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Pillar 2 and the States: Transcript

Posted on May 2, 2024

The OECD’s pillar 2 will not only shape international and federal taxes but also affect many state and local taxes classified as covered taxes under its framework. That makes state and local taxation a crucial part of its analysis. 

In an April 22 Taxing Issues webinar, Tax Analysts President and CEO Cara Griffith discussed with a panel of experts the choices states face, how to balance compliance with competition, and how state practitioners can prepare for the future. The panel comprised Steve Wlodychak, former state and local tax policy leader for EY LLP's Americas Tax Policy; Jeff Burns, national practice leader of multistate restructuring at Deloitte Tax LLP; and Margaret Wilson, founder of the Wilson Law Group LLC.

Cara Griffith: Welcome, everyone. I'm Cara Griffith, president and CEO of Tax Analysts. Thank you for joining us today to discuss the intersection of pillar 2 in state and local taxes.

Today's event is another in Tax Analysts' series of public discussions that we call Taxing Issues. We launched this series as another way for Tax Analysts to encourage debate on tax issues. We've been bringing the tax community together with leading policymakers and experts for bipartisan discussions on the future of tax policy and administration. As always, we welcome your feedback on how we can make our webinars more useful and also on different webinar topics. You can send your feedback and suggestions to

For our panel discussion, I'll begin by asking a few questions, and then we'll turn to questions from you, our audience. And I promise to get to as many as time permits. And now onto today's topic. We all watched for several years as member nations of the OECD and G20 developed the inclusive framework on base erosion and profit shifting, or BEPS. Then, as a product of that inclusive framework, in October of 2021 the OECD and G20 released the two-pillar approach to international tax reform. Pillar 1 addresses nexus and profit allocation. Pillar 2 addresses a global minimum corporate tax of 15 percent.

Today, over 140 countries have signed onto the inclusive framework, and several have already begun implementing pillar 2. Now, while much of the conversation about the inclusive framework has revolved around the implications of pillar 2 to a corporate taxpayer's U.S. federal or international tax liability, pillar 2 also has significant implications for state taxes across the United States.

Now, although they're very common in our country, subnational taxes on corporate income are not common in most other industrialized nations. U.S. state taxes may be an even greater outlier as a subnational tax because many state tax regimes can also include foreign-source income in their corporate tax base. In general, states use federal taxable income as the starting point for determining state taxable income, along with some modifications. If a taxpayer does business in more than one state, states apportion business profits among themselves based on a company's property, payroll, and sales within each state.

And just because a taxpayer has no federal taxable income does not mean that it has no state taxable income. Federal taxation is often restricted by income tax treaties. Those treaties do not apply to state taxation unless the state has elected to conform to the treaty's provisions. That means that a state may be able to tax the income of a multinational even if the federal government cannot.

Also, while the federal government can only tax a company's effectively connected income — that is, the income related to a company's U.S. operations — several states may tax the apportioned share of a company's worldwide income. This means that corporate taxpayers pay more in the United States than what the standard corporate income tax rate would suggest. Although the current U.S. corporate rate is 21 percent, you can reasonably add another 5 percent or so in state corporate income tax to calculate a corporate taxpayer's total liability.

The same dynamic plays out with global intangible low-taxed income. The current federal tax rate on GILTI is 10.5 percent after a 50 percent exclusion for U.S.-based corporations on their foreign-source income. But because taxpayers can only get an 80 percent foreign tax credit on foreign-source income that's added to the tax base, the effective federal tax rate on GILTI is closer to 13 percent. And when you add in the state taxation of GILTI, you get an effective total tax rate that is higher than 15 percent.

Now, the nexus between pillar 2 and state and local taxes is even more complicated because not all state and local taxes are considered covered taxes for purposes of pillar 2. Now more than ever, it is vital that as we think about pillar 2, we don't lose sight of the state tax piece and its ramifications.

