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The Consistency of Pillar 2 UTPR With U.S. Bilateral Tax Treaties

Posted on Jan. 23, 2023
Stephen E. Shay
Stephen E. Shay
Allison Christians
Allison Christians

Allison Christians is the H. Heward Stikeman Chair in Tax Law at McGill University in Montreal. Stephen E. Shay is the Paulus Endowment Senior Tax Fellow at Boston College Law School. The authors thank Reuven S. Avi-Yonah, Philip Baker, Cliff Fleming, James Repetti, David Rosenbloom, and Heydon Wardell-Burrus for comments on an earlier draft.

In this report, Christians and Shay explain why the pillar 2 undertaxed profits rule would be consistent with U.S. bilateral income tax treaties, and they explore some of the reasons underlying claims that the UTPR is incompatible with those treaties.

The views expressed here are made in the authors’ individual capacities and do not necessarily represent the views of any university with which they are associated, any organization for which they serve as officers or trustees or are members, or any client for which they act or have acted on a compensated or pro bono basis.

I. Introduction

Over the past several weeks, there has been a lively debate among tax experts about whether the so-called undertaxed profits rule or UTPR, a component of the global anti-base-erosion (GLOBE) rules of the G-20/OECD inclusive framework’s pillar 2, is inconsistent with existing bilateral tax treaties.1 A comprehensive answer to this question will depend on the design of a given UTPR in relation to the specific terms of a given tax treaty. Nevertheless, in mid-December 2022, 15 Republican members of the Senate Finance and Foreign Relations committees and 17 GOP members of the House Ways and Means Committee wrote Treasury Secretary Janet Yellen with their collective view on the matter.2 Relying on a vague reference to a “growing consensus among tax experts, including former Treasury officials,” the lawmakers asserted that the pillar 2 UTPR “is inconsistent with our bilateral tax treaties.”3 This report explains why that conclusion is incorrect.4

In fairness to the lawmakers, and to tax experts generally, pillar 2 and the UTPR have been moving targets. As the letter to Yellen observes, changes were made between the pillar 2 blueprint released in 2020 and the documents released over a year later as the pillar 2 model rules and commentary.5 What the letter and some commentators miss is that the UTPR tax amount is a tax on neither income nor capital. In relation to the UTPR country imposing the tax, it is an arbitrary amount determined in part on income of an affiliate, in part on the affiliate’s effective tax rate (ETR) in another country, and in part on apportionment metrics that take no account of the factors of the affiliate with the income and other affiliates in countries not applying the UTPR.6 Consequently, the UTPR properly is excluded from the scope of taxes covered by existing U.S. bilateral income tax treaties.

We demonstrate why this is so by examining the technical features of the UTPR tax amount and then analyzing these features in light of relevant U.S. tax treaty provisions and domestic legal principles. Finding from this analysis that there is little content in the broad claim that the UTPR violates U.S. tax treaties, we then examine why this claim is being repeated in public debate, including by U.S. lawmakers. We conclude that the claim that the UTPR violates U.S. tax treaties not only is technically incorrect but also misjudges the U.S. interest in encouraging the GLOBE reforms, which would reduce tax competition and level the playing field by creating tax parity for U.S.-based companies vis à vis foreign-based companies. Instead of being confrontational in this process, the U.S. national interest lies in solving coordination problems resulting from the lack of convergence of U.S. tax legislation passed in the 117th Congress with pillar 2 until the United States aligns its legislation more closely to the GLOBE framework.

II. The UTPR Tax Amount

Admittedly, the UTPR component of the GLOBE framework is unusual. It is designed exclusively as a backstop to the other elements of that framework — namely, the income inclusion rule and its counterpart, the qualified domestic minimum top-up tax (QDMTT). If either an IIR or a QDMTT is applied by a jurisdiction with an in-scope multinational entity, either should eliminate the possibility of a UTPR tax amount in another jurisdiction in respect of that entity. Even so, there is a possibility that, especially in the short term as countries adopt and implement their domestic rules on different schedules, some entities may find themselves subject to the UTPR in pillar 2 jurisdictions. As such, it is worth understanding the technical aspects of the UTPR and how these taxes are likely to be viewed from a U.S. perspective. We do so in this part by first examining the elements and operation of the UTPR as defined in the model rules and then examining the nature of the tax.

