how you allocate interest under the 861-20 reg and 861 interest allocation regs -9 to -13. But how you allocate interest to different categories of CFC stock, and a portion of it under this regime presumably would be allocated to assets that are now treated as exempt and then disallowed. That could be a significant proposal.

David Farhat (05:48):
We talk here a lot about transfer pricing and international tax. It sounds as though we could run into a significant amount of double tax with this. I have interest income in one jurisdiction, and I'm not getting a deduction here in the US.

Paul Oosterhuis (06:03):
Sure. Yeah. Of course it applies to third party interest not to just intercompany interest. In fact, most of it might well be third party interest. It would just flat out be disallowing a deduction so it increases your effective tax rate. Now, they may take an alternative approach, which is just to reverse the treatment of exempt assets that the Trump administration Treasury Department proposed the assets that are treated as exempt by reason of the 250 deduction and say, "No, we're going to allocate interest to those assets." Because technically when Congress adopted the 2017 Act and the 250 deduction, they didn't identify that deduction as being something to which you did not allocate interest unlike say the section 243 deduction. There's a more of a technical basis to just change the assets that interest is allocated to, which has the effect of disallowing interest expense if you're in an excess credit position in your guilty basket. A lot of folks are these days and of course three years from now a lot of folks will be if foreign countries are raising their rates, like Ireland raising their rates from 12 and a half to 15%, and Puerto Rico potentially raising their rate. That could be a pretty effective disallowance mechanism as well.

Nate Carden (07:29):
That'll put us in a world where we're going to have country by country plus the baskets, so 700 baskets to which we have to allocate some interest expense?

Paul Oosterhuis (07:40):
Well, that's true. If BBB is not enacted then we still have the overall guilty basket. Some companies are in an excess credit position in that basket today. But a lot of companies that are not in an excess credit position today are assuming they're going to be in an excess credit position in a few years if foreign countries react to Pillar Two by increasing their tax rates, which wouldn't be surprising. That's one thing that Treasury can do that would be pretty significant and not favorable to taxpayers obviously. A second thing, we hear rumors from Treasury that they're thinking about changing the check the box regulations. How serious that is, we don't know. But the check the box regime is a regulatory regime. There's a widely held view, David Hemel has written about it, that you could revoke check the box if you wanted to or you could limit its application. If they did that, that could substantially limit everybody's ability, for example, to reduce foreign tax in ways that check the box helps you do and reduce US tax in some circumstances as well. We could worry about that coming down the pike if BBB is enacted.

Nate Carden (09:03):
I'm trying to, I guess, understand what would motivate that. Because if I also then look at the BBB proposals and Subpart F, the Subpart F reform proposals. The direct of travel in the Subpart F reform proposals is broadly speaking to say, foreign to foreign we don't care. We're not going to worry about it for Subpart F sales. We're not going to worry about it for Subpart F services. Certainly the direction of travel and the foreign tax credit regulations is we don't want to give you credits. Given that, as you say, check the box is principally, I think, a non-US tax issue for a lot of US multinationals, not exclusively but often, what's motivating Treasury to think about getting into the way back machine and taking us back 25 years?

Paul Oosterhuis (09:49):
I can't tell you, because I haven't talked to them about it. I'm getting this information indirectly. But my guess, given the criticisms that some of the academics have had about check the box, first of all that will give you low tax income that can then keep you from getting too far into an excess credit position under GILTI. It in effect operates through cross crediting to allow you. That in turn, if you can reduce your foreign tax without increasing your US tax, because you're otherwise in an excess credit position. With cross crediting, that in turn gives you an incentive to move income at least and maybe economic activity outside the United States, because on the margin you're not paying any tax beyond the local tax rate. Let's face it, check the box was something that if a whole range of tax policy people were today thinking fresh about would not end up being what it is. Because it's very much a taxpayer planning tool to reduce not just foreign tax, but in the end to reduce US tax through Subpart F. That would otherwise be imposed under Subpart F and or GILTI. It's not surprising to me that there's some interest in this Treasury Department, if they have the time and the resources, to reconsider right.