So this is a world of great uncertainty. Thankfully, we have three terrific experts here today to discuss it all and provide their insights. First, we have Steve Wlodychak. He's the former state and local tax policy leader for Ernst & Young, and he is also a frequent contributor to Tax Notes State. Next, we have Jeff Burns, who's the national practice leader in multistate restructuring at Deloitte. And we have Margaret Wilson, the founder of Wilson Law Group LLC, and she's worked heavily on state and local tax controversies and multistate planning. Welcome to all three of you, and I'm so delighted to have you here today. I think this is going to be a very fun and educational conversation.

Now, I tried to do the super high-level intro, but Jeff, could you help us out by providing a little more background on pillar 2 generally and also get a little bit more into what is considered a covered tax and an adjusted covered tax?

Jeff Burns: Thank you, Cara. I think this is great that we're starting here because I've tried to bucket this into two areas for state tax, one being quantitative and one being qualitative. And this is really the quantitative aspect of it. So when we think about pillar 2, at its core, what it's trying to do is establish a global minimum corporate tax rate of 15 percent in each of a multinational entity's operating jurisdictions. So when we think about that and we think about how it's important for state purposes, the numerator in that calculation is covered tax, and state tax is a covered tax. I'll talk a little bit more about that in a sec.

But to think about what a covered tax is, the baseline definition is really current tax as recorded in a constituent entity's net income or loss in their consolidated financial statements. Plus there's a deferred tax component of that, which is capped at 15 percent. And it looks at it by constituent entities, which means entities that are operating in a particular jurisdiction. So that's the baseline of covered tax. If we move from there and we go to, "well, what is an adjusted covered tax?" what we're really talking about is taking that covered tax and reducing it by nonrefundable credits, increasing it by in-lieu-of taxes.

And it's also important to point out that to get to adjusted cover taxes, you exclude taxes related to GLOBE [global anti-base-erosion] income, certain components of it, amounts related to uncertain tax positions or UTPs until you actually pay, and accrued taxes not expected to be paid within three years. We also think about those nonrefundable credits. I know we'll talk a little bit more about that as well, but that's really how we think about covered tax and getting to that adjusted covered tax piece.

Now, I want to point out how state tax plays into that because to just say state taxes are a covered tax is a broad assertion, but what does it really mean? And to understand that, you have to look at both the OECD commentary as well as the model GLOBE rules. There's four subparagraphs within the GLOBE rules that talk about what a covered tax is and what qualifies. Three of those are really important for state taxes. The first one's effectively subparagraph (a), and really what that points to is state taxes that are classified as current income taxes for financial statement purposes, less those nonrefundable credits and UTPs. On that basis, it would also include, depending on how you calculate it, the Texas margins tax.

The next subparagraph, which is probably the most complex of all of them, is in-lieu-of taxes. And the reason I say that this is likely the most complex of the covered taxes when it comes to state tax, I think early on, we looked at that and thought, "Wow, we have a lot of in-lieu-of taxes at the state level." We think about things like gross receipts taxes, the Ohio commercial activity tax (CAT), the Oregon component, much similar to that being the CAT.

But in reality, when you look at the commentary and you think about how those gross receipts-type taxes play in, we're really only talking about state premium taxes being qualified as in-lieu-of taxes. And that's because there's differing regimes that apply depending on how you qualify or are required to pay and remit from a premium tax perspective. So that's why I say that subparagraph is probably the most complex and likely up for discussion even further.

And then the last subparagraph (d) just talks about taxes that are akin to a net worth or a franchise-based tax, which does encompass a number of what I'll call state balance sheet-based taxes and the reason — as we think through all those and how they're important, the last thing I do want to say is it's important to note that covered taxes don't include value added tax, property tax, sales and use, or certain other indirect tax. Sorry for the long answer, but I think it warranted as such just so we could set that stage.

Cara Griffith: It definitely warranted a longer answer because I think there's just some very good points and there's a lot of nuance in there. Steve, I want to come to you for a second and go back to a point that Jeff made on these in-lieu-of type taxes. What are your thoughts on the taxes like the Washington business and occupation tax, those taxes that may or may not be covered? What's your take on those taxes that might be covered and some that might not? How's that going to play out?