A. Definition and Allocation

As defined in the model rules, the UTPR tax amount is an “additional cash tax expense”7 that is:

  1. imposed on a resident corporation (or a nonresident corporation’s permanent establishment) (a constituent entity) that is a member of a multinational group within the scope of the pillar 2 rules (an MNE group), and

  2. that is located in a country that has implemented pillar 2 into its law (a pillar 2 country), and

  3. whose MNE group’s ultimate parent entity (UPE) and relevant intermediate parent entities (IPEs) are not in a pillar 2 country, and

  4. whose MNE group has one or more members with a jurisdictional ETR less than 15 percent of book income as defined within GLOBE and this ETR, after application of the substantial business income exclusion (SBIE) and any QDMTT, that is the source of a top-up tax computation.8

When any member of a constituent entity of an MNE group is determined to pay a GLOBE ETR of less than 15 percent on a jurisdictional basis, one of two rules subjects the MNE group to a top-up tax in relation to those constituent entities to bring their jurisdictional effective rate(s) up to 15 percent. The primary rule is an IIR in one or more of the jurisdictions of one or more of the upper-tier entities that would impose additional tax that would bring the ETR of the undertaxed constituent entity up to 15 percent (top-up tax). If the jurisdiction of the group’s UPE collects the entire top-up tax by way of an IIR, none of the other jurisdictions will collect any of the top-up tax. If the jurisdiction of the UPE does not do so, one or more jurisdictions of one or more of the MNE group’s IPEs may collect a proportionate share of the top-up tax, also through an IIR.

However, if no IIR imposes the top-up tax on either a UPE or an IPE of the MNE group, a UTPR may be imposed by another pillar 2 country in which a member of the MNE group is resident. When more than one relevant pillar 2 country has a UTPR in place (UTPR jurisdictions), the amount of UTPR collected by each is determined under an allocation rule. This rule allocates the top-up tax among the relevant pillar 2 countries using a two-factor apportionment based on the tangible property and the number of employees of constituent entities in the pillar 2 country relative to those of all the MNE group’s constituent entities in a jurisdiction that has a qualifying UTPR in force for the year.9 The UTPR’s relationship to the income of a low-taxed constituent entity that gives rise to the top-up tax consists solely of its affiliation through the MNE group.

B. Nature of the UTPR Tax Amount

From the design elements outlined above, some observations may be made regarding the nature of this tax. First, the UTPR is imposed by a jurisdiction on an entity that is resident in that jurisdiction or on an entity operating through a PE in the jurisdiction. As such, when imposed on a resident person, the UTPR is a residence-based tax, and when it is imposed on a foreign person operating through a PE, it is a source-based tax.

Second, the UTPR amount is computed by reference to a defined category of book income of constituent entities of an MNE group in other countries, with adjustments as set out in GLOBE, and not by reference to the financial or taxable income of the resident entity or the financial or effectively connected income of the PE that is liable to the UTPR. Thus, the UTPR amount is unconnected to (1) the income of the entity liable for its payment, (2) any income allocated or attributed to that entity from any other entity,10 and (3) any existing income tax liability of another entity.

Third, the jurisdiction imposing the UTPR may choose to collect the tax in any manner. The model rules state that the UTPR amount can be imposed through denial of a deduction or an equivalent adjustment.11 The mechanism of reducing a deduction to increase the cash tax expense solely to satisfy the UTPR liability is in substance no different from paying an additional tax, a surtax, or any other separate levy. Further, the commentary confirms that “the UTPR does not prescribe the mechanism by which the adjustment must be made.” Instead, it simply requires the local entity to pay the tax amount.12 Accordingly, the UTPR tax amount can best be understood as an additional tax, in the nature of an excise tax, imposed on the constituent entities of an MNE group in a UTPR jurisdiction by virtue of their being members of that group.

Some may wish to analogize the UTPR to the joint and several liability of a member of a consolidated group for group taxes. That analogy fails because the UTPR is a separate tax from the QDMTT and the IIR, being imposed by a separate jurisdiction on its own taxpayer.13 As such, the amount being paid is not the tax liability of any other group member; the only top-up tax liability is that of the entity or entities with UTPR liability. The analogy might fit if the tax were paid because of a contractual obligation to the constituent entity that has the top-up tax liability, but under pillar 2, no such other entity has the top-up tax liability. As a backup tax to the IIR and the QDMTT, no top-up tax will be allocated under a UTPR if an IIR or QDMTT is imposed. When a UTPR applies, it is imposed only by a jurisdiction other than one imposing an IIR or a QDMTT.14

From the preceding, we may conclude that the UTPR tax amount is not a tax on income since the UTPR liability does not relate to the constituent entity’s income or any attribute other than the attributes used as allocation metrics.15 The tax is best understood as an excise tax on the status of membership in a MNE group subject to the UTPR.

C. Likely Not a Creditable Foreign Tax

As an excise tax, the UTPR would likely not be a creditable tax under U.S. foreign tax credit standards, flexible as they may be as interpreted by the Supreme Court.16 It also does not fit standards to be a tax in lieu of an income tax under section 903.17 Concerns about the creditability of the UTPR could be addressed by competent authorities in respect of treaties that provide them authority to consult together to eliminate double taxation in cases not provided for in the treaty,18 by legislation, by the adoption of amendments to existing bilateral treaties one by one, or, more efficiently, through a multilateral treaty. Neither legislation nor treaty amendment seem likely in the immediate or intermediate term.19

The UTPR, of course, would not apply if a local country adopts a QDMTT under the pillar 2 model rules because the additional local tax would bring the local ETR up to 15 percent.20 There is little doubt that a QDMTT should be a creditable tax.21 For this reason, it would be rational for MNE groups to encourage the host countries in which they operate to adopt QDMTTs rather than lose revenue to countries that otherwise would apply an IIR or UTPR.