Eman Cuyler (11:18):
Do you have any view from a policy standpoint whether these rules should actually be limited or completely revoked? Do you have a view either way?

Paul Oosterhuis (11:28):
Well, depends on whether I'm representing clients or teaching my class. When I teach my class, we actually talked about this yesterday in my class, I talk about how we wouldn't enact check the box as it is today if we were doing this fresh. One of the things I learned when I was on the joint committee staff in my young lawyer days is that giving taxpayers an election is a dangerous thing because they will always choose the election that minimizes their tax and therefore minimizes governmental revenue. You only want to give elections where there's a good governmental reason to give elections and check the box is the ultimate election that gives taxpayers enormous flexibility. I am confident that nobody who thought about check the box back in 1995, '96, '97, fully contemplated or appreciated the extent to which that electivity was going to give a tool to tax planners.

Paul Oosterhuis (12:29):
It's not just check the box itself. It's treating transactions between a single owner and a transparent entity as disregarded. It's the disregarded entity treatment that leads to disregarded transaction treatment that gives the potential for arbitrage because foreign governments recognize transactions we don't, and it's elective. What more could you want for a tool to enhance tax planning? As Nate says, most of it is foreign to foreign not US to foreign. But there's a fair amount that involves the US and a fair amount that involves inbound, not just outbound. Not just US multinationals but foreigners doing business in the United States. In my class I teach that if I'm, let's say a Brazilian company and I buy inventory in the US and sell it in Brazil. If I check the box on the Brazil entity I don't pay any tax in the US. But if I don't check the box in the Brazilian entity I do pay tax in the US. It doesn't make a lot of sense, but that's what the optionality permits.

Paul Oosterhuis (13:36):
The final thing that is regulatory in nature that comes into play in all of this is the new foreign tax credit regs. The regulations have been like a tsunami coming through the international tax community since they became final. They substantially limit the foreign tax credit as I think most listeners on the podcast appreciate and would have a real impact not just on existing taxes in countries that don't necessarily follow our rules as precisely as the regulations would seek them to, but would also apply to many of the things that could go on in OECD Pillar One and Pillar Two that we will be talking about as we go through this podcast. Treasury is probably going to reconsider some of these rules, at least as they apply to specific taxes and they may have one or more notices or other revenue rulings or something that clarifies the treatment of taxes in different jurisdictions.

Paul Oosterhuis (14:41):
But there's clearly a mismatch between these regulations and what's happening elsewhere in the world that's going to be a continuing problem. We'll see whether Treasury in effect wants to try to use these regulations as leveraged to get Congress to change some of our rules and conform more to some of the international rules or whether they back down on some of the provisions in the existing regs. I'm not confident they'll do the latter.

Huzefa Mun (15:13):
If Build Back Better doesn't happen is there, I guess, a political will or some sort of incent? What is the likelihood of these regulations coming into play given the politics of now and whether there's going to be a push? Is there some sort of motivation to enact some or all these sorts of regulations?

Paul Oosterhuis (15:36):
I think it's a fair assumption that if legislation is not enacted this year, it's probably not going to be enacted in '23 and '24, because we may well have a divided Congress. As we saw in the Obama administration and the last two years of the Trump administration, enacting major tax legislation with the divided Congress is a very difficult thing and unlikely to happen, other than extender type bills. It seems to me like the Treasury Department did during the later Obama years when they came up with the 385 regs and the 7874 regs and things like that unilaterally, that this Treasury Department will probably be pretty active in adopting some of these regulations. One other one that I should have mentioned but didn't is the high tax exception to the Subpart F and GILTI regulations. Some of the folks in the Treasury Department have been on record as criticizing that particular aspect of the Trump regulations, that's an easy thing to reverse. It wouldn't surprise me to see if they did that.

