Agefi Luxembourg - mars 2025

AGEFI Luxembourg 18 Mars 2025 Assurances The US withdrawal from Pillar Two and its impact on European taxation and competitiveness O nhis inaugurationdate (20 Ja- nuary 2025), USpresident Trump issuednumerous execu- tive orders (“EOs”) on a variety of diffe- rent topics, including theUS commitment to the “Global TaxDeal”. This undefined termused in the public com- munication of theWhite Housemainly refers to the globalminimumtax rules agreedupon at OECD/G20 level, i.e., the so-calledGlobal Anti-Base Erosion (“GloBE”) rules or “Pillar Two” (1) . While the US were amongst the driving initiators of the Pillar Two initiative, the GloBE rules have not beenimplementedintheUS.Onitsfirstday,thenew US administration definitely pulled the plug for any potential implementationof PillarTwo in the current legislation period. Accordingly, the EO states that “ any commitments made by the prior administration on behalf of the United States with respect to the Global Tax Deal have no force or effect within theUnited States ”. The EOalsodirectstheUSTreasuryDepartmenttoassess foreign tax regimes for compliance with US treaties and potential discriminatory effects on American businesses as well as appropriate “protective” (in other words retaliatory) measures. So far, the EU and other countries remain committed to their international obligations and the OECD an- nounced its openness to a meaningful dialogue with the US administration. Whether a productive ex- change is possible at this stage remains to be seen, es- pecially since a dialogue is defined as a conversation betweentwoormoreparties(asopposedtotheimpo- sitionof a viewby the stronger party). Tothebestofourknowledge,nocountryhasofficially announced their withdrawal fromPillar Two (yet) as a result of theEO.However, theUSpositionandwill- ingness to take punitive measures create doubts and uncertainties. Indeed, these events raise the legitimate question regarding the impact of the EOon the effec- tiveimplementationandtheexecutionofPillarTwoin Europe andworldwide.As a result, previously raised concerns about the validity of certain Pillar Two rules in the context of international tax treaties will need to be assessed inmore detail. Background BackinDecember2021,theGloBEruleswerereleased throughtheOECD/G20InclusiveFrameworkonBase ErosionandProfit Shifting (“ InclusiveFramework ”). TheGloBErulesprovide for a co-ordinatedsystemof taxation intended to ensure that large multinational enterprise (“ MNE ”) groups pay a minimum level of tax on the income arising in each of the jurisdictions where they operate. Numerous clarifications, inter- pretationsandadditionaltechnicalprovisionstothese ruleswereprovidedafterwardswithinvarioussetsof administrative guidance. The GloBE rules were published after 134 members (later increased to 139) out of 147members of the In- clusive Framework, representing more than 95% of global GDP, consented to the Inclusive Framework, includingtheUS,RussiaandChina.Theparticipating jurisdictionscommittedtoreformtheinternationaltax rulesandtacklethechallengeofafairleveloftaxation forMNEgroupsinadigitalizedandglobalizedecon- omy.TheOECDBaseErosionandProfitShiftingpro- ject also includes the “Pillar One” initiative (together withPillarTwothe“ Two-PillarSolution ”).PillarOne aims to transform the allocation of taxing rights on corporateprofitsbetweencountriesbyallocatingtax- ing rights to markets jurisdictions. Pillar One is still subjecttodiscussionsatOECDlevelandhascurrently not been implemented yet. TheGloBErulesweresupposedtobetreatedasacom- mon approach. Accordingly, jurisdictions are not obliged toadopt theGloBE rules, but if they choose to do so, theymust implement and administer the rules inamannerconsistentwiththeagreedoutcomes.This common approach also means that Inclusive Frame- workmembers, including theUS, accepted the appli- cation of the GloBE rules by other members. In the contextofPillarTwo,theInclusiveFrameworkspecifi- cally agreed to consider the conditions under which the US Global Intangible Low-Taxed Income (“ GILTI ”) regimewill coexistwith theGloBE rules to ensure a level playingfield. VariousjurisdictionshavealreadyimplementedPillar Two (2) , including theEUmember stateson thebasisof aCouncilDirective (the “ PillarTwoDirective ”),Aus- tralia, Brazil, Canada, Guernsey, Switzerland, United Arab Emirates, Türkiye, the United Kingdom, Viet- nam,Barbados,Curacao,Japan,Korea,Indone- sia, Isle ofMan,Malaysia, Kuwait, Kenya, Jer- sey,Singapore,Oman,Norway,NewZealand and Thailand. Other jurisdictions such as Hong-Kong, Qatar, PuertoRico, SouthAfrica or Antigua & Barbuda have published draft legislations. Finally, jurisdictions such as Israel indicated that their governments were working on a domestic top-up tax. On the other hand, major jurisdic- tions have not yet imple- mented Pillar Two