D. Viability if Imposed by the United States

Although irrelevant to the imposition of the tax by another country, as an excise tax, the UTPR liability would clearly be constitutional if imposed by the United States because the U.S. Constitution empowers Congress to “lay and collect taxes, duties, imposts and excises,” with the only caveat being that “all duties, imposts and excises shall be uniform throughout the United States.”22 This broad grant of authority has been affirmed in two cases of note: Flint23 and Billings.24 Flint upheld the 1909 federal corporation tax, which was an amount imposed for “doing business,” without regard to the property or income of the taxpayer. The Supreme Court stated:

It is therefore apparent, giving all the words of the statute effect, that the tax is imposed not upon the franchises of the corporation, irrespective of their use in business, nor upon the property of the corporation, but upon the doing of corporate or insurance business, and with respect to the carrying on thereof, in a sum equivalent to 1 per centum upon the entire net income over and above $5,000 received from all sources during the year; that is, when imposed in this manner it is a tax upon the doing of business, with the advantages which inhere in the peculiarities of corporate or joint stock organization of the character described.

In turn, Billings upheld an excise tax on “the use of every foreign-built yacht, pleasure boat, or vessel . . . now or hereafter owned or chartered for more than six months by any citizen or citizens of the United States,” even when the boat was not chartered or used in the United States.

Having thus established that the UTPR is not in nature a tax on income, but rather an additional tax in the nature of an excise tax, we turn to the analysis of a foreign jurisdiction’s UTPR under existing U.S. bilateral tax treaties.

III. The UTPR Under U.S. Bilateral Tax Treaties

In considering the possible application of U.S. bilateral tax treaties to a UTPR, the nature of both the taxpayer and the tax are relevant. That is, the taxpayer paying the UTPR must be resident in a treaty partner jurisdiction, and the tax must be covered by the treaty. As we saw above, the UTPR is a residence-based tax when imposed on a resident person, and it is a source-based tax when it is imposed on a foreign person operating through a PE in a jurisdiction. Only the latter category would give rise to a treaty-based analysis of the UTPR tax amount under a treaty’s rules other than nondiscrimination since the former is a strictly domestic tax on a domestic taxpayer and should be excluded from a U.S. treaty’s scope by the savings clause found in every U.S. treaty.25

Article 1(4) of the U.S. model, for example, provides in its first sentence: “Except to the extent provided in paragraph 5, this Convention shall not affect the taxation by a Contracting State of its residents (as determined under Article 4 (Resident)) and its citizens.” The paragraph 5 exceptions are not relevant to a UTPR, except for the nondiscrimination article discussed separately below.26

Therefore, for an entity paying a UTPR through a PE, the question is whether the tax is covered by the terms of an existing U.S. bilateral tax treaty. In this section, we first examine the likelihood that the UTPR would be considered a covered tax and then consider whether it would violate the nondiscrimination terms of an existing treaty.

A. Not a Listed Tax or a Substantially Similar Tax

Quite obviously, the UTPR has not been listed in any U.S. tax treaty because no UTPR yet exists. Accordingly, it is not a “listed tax” in any existing U.S. tax treaty. As such, a UTPR would be a covered tax only if it is viewed as an “identical or substantially similar” tax “imposed after the date of signature of this Convention in addition to, or in place of, the existing taxes.”27 This is unlikely because the UTPR is not a tax on income.

The U.S. model (starting with the 2006 model) and more recent U.S. treaties have added two beginning paragraphs to article 2 that are in the OECD model:

  • Article 2(1) provides: “This Convention shall apply to taxes on income imposed on behalf of a Contracting State irrespective of the manner in which they are levied.”

  • Article 2(2) provides: “There shall be regarded as taxes on income all taxes imposed on total income, or on elements of income, including taxes on gains from the alienation of property.”

One question is whether and, if so, how article 2(2) interacts with the rules governing a later-enacted tax under article 2(4), particularly whether article 2(2) expands the nature of a later-enacted additional tax that would be treated as covered by the treaty.28

The article 2 OECD commentary starts with a statement of intent:

This Article is intended to make the terminology and nomenclature relating to the taxes covered by the Convention more acceptable and precise, to ensure identification of the Contracting States’ taxes covered by the Convention, to widen as much as possible the field of application of the Convention by including, as far as possible, and in harmony with the domestic laws of the Contracting States, the taxes imposed by their political subdivisions or local authorities, to avoid the necessity of concluding a new convention whenever the Contracting States’ domestic laws are modified, and to ensure for each Contracting State notification of significant changes in the taxation laws of the other State. [Emphasis added.]