Paul Oosterhuis (16:48):
Now, how many taxpayers benefit from it today is an open issue because of restrictions that the Trump administration put on those regulations. But clearly companies that have losses in the US benefit from making the high tax exception election and also a lot of financial institutions, for example, benefit from it. Both of those are actually very sympathetic cases. If you have losses in the US, having to use those losses against your GILTI income is really unfortunate from a broader tax policy point of view. If they get rid of the high tax exception they will be limiting that in sympathetic circumstances. But like I say, there are some senior people at Treasury who've been on record saying that that was not an appropriate tax policy, so they may well get rid of it.

Nate Carden (17:39):
Yeah. I promised myself I'd sit on my hands during the foreign tax credit reg discussion and not throw things at the screen and start flailing the microphone around. But I just got to ask, so let's play this out. Build Back Better doesn't pass then the GILTI regime potentially is not a conforming regime. That means that either somebody else's incoming inclusion under Pillar Two comes into play or under tax payment rule comes into play. So you have additional foreign taxes in these countries as a result of Pillar Two. Then the Treasury Department goes forward with regs that say, these taxes are not credible. Is Treasury really going to say, "We created this monster. We got behind Pillar Two. We were the first ones to adopt global minimum tax, nobody else is doing it." But then after we create the monster, we're going to have regulations that tell us that the taxes associated with that are not creditable. That feels nervy to me.

Huzefa Mun (18:42):
It seems a little bit unlikely to me just based on the preamble language of the foreign tax credit regs. Just because it sounds like, at least from the preamble, and anybody that has learned anything contrary to that definitely let me know. But it looks like they're focused on the right now what's going on with the DSTs and the immediate nature of some of these non-traditional nexus-based taxes. But they left an opening that if there's new laws or new regimes in place, that we might revisit our rules and maybe tweak them. But whether that's actually going to happen I'm not sure.

Paul Oosterhuis (19:19):
Well, and the other thing though Nate, within Pillar Two you have to divide the world between UTPR and IRR. Because the new regs, IRR is a CFC regime, other countries Subpart F type regimes. That's creditable under, but the UTPR is not creditable.

Nate Carden (19:42):
You still got to pass the arms length standard rule. It's a resident's tax. I don't know how you think about that.

Paul Oosterhuis (19:48):
Let's put it this way. They put a specific rule in the realization requirements that a deemed dividend, it meets the realization standard. I don't know why taxing deemed dividends wouldn't meet the arms length standard as well. I mean, they may need to clarify that but I think the taxes that are... if you have a Dutch holding company. You're a US multinational, you have a Dutch holding company, and the Dutch adopt an IRR regime, then you should be okay. But if you have a flat structure and don't have a foreign company that has an IRR in your structure, then you could have the under tax payment rule applying, and that's not a deemed dividend. That's a sideways apportioned mode of income or at least it can be. I don't see how you get a credit for that. But I do think if it's a vertical structure with a country that has a qualified IRR regime in the top tier holding company you may well be okay. It would be good for them to clarify that though.

Nate Carden (20:48):
So basically the Treasury Department's policy is we'd like to subsidize the people of the Netherlands. Dutch people are great people, I get it, but why exactly we're doing that and saying, "Hey, choose your hold code jurisdiction wisely," is a mystery to me, but I digress.

Paul Oosterhuis (21:05):
Yeah. What Treasury would say is, well, then you should be pushing for BBB because that would get around it, because we would have a qualifying IRR ourselves and therefore that would trump the Dutch IRR. We would get the revenue not them. But because BBB is not being enacted. That would be the Treasury Department.

Nate Carden (21:27):
I don't think companies vote in the Senate. Somebody go knock on...we're back to Joe. But in any case, while all this is going on we also have the pillars, my favorite topic. Because if I was ever going to design something architecturally, the steadiest way to have something stand up is to put it on two pillars, that will never fall over. Huzefa, what's the first pillar.