Steve Wlodychak: The interesting thing is when you go in there and you read the rules for the first time and you skim over them, just like Jeff, I jumped on there and said, in-lieu-of taxes, sure, B&O tax is an in-lieu tax, so is the Texas margins tax. But the definition is in the details. It's really important to understand the details, and that is not what the OECD is talking about. The OECD is talking about a tax that technically operates just like an income tax where you take your — what's the line they use? It's basically that it's recorded in the financial statements, a constituent entity with respect to income or profits, those are the words they use, and accounting principles are key.

Now, when we talk about the Washington B&O tax, that's a tax that we all know is based on gross receipts. And so I think from a technical standpoint, that is not an in-lieu tax. It's not in lieu of an income tax; it is the tax of the state of Washington. That's how they do it. So that's how that applies.

Now, the Texas franchise tax is much more interesting. Because we struggled years ago in California when the Franchise Tax Board came out on whether the Texas margins tax was an income tax or not an income tax for purposes of personal income tax, we had conflicting guidance where they said, "It depends," that old state adage. It's the same as federal; it's different than federal — it depends. This is on the OECD. It depends because it's a tax that operates as a income tax with certain deductions, limited deductions, but nevertheless an income tax. But in other instances, it works as a gross receipts tax, and you have to look at that. Likewise, in Ohio, the commercial activities tax is a purely gross receipts-based tax.

I think a lot of people were really surprised about that because if you look at the legislative reason for why they created the tax that they did, it was supposed to be in lieu. That's the words we used, but that's not what it means at the OECD, and that's what the problem is. Another interesting thing is if you look at how the OECD went through its guidance, jurisdiction is a specifically defined term. Most of us would say, "Wait a second, jurisdiction? State's a jurisdiction. Sure, they have their own principles." It's not a jurisdiction.

The New York State Bar Association pointed out in its report that you could still be a covered tax even though you weren't a jurisdiction. And that's really the never-never land where the states fall in. There's nobody out there representing the states on this stuff. There's nobody providing any input at the state level on this. And so consequently, I think one of the real problems is you have to look at these state taxes state by state, provision by provision to figure out, how does this meld and fit into the OECD principles?

I look back years ago at the Washington B&O tax, and for those who don't remember, in 1933 there was a Supreme Court decision there that invalidated a constitutional amendment to Washington's constitution to allow for an income tax. The Legislature came up with an alternate, which was to create the B&O tax. And all of us are familiar with the fact that there are various different rates.

If you look at the original intention, that was intended to imitate what the amount of income tax would have been for each of those different industries, and that's why those rates differ. Yet that is not one of the qualifying definitions under the OECD. It would've been great, Jeff, if you were in Paris helping to negotiate this to explain, "Guys, we got to do . . . Even though we're not jurisdictions, let's be really clear that maybe these are the principles that ought to apply as qualified taxes."

So this is going to be a really fascinating issue to try and figure out which one of these state taxes apply. You also get an interesting anomaly in Ohio, where the Ohio CAT tax wouldn't qualify as a covered tax, but all the city taxes do because they're all based on income. It's going to be a fascinating ride here, and state taxes can be very important in these determinations.

Cara Griffith: Do any of you happen to know, and I actually don't, how involved any multistate organizations have been? Local taxes can actually be a pretty significant portion of a taxpayer's tax liability, particularly if you add in property tax, but it still is a big chunk. 

Steve Wlodychak: I can add some anecdotes. Some of my retired partners from EY were actually recruited to work on the OECD project, and they were state and local people with some experience in state and local taxes. They were in the very early phases of the BEPS project, and I would think they contributed some of the ideas about state and local tax, but it's obvious to me, in the final commentary and in the rules, that there was nobody really thinking about some of these real anomalies of state and local tax that fit in there.

I can't find anything at the Multistate Tax Commission where they were participating other than general input to some of the ideas there, but not to these definitions on that. I don't think there has been any real involvement. From the U.S. federal perspective, the key thing there is to make sure that GILTI and base erosion and antiabuse tax qualify for the covered taxes in these calculations as a qualified domestic minimum tax, which is another whole big thing.