Nothing in that statement opens the possibility for an income tax treaty to apply to a tax that extends beyond the definition laid out in article 2(2). It strains credulity to argue that a new kind of tax that is enacted after the treaty, that is not in nature an income tax, and that is not substantially similar to a previously covered tax, could nevertheless be read into the treaty as a covered tax on general principle. We do not think the sentence in the article 2 OECD commentary, read in context, is intended to mean that article 2(2) reaches — or article 2(4) could reach — a tax amount determined by reference to a deemed top-up to a low effective rate of tax on the GLOBE book income of a treaty partner group member apportioned based only on factors of a subgroup of members that did not earn the undertaxed income. The fact that a tax has an indirect connection to another entity’s GLOBE book income does not transform it into a tax “on income” as envisaged by article 2(2).

No precedent for the UTPR has been identified so far, nor are we aware of authority that would support the view that the UTPR is identical or substantially similar to any treaty partner’s existing covered tax under a U.S. tax treaty.29 Accordingly, a UTPR is not inconsistent with the business profits article or any of the other substantive treaty rules restricting a covered tax.30

B. Not Discriminatory

The nondiscrimination article of U.S. treaties typically applies to all taxes imposed by a treaty partner and not only to those addressed by the treaty’s “taxes covered” article.31 In our view, the UTPR as set out in the pillar 2 model rules does not in substance or in principle violate the nondiscrimination article of a U.S. tax treaty.

The person being taxed by the treaty partner under the UTPR is either a corporation resident in that country or a branch of a nonresident corporation. Because both would be subject to the UTPR in the same way, there would be no discrimination for purposes of paragraphs 2 or 4 of the U.S. (or OECD) models.

Paragraph 5 of the U.S. model addresses whether a treaty country corporation “wholly or partly owned or controlled, directly or indirectly,” by a resident of the other country would be subjected by reason of the UTPR to “any taxation or any requirement connected therewith that is more burdensome than the taxation and connected requirements to which other similar enterprises of the [treaty partner] are or may be subjected.” This raises the question whether imposition of the UTPR would be discriminatory under this paragraph.

Assuming that the United States is not a pillar 2 country and that the treaty partner is, a U.S.-parented local entity would be subject to the UTPR, but a locally parented entity presumably would not be (because its UPE would apply the IIR under the pillar 2 model rules). Is the different treatment in this case of the U.S.-parented corporation compared with the locally parented corporation discriminatory for purposes of paragraph 5?

In the treaty partner country, only a foreign parented local company from a non-pillar 2 country would be subject to the UTPR. That foreign-parented company would not be subject to the UTPR to the same extent as a locally parented company. Any discrimination that might arise, however, would not arise because the U.S.-parented company is foreign owned, but because its parent is from a non-pillar 2 country.

The U.S. technical explanation for the 2006 U.S. model convention32 provides an example that supports differences in treatment when the tax is imposed in differing circumstances:

This rule, like all non-discrimination provisions, does not prohibit differing treatment of entities that are in differing circumstances. Rather, a protected enterprise is only required to be treated in the same manner as other enterprises that, from the point of view of the application of the tax law, are in substantially similar circumstances both in law and in fact. The taxation of a distributing corporation under section 367(e) on an applicable distribution to foreign shareholders does not violate paragraph 5 of the Article because a foreign-owned corporation is not similar to a domestically-owned corporation that is accorded non-recognition treatment under sections 337 and 355.

By analogy, a local corporation that is a member of a locally parented MNE group that has a low-taxed constituent entity in a third country would not be subject to the UTPR because its UPE would pay the top-up tax under the IIR, but a U.S.-parented local corporation would be subject to the UTPR because the U.S. group would not pay top-up tax under an IIR.33 In that case, application of the UTPR by the treaty partner to a U.S.-owned resident constituent entity should not be considered discriminatory because the corporations being compared are in different circumstances. In other words, a constituent entity of an MNE group parented from a non-pillar 2 country is not in the same circumstances as a constituent entity of an MNE group parented from a pillar 2 country.

In the reverse case, if the United States were a pillar 2 country and a U.S. corporation is owned by a parent in a non-pillar 2 treaty country, it would seem unlikely that the United States would find it discriminatory under paragraph 5 to apply the UTPR to the U.S. corporation with a non-pillar 2 parent. The discrimination would not arise from the fact of foreign ownership or control but would result from the fact that the foreign owner is not in a pillar 2 country.

There is practical difficulty with relying on paragraph 5 nondiscrimination to protect a U.S. MNE group.34 Even if a treaty nondiscrimination claim were successful, in many if not most cases, it would mean that the taxing right is shifted to affiliates in non-treaty countries.35 A review of IRS country-by-country data suggests that there are thousands of U.S.-parented affiliates in non-treaty countries, any one of which could decide to become a pillar 2 country.36

C. Pillar 2 Commentary

Paragraph 47 of the commentary on article 2.4 of the model rules says that an “equivalent adjustment” under the UTPR shall be coordinated with “a jurisdiction’s international obligations, including those under Tax Treaties.” The commentary does not further discuss the nature of those obligations and whether or how they might affect the imposition of the UTPR.37 We do not address whether other countries might have or interpret income tax or other tax treaty provisions in a manner that differs from our analysis of U.S. income tax treaties. We submit, however, that existing U.S. income tax treaties would not impose obligations that would preclude application of the UTPR.