Huzefa Mun (21:56):
Yeah. The first pillar here, just to give everyone a quick background, as most people are probably somewhat familiar with it, is there's a new taxing rate on profits related market jurisdictions. The proposal to extract these taxes is to put in scope a company is making 200 billion euros or more and taxing them above their 10% margin if they are able to make that much. You have this group of companies, a large portion, as you might imagine, are going to be United States companies. Probably around like 50 or 60 of the 100 companies that fall into scope here. We can imagine a scenario where Pillar One is enacted. You have an allocation to market jurisdictions like on a destination based regime and no corresponding United States law or no buy-in by the United States, either through the current administration or maybe a future administration depending on how long Pillar One takes actually to be enacted. That you have a mismatch where you have the rest of the world signed up onto Pillar One, and then United States just doing its own thing.

Huzefa Mun (23:15):
In this sort of situation there's multiple double tax problems for United States companies and their foreign biggest subsidiaries. If we're looking at transactions with United States residents, and between them and either third parties abroad or related parties abroad. In the first instance, treaty networked jurisdictions, you're going to have a conflict there because under Pillar One, Pillar One is not an arms length-based. The amount A that they talk about, which is the market jurisdiction allocation, that's not an arms length amount, that's something else outside of the arms length standard. United States treaties have a particular provision in them where the related parties between each other have to be operating in the same sense as independent enterprises would. In that situation, you'd think that treaties are going to override the ability for there to be Pillar One-related adjustments between just those two, the United States and a treaty partner.

Huzefa Mun (24:27):
But it also raises an interesting point because you have all these. Much of the OECD is treaty network with the United States. If you're looking at who is going to ultimately pay this amount A, and many times in whatever iteration you might look at the United States as being a source of that. There's treaty countries and then there's conflicts between the treaties that all these OECD countries might have with the United States and the Pillar One regime itself. That I think is an interesting point of, what are these countries going to do with that treaty out there, the United States treaty, that's presumably not going to be rescinded.

David Farhat (25:07):
Let's unpack that a little bit, Huzefa. If I have the regular income tax, if I have a treaty relationship, I've done my transfer pricing, I have an adjustment in country A. If I have a treaty with the US I can go to MAP to figure out exactly, okay, can I get this [inaudible 00:25:24] adjustment in the US or have the company authorities work it out and pull that amount back? What happens here with this amount A? You mentioned there could be double tax. So if I have amount A, looking at the rules they're very convoluted. Country A, B, and C could take a whack at the same dollar. How does that work under the treaty? Do I still have my same MAP rights? Do I go to the table and discuss it that way? Is transfer pricing even relevant here? What happens there?

Nate Carden (25:58):
Am I allowed to say it works badly? No, go ahead.

David Farhat (26:01):
Well, I think that's assumed.

Nate Carden (26:04):
Go ahead.

Paul Oosterhuis (26:05):
David, Huzefa's point is that, let's say it's an export from the US to the UK and the UK is asserting an amount A on that export. The treaty would say, no, you can't do that because the related article says you use arms length pricing and amount A is not determined under arms length pricing. Then you would think a MAP discussion would say, UK has to back off. Now, the UK is one of those jurisdictions that can override treaties with legislation, if later in time, and they intentionally do it. In which case they would say, "Well, tough bounce. We are overriding the treaty." But most countries don't have provisions at all. In most countries treaties cannot be overridden by legislation. In those countries you would think they would still be, they wouldn't be able to impose an amount A if it's inconsistent with the arms length standard.

Nate Carden (27:06):
Let me play devil's advocate here because we also see a number of countries that impose a number of taxes that they say are outside the scope of their covered taxes under the treaty. Why can't they just say, "Look, this is an additional surtax that we put on resident companies. It's not one of the covered taxes under the treaty." I mean, I don't think we're going to send the Navy, so what are we going to do if they follow the diverted profits tax approach and just say, "We have a extra book tax."