That's the big thing the United States wants to do because I just can't see the U.S. government giving up on GILTI and BEAT; it's just too much of a contributor to the federal budget. I don't think this has been on the front burner for anybody representing the U.S. government or, for that matter, individual states being involved at contributing their ideas to this very important piece that's going to affect global taxation for multinationals around the world.

Cara Griffith: Yeah, that was my assumption. Margaret, I want to bring you into the conversation. I feel like at the state level, we have been talking about the race to the bottom for so long, so then when it came into the international circles and then they're working through BEPS to essentially stop this race to the bottom. I feel like we have been talking about this for many, many, many, many years. From your perspective, what's missing from the pillar 2 regime that is currently present in the U.S. SALT regime?

Margaret Wilson: Sure. I agree with you, Cara. I think that the states have had a theme of concern that some lower-tax states were effectively creating a race to the bottom and that they could — individual states could — change the way that they impose tax based on that, either through addback provisions or mandatory combined reporting, ways to pull greater income into their state based on the fact that another state has chosen to tax at a lower rate. And you can debate whether that's fair or not in that it's really not a change in how the particular taxpayer is doing business in the taxing state. It's more a question of another state's tax policy, but that's exactly where we find ourselves with pillar 2.

But as far as what's missing, I think that the U.S. has a long history of addressing the boundaries of taxation among competing jurisdictions. That's largely the theme of U.S. state and local income tax, anyway. Our system has of course the U.S. Constitution as a limiting factor on what the states can do. And then we also have, importantly, the U.S. Supreme Court, which doesn't often step in but can step in. And that is something that both state judiciary, the highest court in each state knows that there's the potential that the U.S. Supreme Court could take cert over a constitutional question.

And so they're subject to scrutiny in that regard. The states themselves know that as well. That's an overarching layer of review that taxes will be tested under. Same thing with the — or a similar thing with the European Union. They've got the Treaty on the Functioning of the European Union; it's got a freedom of establishment clause. And of course, there's the European Court of Justice that ultimately can take jurisdiction over some of these types of competing jurisdiction questions.

There's no similar overarching judicial review for pillar 2. Taxpayers are going to be limited to in-country judicial challenges when they feel that a particular country is applying their pillar 2 tax improperly or aggressively. And so that means that some countries have very limited tax appeal rights for taxpayers. And while the model treaty and the multilateral instrument is starting to move into the space of arbitration, not every country has agreed to allow that or consented to going down an arbitration route. And we talked leading up to this panel about whether pillar 2 is even a treaty tax, a treaty covered tax. So that type of recourse may not be available. So if a country unfairly applies its pillar 2 taxes, the only recourse may actually be political.

Cara Griffith: Dispute resolution is going to be such a huge issue as we move forward, and getting a handle on that is going to be a big challenge. Jeff, I'm going to circle back to you, and let's talk about what taxpayers should do right now. We have pillar 2 being adopted in several countries. We expect several more to follow. What do taxpayers need to be doing now with respect to their state and local tax profile to sort of help them going forward.

Jeff Burns: As you look at this and think about, what's pillar 2 going to do to my global structure? How's it going to impact me as I operate in a multitude of jurisdictions? I think as business and operational changes occur, and quite frankly taxpayers experience disruption related to global tax reform, it's likely many taxpayers will take a fresh look at their overall global structure for potential changes that are also driven business and operationally. It's important to note that a lot of the changes to global structures can have an impact on state and local tax. I think we saw that groundwork laid under the Tax Cuts and Jobs Act and conformity or lack thereof. And so it's really important to think about, what are those impacts going to be and how do we address them?

I'd like to break it down into a few different components. What should we be thinking about as state and local tax professionals when we think about pillar 2? I think the first one is this: Gain an understanding of pillar 2. You don't necessarily have to be the expert, but I do think it'll be important for state tax professionals to really understand what's happening. What's happening on a global basis, how is it impacting my organization, and how do I think about it in the context of state and local tax? There's a lot of information that's coming up out there, more to come. So I do urge everyone to really get a good understanding of pillar 2.