IV. Reasons for Claims of Treaty Conflict

Having established that the chance a UTPR violates a U.S. tax treaty is low to nonexistent, the question remains why a contrary claim is being advanced by GOP lawmakers and to what ultimate purpose regarding the U.S. interest in pillar 2.

The United States has supported pillar 2, but opposition by Congress has prevented U.S. adoption of tax changes convergent with pillar 2 rules that would cause global intangible low-taxed income to be treated as a pillar 2 qualifying IIR.

Given that global adoption of pillar 2 would significantly level the playing field for U.S. multinationals (which already are subject to GILTI), the apparent motivation for the GOP opposition was to kill or delay pillar 2 altogether (perhaps in hopes of weakening or eliminating GILTI).38 The judgment that other countries would not go ahead with pillar 2,39 which was the basis for opposition to adoption of U.S. rules consistent with pillar 2, has been proven wrong with the EU’s adoption of a pillar 2 directive to be implemented into EU countries’ national law by the end of 2023.40

So what is the endgame now? The GOP senators and representatives must have been aware that pillar 2 was in the process of increasingly broad adoption.41 Their letter may have been intended as a symbolic, if misguided, separation of powers move to assert legislative prerogatives. Congressional oversight is an important and valued function, but it is possible that political considerations were a more important motive for the letter, timed to anticipate global movement on pillar 2.

The tax competition playing field is being leveled by broad adoption of pillar 2. The United States will be subsidizing other countries if it does not participate in coordinated rules. Without U.S. participation in coordinated rules, it appears that revenue will be paid to other countries for low-ETR U.S. companies and their controlled foreign corporations (after taking account of the new corporate alternative minimum tax).42 Moreover, there are important issues to address to mitigate multiple taxation of the same economic income by different instruments.

It appears increasingly likely that the strategy of stopping pillar 2 altogether, which is being pursued by some in the United States (but not the current administration), will be unsuccessful. Although the United States could theoretically threaten unilateral measures, those tactics have a diminishing utility and do not sit well in a world seeking combined action against threats from Russia and China. Because both the EU and Japan have indicated their need to bolster defense expenditures to meet those threats, it is irrational for the United States to frustrate coordination on measures that increase the revenue mobilization capacities of our allies as well as ourselves. The absurd notion that taxes paid to allies for their public goods in areas of defense, energy transformation, healthcare, environmental adaptation, and technological innovation do not enhance U.S. welfare should be put to rest. Moreover, it is important that the United States share in this revenue flow rather than relinquish it to others. If we have learned nothing else since 2020 from the pandemic and repeated climate crises, it is that we are globally interconnected and that poor outcomes in other countries result in burdens on the United States.

The U.S. multinational community should invest its political capital and energies in achieving a more effective and efficient international tax system including pillar 2. The resources previously invested in tax avoidance can be more effectively used in developing business efficiencies and innovations.

Preparing for cooperation rather than conflict will not only increase certainty for taxpayers subject to GLOBE but also enhance the overall efficacy of GLOBE in reducing tax competition and creating a level playing field, with long-term positive effects for the United States, its companies, and its workers. We respectfully submit to our GOP friends that U.S. interests lie in making international tax coordination work so that U.S. multinationals compete on the field of commerce and not tax avoidance. We have confidence based on experience that U.S. businesses will be successful.

V. Conclusion

The UTPR is not a tax on income, nor is it likely to be characterized as in lieu of a tax on income. Instead, it is a cash tax expense that can be collected in any manner and most probably is in the nature of an excise tax. Contrary to the claims of GOP lawmakers and other commentators, the better view is that the UTPR is not covered by existing tax treaties at all, so it cannot be said to conflict with their terms.

Given its role as a backstop to the coordinated efforts of pillar 2 countries to ensure that in-scope MNE groups pay a minimum ETR of 15 percent in all jurisdictions, it is possible — even likely — that after a transition period, countries will collect little if any UTPR. As a result, the priority of the United States ought to be to work cooperatively with fellow members of the inclusive framework to solve coordination issues with non-convergent U.S. tax rules as adoption of pillar 2 rules proceeds across jurisdictions.


1 Reuven S. Avi-Yonah, “The UTPR and the Treaties,” Tax Notes Int’l, Jan. 2, 2023, p. 45; Jinyan Li, “The Pillar 2 Undertaxed Payments Rule Departs From International Consensus and Tax Treaties,” Tax Notes Federal, Mar. 21, 2022, p. 1695; Maarten van de Wilde, “Why Pillar Two Top-Up Taxation Requires Tax Treaty Modification,” Kluwer International Tax Blog, Jan. 12, 2022; cf. Casey Plunkett, “What’s in a Name? The Undertaxed Profits Rule,” Tax Notes Federal, Mar. 28, 2022, p. 1873 (responding to Li).

2 Letter to Yellen (Dec. 14, 2022). The lawmakers were members of the of the 117th Congress, which just ended. For the list of signatories, see infra note 3.