David Farhat (27:38):
You can see how that snowballs with the Pillar One.

Paul Oosterhuis (27:41):
That's a very good question. I think we either have to threaten to revoke the treaty, because they're clearly misinterpreting the treaty because it is a tax on income or at least... it's ironic, isn't it? We would be saying it's not a creditable tax but it's still a covered tax under the treaty. Maybe the foreign tax credit regs actually help the foreign government say it's not a covered tax because it has to conform in order to be a cover. That's an interesting argument.

David Farhat (28:13):
Exactly right Paul. Huzefa, please go ahead now.

Huzefa Mun (28:16):
Let's say it was out of scope of the treaty for whatever reason. You're not going to get credit under the current rules for that tax being a non arms length amount.

Paul Oosterhuis (28:27):
Certainly with non treaty countries you've got a real problem. You're not going to have the foreign source income with export transactions in all likelihood, much less have a creditable tax.

David Farhat (28:38):
To take this a level up, and Nate this is a conversation we've been having, it's what's the goal here? It looks like we have a lot of rules. Some on the domestic side, some coming out of OECD. You look at all the unilateral measures. We have all these rules that don't link together. Don't have a shared purpose that will create absolute amount of havoc. As a tax person that's been doing this for a little while, I think the general rule has always been, I don't necessarily have to agree with the rule I need to know it. I need to have some certainty as to what's happening to be able to operate, whether it's to advise my clients or to do business. I know I'm asking you to crystal ball a little bit here, Paul and Huzefa as well. How do you see all of this shaking out? Because we can't live in a world where you have all this uncertainty and you're even saying, well, the treaty process may not even help.

Nate Carden (29:34):
Paul, maybe before you start that, I think one of the things that I get very frustrated by, and you've known for a long time that I get very frustrated by, is what's the policy north star here that informs the crystal ball? Because it almost feels like at this point Pillar One's being done for the sake of doing Pillar One as opposed to trying to get to an end game.

Paul Oosterhuis (29:57):
Yeah, those are all very good questions. I think the first question is what motivated the train to start going? If I can use that metaphor. Maybe that's not the best metaphor, but the snowball to start going. How about that? To my mind, what motivated it is that the combination of remote transactions, in part through the internet. We used to order remote transactions through catalogs and on the telephone, but that was a small part of our commerce. Now we're ordering a lot of things over the internet that maybe in the US they're mostly US websites. But if you're in Portugal or Estonia, there's a lot of stuff that's coming from outside your country that's done over the internet and you're not getting any revenue out of it because there are no boots on the ground. The second thing, and this is US multi nationals in a lot of countries, is limited risk distribution.

Paul Oosterhuis (30:55):
The centralization of functions. You now have global marketing rather than separate marketing teams in France, in Germany, in Spain, and in Portugal. You have all of them in one country, maybe it's Switzerland, for example. Means that the market jurisdictions are either getting no revenue because of remote transactions, or getting not very much revenue compared to what they got 20 years ago. That's one element I think that is an underlying motivation. The other element is just that, because we're rewarding income where economic activity is taking place, we've seen a migration of economic activity to tax favored jurisdictions, and that's just a reality. It's a reality that US companies and companies that are in systems like the UK systems tend to be the countries whose companies do it the most. Other countries are saying, "Wait a minute, why should there be so much income in Ireland? Why should there be so much income in Switzerland, or Singapore, or Puerto Rico for that matter?"

Paul Oosterhuis (32:04):
Shouldn't it be in some place that's less movable and that is the market? You have those different things coming together to my mind to say more income should be allocated to the market. That's what Pillar One is all about with its amount A. Now, once they got into it, particularly because it's not 10 people sitting in the room it's 120 plus countries doing a Zoom call, you end up with both the business community and the government saying, "Well, if we do that through arms length pricing mechanisms, but changing the ground rules for arms length pricing and changing the ground rules for permanent establishment, we've got a facts and circumstances test in every case and that's too hard. We can't do that." We need mechanical rules that don't necessarily come up with the right answer. But if everybody agrees to it, at least the income isn't being double taxed.