and will likely not do so in the short term. Despite previous state- mentssupportingtheimpor- tance of Pillar Two, China has been rather quiet about Pillar Two in the recent past. India, that has always expressed con- cernsaboutPillarOne,isassessing whether the Two Pillar Solution can stillwork following theUSwithdrawal. CertaintaxexpertsalsospeculatewhetherGermany’s new coalition may put the application of Pillar Two intoquestionandtrytowithdrawfromtheTwo-Pillar Solution. However, this does not seem realistic at this stage as the repeal of the Pillar Two Directive would require the unanimous agreement of all EUmember States-itwillthereforebedifficultforGermanytoim- plement such a decisionunilaterally. Nevertheless,theEUneedstodecidehowtoposition itself in light of the EO including related measures andwhether it would accept the risk of an extension of the tradewar already fuelledbyadditionalmutual tariffs recently imposed by both the US and the EU on a number of products. Uncertainty in regard to a potentially significant amount of additional tax bur- den for MNE groups will hamper investment and impede desperately required economic growth/re- covery within the EU. In the long run, a standoff in- volving a vicious circle of punitive taxes and increased tariffs is counterproductive for both sides andmay,nexttoanincreasinglycomplextaxsystem, severely impact the EU’s attractiveness and compet- itiveness. In the meantime, the OECD seems to do business as usual. On 15 January 2025, the Inclusive FrameworkissuedseveraladditionalPillarTwotran- sition rules and statements. USposition Sincetheverybeginning,theUShavehadmixedfeel- ings about the Two-Pillar Solution. In a certain way, theUS pioneered the implementation of global min- imum tax rules to prevent profit shifting to low tax jurisdictions. In 2017, US Congress introduced the GILTI regime as a measure to combat base erosion, targeting income that is highlymobile and subject to low effective tax rates (3) . Like the income inclusion rule (“ IIR ”) under Pillar Two, theGILTI regime aims to ensure a global minimum effective tax rate on US GILTIbyimposingaresidualUStaxontheUSparent entity of anMNE group. While the Biden administration generally rallied be- hind the Two-Pillar Solution, severe concerns were raised from the outset against the Undertaxed Profit Rule (“ UTPR ”) that is part of Pillar Two. The UTPR works as a backstop notably when a parent jurisdic- tion does not apply a qualified IIR. In simple terms, this may oblige an EU subsidiary company of a US MNE group in the scope of Pillar Two to levy top-up taxes onUS income. Taking the example of aLuxem- bourgholdingcompanyofaUSmultinationalpoten- tiallyhaving to collect (Luxembourg) top-up taxes on incomegenerated in theUS furtherup the chaindoes indeedraiseanumberofquestionsontheenforceabil- ity of theUTPR in such a context. The American Free Enterprise Chamber of Com- merce, for example, supported by the American Chamber of Commerce (the “ ACC ”), filed an action for annulment in front of the Belgian Constitutional Court against the UTPR implemented by the Pillar TwolawinBelgiumthattransposesthePillarTwoDi- rective (4) . TheCourt has to assesswhether the Belgian lawbreachestherightsprotectedbytheBelgianCon- stitution, such as equality. US opposition to theUTPR, such as theACCand the Republican Party (5) , is based on the following state- ments: -TheUTPRwilladverselyimpactUSMNEswithEu- ropeansubsidiaries.Indeed,accordingtotheACC,al- though the statutory corporate income tax rate in the United States is 21%, the overall U.S. effective tax rate (“ ETR ”) of many US MNE groups could fall below 15%duetoinconsistenciesinthecalculationofETRfor US income tax andPillar Twopurposes. - The UTPRwill undermine legitimate bipartisan US public policy goals because Pillar Two favours so- called- “qualified refundable tax credits”over non-re- fundable tax credits, which is problematic for US businesses since their tax credits are typically non-re- fundable. This contradicts US public policy aimed at encouraging investments in areas like domestic re- search and affordable housing and undermine US publicpolicygoalsrelatedtothedeductionforforeign- derived intangible income (“ FDII ”). This treatment of US tax credits and incentives is seenasunfair anddis- advantageous to US MNEs compared to their EU- based competitors since US MNEs investing considering US tax credits are engaging in legitimate businessactivities,nottaxavoidance.Thispointisabi- partisan argument. - The UTPR, notably under the Pillar Two Directive, will inappropriately taxUSMNEs by failing to recog- nizetheUSGILTIasaqualifiedIIRdespiteinitialsug- gestions by OECD officials that this regime —the prototypical global minimum tax—would be taken into consideration and respected as such under Pillar Two. As a result, many US MNEs that are