The second piece is understand your state and local tax profile. And when I say that, I mean it in the context of both U.S. and non-U.S. entities. Think about what your profile is for U.S. and non-U.S. — it's a very important piece to this. The other piece is ensuring we really have that inventory of what your credits are — refundable, nonrefundable, your incentives, and net operating losses. All are going to play a factor into this.

The other piece is data analytics. As we think about what pillar 2 is looking to, it is going to be a data-intensive exercise. And so as others in the tax department are looking at datasets, analyzing volumes of data that's required for pillar 2 purposes, I do think it's important to understand whether we're looking at the appropriate effective tax rates or the safe harbor analysis. What does that data mean to a state and local tax person, and how can we leverage those datasets to ensure that we're capturing the appropriate state and local taxes? We talked about what acovered tax is. Now it's in the details of the datasets. That's another area to be very focused on.

Stay involved. Understand, be active in discussions relative to any changes to the global structure, any changes to the global tax footprint, because there is going to be potentially state tax impacts, and that should be identified early and often in that analytical process.

The last piece is really continue to leverage and build on those strong teaming relationships that were developed with our federal and international counterparts in response to TCJA and pillar 2. We do continue to see tax policy discussions, legislative proposals both in the U.S. and abroad that are really centered on the international tax landscape, with many of the items likely having what I would say, quite frankly, is a direct, and sometimes indirect, impact on the taxpayer state posture. And I do expect to see that trend to continue.

That's how I've compartmentalized those areas, and I do think, at its core, really understanding what's happening on a global basis for us as state tax professionals is going to be extremely important.

Cara Griffith: You make some very good points, and I feel like every time we talk about pillar 2, some portion of the discussion always comes to data, and that's going to be a huge one. And figuring out how to analyze that data, what to do with it, what does it mean is going to be vitally important.

Steve, I want to ask the same question of you, maybe in a slightly different vein, but from your perspective, can and should — I guess it's more theoretical — global tax planning impact an organization's state and local profile? In other words, should the two, can the two, be intertwined such that you're utilizing your state and local tax profile in order to inform at least a small piece of your overall global tax planning?

Steve Wlodychak: Absolutely. Regardless of whether the United States adopts a pillar 2 requirement or not, it's still going to have an impact in all these other countries around the world. And consequently, what those state taxes that you pay — the state taxes that you pay, they'll end up being "taxes that are covered taxes" that go into the numerator of your factor in every one of the countries of the world. So it's really important to coordinate those at a global level.

There's no question that state and local tax is going to play an important role here. And like we just talked about, all these odd definitional issues, what does this really mean for worldwide combined reporting? As Margaret points out, now all of a sudden, these countries are going to say, "Wait a second, you've already taken a piece of the pie from our country. That's completely antithetical to what the whole principle of international taxation is."

We still have countries like our dearest, closest trading partners, the United Kingdom and Canada, where we actually have in our treaties with them reservations on worldwide combined reporting. And yet we see people trying to promote worldwide combined reporting as something that the states ought to pursue at this point in time, and there are objections around the world for it. And I think pillar 2 is going to be a big controversy with that going forward.

The other aspect, I think, that's fascinating is watching which countries in the world have adopted this so far. It's not the United States; it's not Canada — it's Switzerland, Liechtenstein, and Luxembourg. These are not exactly your tax-heavy states. They're all the tax havens. And the reason they're doing that is in response to the whole furor to have a 15 percent rate. They're enacting them themselves.

Marty Sullivan just wrote a great article where he talks about Bermuda, that big taxing authority in Bermuda, finally enacting an income tax, which is in response to pillar 2 as a way to preserve their tax base as well from their activities.

All this stuff is going to have an impact on the flow of funds, how things go around, and state and local tax is going to play a very, very important role going forward, regardless of how the United States plays in this. We got 54 countries that have already enacted this, and it's all going to back into how it all plays out.