Paul Oosterhuis (33:01):
That's the direction that amount A has become. It's become more like formulary apportionment to my mind. Obviously because it's not arms length pricing, there's going to be a big difference between the countries that adopt it and the countries that don't. It's going to be a hard enough to get the formula working right in the countries that adopt it in terms of who gets what of the amount and not having overlapping claims on it. But if you have some countries adopting it and some countries don't, you have a mess. To my mind the question is, okay, after that's out there for five years, are people just going to throw up their hands and give up or are they going to say, "No, we need to keep working on this so that we eliminate some of the frictions that we have in the system." Very hard to know how that's going to come out, but that's my perspective on what motivated it and how we got to where we got.

Stefane Victor (33:58):
I have a question. Might businesses affected by Pillar One be incentivized to potentially restructure?

Paul Oosterhuis (34:04):
Yes. Particularly to qualify for the marketing and distribution safe harbor. Because that would get you out of the issue of needing to figure out who's going to give up taxing jurisdiction. You decide who's going to give up taxing jurisdiction if you change your transfer pricing to qualify for the marketing and distribution safe harbor rather having it be decide by some sort of proportionality. Actually it's interesting. This goes back to the electivity point. Because that safe harbor is elective, you can choose whether to let the amount A happen or to qualify it for the safe harbor. Let's face it, if the amount A has to be surrendered in part from high tax jurisdictions, and if you qualify for the marketing and distribution safe harbor, the surrender is effectively from low tax distributions. You might prefer the amount A even though there's some double tax because you're getting a surrender in high tax jurisdiction. There will be quite a bit of planning around all of that I would assume. David, that would be in your sweet spot.

Huzefa Mun (35:13):
Yeah. I think also as part of that or just to flesh that out a little bit more is you would have more companies looking into actually establishing presences in local countries and then getting their transfer pricing run through those entities.

Paul Oosterhuis (35:29):
Right.

David Farhat (35:30):
Yeah. That was a question I wanted to ask a little bit. I know as a transfer pricing guy, sounding like you're coming out in favor of formulary apportionment is a crime punishable by very, very harsh things. But wouldn't some sort of formula help here, to Huzefa's point, if it's aligned with your transfer pricing? If you're doing a profit split or something along those lines and you have that kind of marketing intangible that you allocate to those market jurisdictions and you split it that way. Doesn't that help with the double tax problem and deal with the amount A issue as opposed to coming up with this side regime that seems ridiculously complex?

Paul Oosterhuis (36:10):
Well, you're preaching to the choir on that, David, because I advocated in the early stages of this process that they just revised transfer pricing rather than come up with a formula. But I was hooted out of the hall by both the business community and the governmental representatives, because they said, no, that's going to be too complicated. Back in the days when they were going to apply this to consumer facing they said, you can't have profit split be applied in every circumstance because that's impossible. It's a good point. It's a good point. I mean, you know how difficult profit splits can be. They said, we need to simplify it by having it be a formula. Now they've got a formula that because it's simple and is one-size-fits-all doesn't fit with transfer pricing. Because by definition you can't have a formula fit with transfer pricing. To my mind, there's a real battle in whether they keep the marketing and distribution safe harbor because that is the last vestige in this area of transfer pricing. If they give that up for example, then it seems to me we're on a path to do a lot more formulary apportionment down the road to try to make this whole system work. We're really at a crossroads here between transfer pricing and formulary apportionment.

David Farhat (37:34):
Well, I think you should go back and talk to those folks again, because there's an old saying that a dying man will pray for high fever. I think in that situation, given what we've seen recently, you might be the high fever that they're more than willing to accept now.

Nate Carden (37:47):
And you already brought governments and the business community together, which nobody else has been able to do so good work.