3 Signed by Finance Committee ranking member Mike Crapo, R-Idaho; Foreign Relations Committee ranking member James E. Risch, R-Idaho; Sen. Chuck Grassley, R-Iowa; Sen. John Cornyn, R-Texas; Sen. John Thune, R-S.D.; Sen. Richard Burr, R-N.C.; Sen. Rob Portman, R-Ohio; Sen. Patrick J. Toomey, R-Pa.; Sen. Tim Scott, R-S.C.; Sen. Bill Cassidy, R-La.; Sen. James Lankford, R-Okla.; Sen. Steve Daines, R-Mont.; Sen. Todd Young, R-Ind.; Sen. Ben Sasse, R-Neb.; Sen. John Barrasso, R-Wyo.; Ways and Means Committee ranking member Kevin Brady, R-Texas; and Ways and Means members Vern Buchanan, R-Fla.; Adrian Smith, R-Neb.; Mike Kelly, R-Pa.; Jason Smith, R-Mo.; Tom Rice, R-S.C.; David Schweikert, R-Ariz.; Darin LaHood, R-Ill.; Brad R. Wenstrup, R-Ohio; Jodey C. Arrington, R-Texas; A. Drew Ferguson IV, R-Ga.; Ron Estes, R-Kan.; Lloyd Smucker, R-Pa.; Kevin Hern, R-Okla.; Carol D. Miller, R-W.Va.; Gregory F. Murphy, R-N.C.; and David Kustoff, R-Tenn.

4 To be sure, the application or non-application of a treaty ultimately is limited in practical effect for the United States if a material number of non-treaty countries implement pillar 2 (and its UTPR) to claim top-up tax revenue that otherwise would go to other countries. See J. Clifton Fleming, Robert J. Peroni, and Stephen E. Shay, “Viewing the GILTI Tax Rates Through a Tax Expenditure Lens,” Tax Notes Federal, Dec. 12, 2022, p. 1525, 1534-1535 (explaining the likelihood of pillar 2 adoption before the announcement of the EU decision to adopt pillar 2 rules). We expect the UTPR to decline in significance with growing adoption of pillar 2. See infra note 8.

5 OECD, “Tax Challenges Arising From Digitalisation of the Economy — Global Anti-Base Erosion Model Rules (Pillar 2),” rules 2.4-2.6 (2021) (pillar 2 model rules); OECD, “Tax Challenges Arising From Digitalisation of the Economy — Commentary to the Global Anti-Base Erosion Model Rules (Pillar Two),” at arts. 2.4-2.6, paras. 43-94 (2022); contrast OECD, “Tax Challenges Arising From Digitalisation — Report on Pillar Two Blueprint,” at 121-141 (2020).

6 See generally Wei Cui, “Taxes Covered,” in IBFD, Global Tax Treaty Commentaries (2021). While it is plausible to argue that the denial of a deduction related to an income payment to another person is a reallocation of income, that linkage was limited even under the pillar 2 blueprint and has been effectively discarded under the pillar 2 model rules.

7 The model rules indicate that the amount will result in an “additional cash tax expense.” Pillar 2 model rules 2.4.1-2.4.2 and 2.6.3.

8 This description of the conditions for a UTPR to apply should suggest to the reader why the imposition of a UTPR tax amount will likely be modest and diminish over time as pillar 2 is adopted by more countries. Even so, our argument on U.S. treaty compatibility does not rely on this prognostication.

9 Pillar 2 model rule 2.6. It is up to the country to determine how to allocate the UTPR allocated to that country among the constituent entities in the country. OECD commentary 2.4.1, para. 46. In contrast to the UTPR, the IIR top-up tax liability is based on an allocable share of GLOBE income. Pillar 2 model rule 2.2.

10 See pillar 2 model rule 3.2.3.

11 Pillar 2 model rules, art. 2.4.1 (requiring that the constituent entity liable for a UTPR amount “be denied a deduction or required to make an equivalent adjustment under domestic law”).

12 OECD commentary, art. 2.4.1. A complete answer to the question of treaty conflict must rest on the tax as brought into the local law. Our analysis necessarily is based on the UTPR as we understand it under the pillar 2 model rules. Thus, for example, there may be reasons a jurisdiction is compelled by its constitutional arrangements to integrate the UTPR into its income tax rules in a manner that is not apparent from the structure of the UTPR in the model rules. In that case, there might be a different nature of linkage of the tax obligation to income. We thank Heydon Wardell-Burrus for raising this as a possibility.

13 Reg. section 1.901-2(d)(1)(i) (a levy imposed by one taxing authority is always separate from a levy imposed by another taxing authority).

14 Pillar 2 model rules, art. 10.1 definition of UTPR jurisdiction. A further indication of the distinct nature of the UTPR is that it becomes effective in the year following the year an IIR is to be effective. OECD/G-20, “Statement on a Two-Pillar Solution to Address the Tax Challenges Arising From the Digitalisation of the Economy,” at 5 (Oct. 8, 2021).