subject to theGILTI regimewill alsobe subject to foreign top-up tax under theUTPR. - The UTPR’s applicationwould breach the principle ofterritorialjurisdictionundercustomaryinternational lawbecause it allows a jurisdiction to levy a local top- up tax on US profits that have no nexus to that juris- diction. On the contrary, GITLI, as well as commonly applied controlled foreign company (“ CFC ”) taxes or top-up tax based on the IIR are levied at parent com- pany level in relation todirectlyor indirectlyeconom- ically owned profits of a foreign subsidiary. Here, a nexus between the jurisdiction in which the parent company is resident and the profits of its foreign sub- sidiary are usually recognised. - The UTPR could threaten the economic viability of foreign subsidiaries that may not have sufficient meanstosettlealargetaxbillleviedbyreferencetothe USprofits of itsU.S. parent company. - The UTPR will be ineffective against Chinese com- panies because China which, like the US, has not adopted Pillar Two will take advantage of the deal’s ‘loophole’ for direct government subsidies. In September 2024, the Republicans in the US House of Representatives already suggested retaliatory “countermeasures” against jurisdictions that seek to apply theUTPRagainst US-based companies. Subse- quently in January 2025, a bill that was already pre- sented in 2023 was reintroduced in the House of Representatives(“DefendingAmericanJobsAct”).The retaliatorycountermeasureswouldprimarilytakethe formofincreasedtaxationonUSincomeofforeignin- vestorsandcompaniesbasedinjurisdictionsidentified as having “extraterritorial taxes or discriminatory taxes”suchastheUTPRorsimilartaxesonUSMNEs. Thebill suggests increased tax rates of up to20%until these foreigndiscriminatory taxes are abolished. In line with these measures, President Trump also signedanotherEOinJanuary2025authorizingtheun- precedenteduseofSection891oftheInternalRevenue Code (“IRC”), which could even double US tax rates on income earnedby foreign companies and individ- uals in theUS. The total tax leviedwouldgenerallybe capped at 80%of the taxpayer’s income (6) . Under Sec- tion 896 of the IRC, the presidentmay also act against “moreburdensome taxes” if a foreign jurisdiction im- poses higher effective tax rates on US taxpayers than on its own taxpayers “under similar circumstances.” The application of retaliatory measures towards for- eign investors while at the same time trying to attract them seems however counterproductive as investors are generally looking for legal certainty and stability. It should also be noted that, so far, the US have not withdrawn fromtheOECD. TheOECDTwo-Pillar Solution (in)compatibilitywithdouble tax treaties As agreed at OECD level, the GloBE rules have to be treated as a common approach underwhich jurisdic- tions are not obligated to adopt these rules, which is the route currently takenby theUS. TheUS have also withdrawn from its commitment to accept the appli- cation of the GloBE rules by other jurisdictions. With thatinmind,theeffectivenessoftheOECDTwo-Pillar Solution in general, and more specifically Pillar Two therefore has to rely on existing international law, in- cluding bilateral double tax treaties which generally takeprecedenceovernationallaws.Doubletaxtreaties based on the OECD Model Convention (or the US ModelConvention)establishaframeworkforallocat- ingtaxingrightsnotablywithrespecttobusinessprof- itsofpersonsandentitiesamongresidenceandsource states. Double tax treaties also generally include non- discriminationprovisions (7) . ForPillarOneandtheSubjecttoTaxRules (8) (“ STTR ”) thatcomplementtheGloBErulesunderPillarTwo,the InclusiveFrameworkconcludedthatmodificationsof bilateral double tax treaties through the adoption of multilateralagreements(“ MLI ”)wereneededfortheir effectiveapplication.Thoserulesaffectandmayover- ride the usual allocation of rights to tax profits under double tax treaties based on the OECDModel Con- vention.Asaresult,anMLIwasdeemednecessarybe- cause profits of a taxpayer would be reallocated to jurisdictionswhere that taxpayer does not have aper- manentestablishment(“ PE ”)orothertaxablenexusas requiredunder international tax standards. However, the Inclusive Framework judged, despite many doctrinal articles concluding otherwise, that such amendments were not required for the effective applicationof the IIRand theUTPRunder PillarTwo. TheOECDstronglyassertedthattheIIRandtheUTPR donot breachdouble tax treatyprovisions (9) . Nevertheless, significant doubts of compatibilitywith international tax treaties remain with regard to the UTPR.TheargumentsraisedbytheOECDseemingly overlookanessentialfact: theUTPRmodifies,inacer- tainway, the allocationof taxing rights onMNEprof- its. This is precisely why there is a global consensus that double tax treatymodifications were required to