David Farhat (37:53):
That's right. That's right.

Nate Carden (37:55):
I have a question that folks I think are going to be very interested in as this thing moves forward, if it moves forward. If you look at the most recent consultation doc, there's a reference to, and this is a defined capitalized term, the tax certainty panel. Who are these people and what are they going to do?

Paul Oosterhuis (38:14):
I have no idea, but I'd like to be on it. I could retire [crosstalk 00:38:20] -

David Farhat (38:20):
Take us with you, Paul. Take us with you.

Nate Carden (38:22):
They better be nicer to the governments and the business community then.

David Farhat (38:27):
Right.

Paul Oosterhuis (38:28):
Yeah. We, long thought that for us lawyers who were getting close to retirement, that being arbitrators and transfer pricing arbitrations was going to be a booming business. That hasn't happened, but maybe this will be an alternative for us.

Huzefa Mun (38:42):
Also we didn't get into the timescale of this, but Pillar One, the amount A portion that we've been talking about, the plan is for that to be in somewhat final form by next year. It is a distinct possibility that we do have this gap between US acceptance and the rest of the world going along with this. But I mean, is it a distinct possibility of it actually completing by next year? That's actually the more important question.

Eman Cuyler (39:12):
What do you think would be the impact if Pillar One and Pillar Two are enacted by other countries and we are not aligned, the US doesn't move forward and enacts those rules?

David Farhat (39:25):
We'll be working a lot longer hours.

Paul Oosterhuis (39:28):
Yeah. Yeah. You're going to be praying that they adopt the marketing and distribution safe harbor and you can hire David in Nate to restructure your transfer pricing to avoid what otherwise would be [inaudible 00:39:38]. That's really what the situation's going to be. Now, should we move to Pillar Two?

David Farhat (39:46):
Yes, please.

Paul Oosterhuis (39:48):
Pillar Two is everybody adopting what they call an IRR regime that is based on financial statements but a country by country minimum tax at a 15% rate. One of the things that's going to be very interesting, if we don't do it and other countries do, will that lead some lower tax countries, including Ireland, to raise their rate? Now, Ireland's probably going to have to anyway because they're part of the EU and the EU is going to adopt Pillar Two, so they probably will have to. But the first order in fact, to my mind, with respect to US multinationals is that foreign countries that have low rates today will be raising those rates. Maybe the Hungarian rate will go up to 15%, the Irish rate will go up to 15%. There's certainly a lot of talk about Puerto Rico restructuring their grants to have a rate of 15% down there.

Paul Oosterhuis (40:51):
That will have an impact on the planning of US companies even if we don't adopt our own version of Pillar Two that adopts a per country foreign tax credit limitation. I would say that's the first order effect. The second order of effect is what we were talking about earlier with Nate, which is do you get a credit for some of these taxes in the various foreign countries that are imposed under their IRR or under tax payment rule if you have CFCs that are still paying a low rate of tax. Let's say Singapore doesn't raise its rates or Hong Kong doesn't raise its rates and you have some income there, won't other countries be trying to grab it? But the biggest one is the fact that there are a lot of companies that on their US income pay less than 15%. There was a letter that just went in from the Senate finance Republicans to the Treasury asking the secretary to explain how we are getting ourselves into this conundrum.

Paul Oosterhuis (41:52):
That there are credits and a favorable rate for FDII, all the credits, the research credit, the low income housing credit, the alternative energy credits, that the Biden administration likes. Yet if you use those credits to get your rate under 15% under Pillar Two, other countries are going to start trying to grab and tax that slice of income that's being taxed at a lower than 15% rate to get the overall rate up. Why should we be in a process that allows that to happen? Now, I think the honest answer for secretary Yellen was that they were planning all this at a time when they thought our rate going to be like 25 to 28%, and so it wouldn't be as big a problem. But without BBB, maybe even with BBB, we're going to have a 21% rate. The spread between 15 and 21 is just not that large when you're talking about all these credits. It's a real difficult position. It's going to be interesting to see what the secretary says in response to all of this.