15 The allocation metrics are tangible property and the number of employees. The UTPR does not in our view bear meaningful relation to an apportionment of income, in contrast to pillar 1’s amount A. It is a tax amount that is allocated, not income, and the allocation fractions include only the factors of the UTPR countries and not those of the countries whose income is taxed. Cf. Sol Picciotto, “Justifying the UTPR: Nexus and Economic Connection,” Tax Notes Int’l, Nov. 7, 2022, p. 667.

16 See reg. section 1.901-2(b); and PPL Corp. v. Commissioner, 569 U.S. 329 (2013) (treating windfall profits tax as an income tax in a U.S. sense).

17 See reg. section 1.903-1(c).

18 See, e.g., U.S. Model Income Tax Convention, art. 25(3) (Feb. 17, 2016) (“They also may consult together for the elimination of double taxation in cases not provided for in this Convention.”). The commentary to the same sentence in the 2006 U.S. model states: “This provision is intended to permit the competent authorities to implement the treaty in particular cases in a manner that is consistent with its expressed general purposes. It permits the competent authorities to deal with cases that are within the spirit of the provisions but that are not specifically covered.” The circumstances of adoption of the 2016 U.S. Model Income Tax Convention were such that the preamble to the 2016 U.S. model discussed only its “significant features.” It is general practice to refer to the technical explanation of the 2006 model for the provisions that were unchanged in the 2016 model.

19 Indeed, it is likely that the United States would be required to give up more in treaty negotiations than if it pursued diplomatic approaches in the more opaque and friendly corridors of the OECD to achieve coordination of technical rules to mitigate taxation under multiple instruments.

20 Pillar 2 model rules 5.2.3 and 10.1.1 (definition of QDMTT). For an analysis of decisions that a developing country would make in deciding to adopt a QDMTT, see Allison Christians, Thomas Lassourd, Kudzai Mataba, Eniye Ogbebor, Alexandra Readhead, Stephen E. Shay, and Zach Pouga Tinhaga, “A Guide for Developing Countries on How to Understand and Adapt to the Global Minimum Tax,” IISD/ISLP (Dec. 2022) (draft for consultation).

21 The QDMTT should not be considered a soak-up tax because its imposition does not rely on the availability of an FTC. See reg. section 1.901-2(e)(6).

22 U.S. Const. Art. I., section 8.

23 Flint v. Stone Tracy Co., 220 U.S. 107 (1911).

24 Billings v. United States, 232 U.S. 261 (1914).

25 See, e.g., U.S. Model Income Tax Convention, art. 1(4) and (5) (Feb. 17, 2016).

26 The article 1(5)(a) exception preserving double taxation relief for a resident does not limit the treaty partner from imposing a UTPR in the first instance. Under the article 1(5)(a) exceptions to the savings clause, the article 9(1) rule permitting reallocation of non-arm’s-length amounts is not preserved in application to a resident taxpayer; but the correlative adjustment rule of article 9(2) applies. See, e.g., U.S. Model Income Tax Convention, art. 1(5). It is a condition for application of that correlative adjustment that the taxing state include “in the profits of an enterprise of that State, and taxes accordingly, profits on which an enterprise of the other Contracting State has been charged to tax in that other State.” As we show, the UTPR does not include profits of another constituent entity in income and tax it accordingly. Accordingly, article 9(2) is inapplicable to the UTPR. The UTPR apportions a MNE group top-up tax amount based on assets and employee factors of only the UTPR subgroup of the MNE group, which does not include entities in respect of which a top-up tax is determined. This is far from an allocation of income.

27 See, e.g., id. at art. 2(4).

28 See Cui, supra note 6, at section 5.1.1.

29 David G. Noren observes the uniqueness of the UTPR, though to make a point with a different objective. See Noren, “Modifying Bilateral Income Tax Treaties to Accommodate Pillar Two UTPR Rules,” 63 Tax Mgmt. Mem. 25 (Dec. 5, 2022) (“Moreover, now that the UTPR does not hinge on the existence of intercompany payments, there are no good analogies to the UTPR in pre-GloBE tax treaty history.”). The crux of the argument in this note is that the U.S. analysts who have considered the UTPR in the context of a treaty have not taken its design elements to a logical conclusion in applying treaties. In each instance, they are trying to fit a non-income tax peg into an income tax hole. The UTPR may be contrasted in this regard with the base erosion and antiabuse tax. See H. David Rosenbloom and Fadi Shaheen, “The BEAT and the Treaties,” Tax Notes Int’l, Oct. 1, 2018, p. 53 (setting out arguments that the BEAT likely would be considered a substantially similar tax); and Avi-Yonah and Bret Wells, “The BEAT and Treaty Overrides: A Brief Response to Rosenbloom and Shaheen,” Tax Notes Int’l, Oct. 22, 2018, p. 383.