avoidanydoubletaxtreatyviolationforPillarOneand theSTTR.Surprisingly,theOECDitselfacknowledges that“ althoughitisnotaprerequisite,amultilateralconven- tion would be the only means to enshrine rule coordination inalegallybindingform. ”Ifdoubletaxtreatyprovisions are applicable and prevail over Pillar Two rules, the OECDTwo-PillarSolutionwouldhavenoeffectatall. Taking back the above example of a Luxembourg holding company that is a subsidiary of a US MNE group:Accordingtothedoubletaxtreatybetweenthe US and Luxembourg, Luxembourg would not have anytaxingrightsonUSsourceincomerealisedfurther upthechainbytheUSgroupentities(andwhichisnot allocable to any taxable presence of the Luxembourg company in theUS). Thus, this raises questions about the practical enforceability of the UTPR under Pillar Two in cases involving double tax treaty partners. (in particular where the parent jurisdiction has not intro- duced Pillar Two into its domestic laws). Similar con- siderationsapply,viceversa,fromaUSperspectiveon the applicationof Section 891. Conclusion ThenewUSadministration’sstanceonPillarTwo,itsreturn to the lawof the jungle in bilateral negotiations and its will- ingness to use tariffs and punitive taxes to impose their will unilaterally have put the EU and national governments undermassivepressure.WhiletheTrumpadministrationis not excelling at the art of diplomacy , it has pointed out a significant weakness of the legal basis of the GloBE rulesinaninternationalcontextthatmayevenjeopar- dise the effectivenessof someof its fundamental prin- ciples. It is indeed debatable whether the UTPR is in linewith existing international tax treaties. As a result, taking into consideration the US position, itmaybeexpectedthatUSMNEgroupssubjecttofor- eign top-up taxes, especially where they are levied under the UTPR, will try to challenge such taxation. Disputes may quickly escalate to the highest political levelandentailsevereeconomicconsequencesascur- rently beingdemonstratedby the ongoing tradewar. Allofthisleavesbusinesseswithlegaluncertaintyand instabilityinanalreadychallengingeconomicandpo- liticalenvironment.TheOECDand,consequently,the EUhave beenparticularlyquiet on this topic since the signature of the EO and related measures. They are probablywaitingfortheresultsoftheUSTreasuryDe- partment’sassessmentofforeigntaxregimesforcom- pliance with US treaties and potential discriminatory effects on US businesses, before taking any action or issuing any official position. Inthemeantime,businesseshavetotakedecisionson howtopositionthemselvesandhandlepotentialrisks. EUcompaniesarefacingyetanothercompetitivedis- advantage in global competition, given that neither their US, Chinese nor Indian competitors have to manage the heavy (and often disproportionate) ad- ministrative burden imposed by Pillar Two in an al- ready overregulated European environment. In the interest of the EU economy and given the unprece- dentedglobal dimensionof the issue, theEUis hope- fully prepared to act quickly. In any case, a solution has to be found as soon as possible to avoid discour- aging investments, the EU’s attractiveness and its competitiveness in global markets. Andreas MEDLER Partner - International & Corporate Tax ATOZ Tax Advisers andreas.medler@atoz.lu 1)OECD(2021),TaxChallengesArisingfromDigitalisationofthe Economy – Global Anti-Base ErosionModel Rules (Pillar Two): Inclusive Framework on BEPS, OECD/G20 Base Erosion and Profit Shifting Project, OECDPublishing, Paris aswell as related administrativeguidanceissuedbytheOECD. 2) For a large part applicable to fiscal years starting on or after 31 Dec2023. 3)SeeS.Comm.ontheBudget,115thCong.,ReconciliationRec- ommendationsPursuanttoH.Con.Res.71,S.Prt.No.115-20,at 370(Comm.Print2017). 4)ConstitutionalCourt,Casen°8267 ,https://lc.cx/Y7BTar 5 )https://lc.cx/JhEWwV 6) G. Mazzoni, A. Martinez, “US rejects OECD global tax deal, raising policy questions”, 13 February 2025, RSM Insights , https://lc.cx/VAL1NI 7)Accordingtosuchprovisions,nationalsorresidentsofonecon- tracting state cannot be subjected to more burdensome taxation orrelatedrequirementsintheothercontractingstatethanthena- tionalsorresidentsofthelatter,insimilarcircumstances. 8)Thisruleallowssource jurisdictionsto“taxback”definedcat- egoriesofintra-groupincomewheretheyaresubjecttonominal corporateincometaxratesbelowtheSTTRminimumrateof9%, anddomestictaxingrightsoverthatincomehavebeenallocated totheresidentstateunderadoubletaxtreaty.Itaimstoenhance the GloBE rules by withholding treaty benefits for certain de- ductible payments made within a group to jurisdictions where thesepaymentsfaceminimalornotaxation. 9)SeeOECD/G20, BaseErosionandProfitShiftingProject-TaxChal- lenges Arising from Digitalisation – Report on Pillar Two Blueprint , 2020 : https://lc.cx/2vn2Rn OECD global agreement on minimum taxation of multinationals called into question