Nate Carden (42:58):
Paul, just to unpack that for folks that are listening and maybe haven't been thinking about it, it's right, isn't it? That we could have guilty reform, but if the US rate itself is below 15, US multinationals are still going to have a big problem.

Paul Oosterhuis (43:15):
Well, and you don't even have to be a multinational. You just have to have international deals.

Nate Carden (43:19):
Just have the international deal.

Paul Oosterhuis (43:20):
Yeah. Fair enough. Yeah, no, that's absolutely right. It's a separate problem. What would need to happen is the global minimum tax that's in the BBB, that's a 15% minimum tax, would have to not allow all the credits that it allows against it. That would substantially undercut some of the incentives in BBB ironically, because you would be judging your tax after the credit rather than your tax before the credit for purposes to that minimum tax.

David Farhat (43:53):
Paul, to ask a question we've been asking about a lot of the rest of these topics. How does the treaty come to play here? Is it completely irrelevant? Is that another thing that just becomes problematic if you have a situation where US tax rate goes below 15% when country A who's a treaty partner tries to get that bit of income?

Paul Oosterhuis (44:12):
I haven't really thought much about that. I suspect there's an argument that the foreign country doesn't have the right to tax that income under the treaty. But it applies in such an arbitrary way that there may not be a transaction that would be relevant with that country to actually have the treaty come into play. I don't know, Nate, whether you've thought about that but I haven't really.

Nate Carden (44:40):
I think the great irony is that the much loved in the United States savings clause that reserves to countries the right to tax their residents as they want to helps a foreign country a lot here. Because they just say, look, we're just denying deductions here locally. This doesn't have anything to do with you. There's no transaction. By the way US, this is the rule you wanted so good luck.

David Farhat (45:09):
As we come close to time, any final comments, Huzefa or Paul.

Paul Oosterhuis (45:15):
I'll volunteer, I've been thinking about this a lot lately. I mean I think Pillar Two is not going to be that hard to get established in the EU, in the UK, probably in Japan, Australia, many of the major countries with multinationals. We won't have it and that's going to cause us some problems maybe until 2025 when we have to have major reform because all kinds of things are going to come close to expiring in the next administration. We'll have a period of chaos that we just have to deal with, but perhaps manageable chaos except for the US credit issue and getting below a 15% rate that we've talked about. On Pillar One it's definitely going to be chaos for a while and I think it's going to be a work in process. We're going to have a beta test basically at best of Pillar One over the next few years with a limited number of companies and a limited number of jurisdictions adopting it. We'll just have to see whether it ends up appealing enough to a broad enough group to be adopted in a more widespread matter or whether it ends up being a beta test that never goes beyond that.

Huzefa Mun (46:37):
Yeah, I would add that it's a really interesting time now because we're following up with tax law in the same way that we're following up with the 24 hour news cycle, because everything is changing so rapidly. It's a very interesting time that there's so many different moving parts and there's so much complication going on. Trying to make sense of it is going to be, I think, the task for a lot of tax practitioners going forward.

Nate Carden (47:03):
Well, as regular listeners know, I can't take this anymore. I'm just going to go sit in the corner. David's going to grieve the demise of the arms length standard, but I want to thank both you guys for coming on. Really appreciate the insight, the perspective, and thought it was a great conversation.

David Farhat (47:20):
Indeed. Thank you guys so much. Hopefully you'll be back with us.

Voiceover (47:26):
Thank you for joining us for today's episode of GILTI Conscience. If you like what you're hearing, be sure to subscribe in your favorite podcast app so you don't miss any future conversations. Skadden's tax team is recognized globally for providing clients with creative and innovative solutions to their most pressing transactional, planning, and controversy challenges. Additional information about Skadden can be found at skadden.com.