30 Discussions about whether the tax is consistent with the arm’s-length principle under a treaty are misdirected. It may be stipulated that the jurisdiction of the constituent entity has taxed (albeit at a low ETR) arm’s-length profits. Under the model rules, the GLOBE tax base for determining the ETR and top-up tax is based on financial income as adjusted in the GLOBE rules after transactions are placed on an arm’s-length basis. Pillar 2 model rules, art. 3.2.3. Accordingly, the top-up tax itself should be based on an arm’s-length book income base. As discussed, supra note 26, under the saving clause, the correlative adjustment rule of article 9(2) could apply (see, e.g., U.S. Model Income Tax Convention, art. 1(5)), but it has no application to the UTPR, which does not tax profits.

31 See, e.g., U.S. Model Income Tax Convention, art. 24(7).

32 See supra note 18 (explaining that 2006 model commentary is used for unchanged provisions of the 2016 model).

33 We assume for purposes of this discussion that the U.S. global intangible low-taxed income regime and U.S. corporate alternative minimum tax are not treated as an IIR for pillar 2 purposes.

34 See Richard Anderson, Analysis of United States Income Tax Treaties, para. 20.02[4][b][ii] (setting out situations in which the United States has found the foreign-controlled enterprise provision would not apply, including outbound subsidiary liquidations, section 355 spinoff distributions, eligibility to use consolidated returns, and deduction for accrued interest). Anderson observes that these applications are not always easy to reconcile with the language of the provision. A further politically awkward point is that many of these same lawmakers voted for the Tax Cuts and Jobs Act, which included clearly discriminatory provisions, including the denial of the section 250 foreign-derived intangible income deduction to a U.S. branch of a treaty-partner foreign corporation, without specifying that the treaty would prevail. But see Rosenbloom and Shaheen, supra note 29 (setting out arguments that the later-in-time rule for interaction between later legislation and existing treaties would not apply to the BEAT).

35 While not directed at treaties as such, pillar 2 model rule 2.6.3 has the effect of shifting the UTPR allocation for a MNE group away from a UTPR jurisdiction in the year following a year in which the allocated UTPR tax amount has not resulted in an equivalent tax expense in that jurisdiction. Until no UTPR jurisdiction absorbs the UTPR tax amount in the prior year, the UTPR tax amount is allocated among remaining UTPR jurisdictions. See OECD, “Tax Challenges Arising From Digitalisation of the Economy — Global Anti-Base Erosion Model Rules (Pillar 2) Examples,” Example 2.6.4-1 (2022).

36 For 2019, 1,140 U.S. companies with revenue of $850 million or above filed a Form 8975, “Country-by-Country Report.” IRS SOI, “SOI Tax Stats — Country-by-Country Report,” Table 1B. These companies reported affiliates in Brazil (786), the Cayman Islands (400), Hong Kong (926), Panama (206), Peru (277), Saudi Arabia (219), Singapore (834), Taiwan (450), and the United Arab Emirates (495) to name some of the non-treaty jurisdictions.

37 See letter from Robert F. Johnson, Silicon Valley Tax Directors Group, to the OECD, “Response to Consultation on Pillar Two Implementation Framework,” at 3 (Apr. 11, 2022).

38 Two House signers of the December 14, 2022, letter to Yellen (see supra notes 2 and 3) — Kelly and Smith — had encouraged Hungary directly to veto pillar 2 in the EU. See letter from Kelly and Smith to Hungarian Ambassador Szabolcs Takacs (June 20, 2022) (thanking Hungary for opposing pillar 2).

39 Richard Rubin, “Sen. Joe Manchin Balks at Global Minimum Tax Championed by Biden,” The Wall Street Journal, July 6, 2022 (“‘We’re not going to go down that path overseas right now, because the rest of the countries won’t follow,’ Mr. Manchin told the radio host Hoppy Kercheval.”).

40 Council of the European Union, General Secretariat, CM5860/22 (Dec. 15, 2022) (announcing adoption of Council Directive on ensuring a global minimum level of taxation for multinational and large-scale domestic groups); see Council of the European Union, “Council Directive on ensuring a global minimum level of taxation for multinational enterprise groups and large-scale domestic groups in the Union,” 8778/22 (Nov. 25, 2022).

41 See Kimberly Clausing, “The Global Minimum Tax Lives On,” Foreign Affairs, Aug. 17, 2022 (“Canada, Japan, and the United Kingdom, for example, have large economies and a strong incentive to act on global tax. Once some countries take the lead, the undertaxed-profits rule will induce others to follow.”).

42 It is too early to predict the effect of the corporate AMT on potential pillar 2 top-up tax amounts. In general, the corporate AMT should constitute a covered tax, and additional corporate AMT liability should reduce pillar 2 top-up tax amounts. See Avi-Yonah and Wells, “Pillar 2 and the Corporate AMT,” Tax Notes Federal, Aug. 8, 2022, p. 953. At least one commentator suggests that the corporate AMT in relation to CFC income be considered a CFC tax for purposes of pillar 2. See Avi-Yonah, “Is the United States Already Compliant With Pillar 2?” Tax Notes Federal, Nov. 14, 2022, p. 995. But U.S. MNEs would be paying tax revenue to foreign countries while this issue is being resolved, and it may not be resolved favorably for U.S. MNEs.


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