Cara Griffith: I think it's important to note that this is an issue that the state and local tax piece, even in pillar 2, is important regardless of what the U.S. does. It seems unlikely that the U.S. is going to be enacting a pillar-2-compliant tax in the near term, but this remains an important issue and is going to have an impact.

Steve Wlodychak: One other thing I want to point out too is the states, in my humble opinion, have been way ahead of this BEPS stuff for years. Let's go for a classic example: the concept of addbacks. We're all familiar with the addback statutes where many states said, "Wait a second, if you've got interest or royalty payments going to a related party, regardless of whether it's in the U.S. or somewhere else around the world, you have to add that back in computing your income." That's a classic BEPS thing.

The problem is that doesn't really work in the international environment where you have the permanent establishment concept. The nexus rules that they have at the international level are different than what we look at from a state and local perspective.

So in essence, the state system's already been challenging BEPS and, in a way, successfully doing that. Does it really need pillar 2 to defend itself? I don't think so, but again, it's very important for tax professionals, as well as state tax administrators, to watch how this all plays out and how it affects their tax base too. The Joint Committee on Taxation also reported, when Congress asked, "What do you think the impact's going to be?" that they only had a minor swing between $173 million loss of federal revenue to a $260 billion increase in revenue. And the problem is it's so unpredictable because it's so dependent upon what the response is going to be to multinational enterprises and how they're going to resource their income in response to the tax rates increasing at these tax havens and closing down on this and how they will affect it.

It's kind of unpredictable what it's going to be, and I think it's important for tax practitioners, as well as tax administrators, to keep their eye on this. This is really important.

Margaret Wilson: I completely agree with Steve. I think that the states have been doing things like this for decades. Addback is a great example. A lot of apportionment tools, though, are focused on trying to attack income shifting by bringing — states obviously in the U.S. use a formulary apportionment method. And so a state can modify its formulary apportionment percentages based on what happens in a destination state. Maybe the sales get thrown out of the origin state's denominator, but that's one tool that states have used for a long time to try to attack what they view as income shifting.

Worldwide combination, as Steve pointed out, the only reason that we don't have that is because there was such political blowback in the 1970s that the states that did try to enact mandatory worldwide combined reporting pulled it back. It's been an option for a long time, but that's something that's been getting a little bit more attention from the states in considering. I think Minnesota recently considered going that direction again.

I think states will point to pillar 2 and to the BEPS project as saying, "See, we were right all along in trying to focus on income shifting." But at the same time, the lack of state uniformity — I mean, what have we talked about just sitting here? There's huge variation among the states and their income taxes, but also the Washington B&O tax, the Ohio CAT, and the Texas margins tax. There's such variation that in a way, pillar 2 at least has a uniform approach. But for inbound companies dealing with, or foreign-source income dealing with, the U.S., there's such a lack of uniformity that maybe that is going to be highlighted now, frankly, by the pillar 2 efforts.

Jeff Burns: One thing I wanted to stick on, just since we're here talking about this cross-reference between what's happening at the state level and what's happening internationally, one thing to really point out that brings this back and I think touches back on a comment I made earlier about state taxes on non-U.S. entities. And the reason I want to raise it is because it's good as part of this worldwide discussion, but as a lot of companies are looking at their constituent entities and their global minimum tax rate calculation, I want to point out that for controlled foreign corporation regimes, taxes incurred by the shareholders on their share of that CFC income are allocated to the constituent entity that earnsthe income. If you think about as the background being that, we look at it from a federal perspective, you can read into that that there's an ability to allocate federal income tax associated with GILTI.

And that starts to trickle down to, how do you look at that from a state point of view? Because it is important as it plays a role in that minimum effective tax rate. But if a state conforms to the federal treatment of GILTI, either in full or in part, there's an argument of allocation of the state taxes on GILTI should follow suit to that foreign entity. I think if you're thinking about it in that context, you also need to consider other state taxes that are related to the foreign income. So how does that play out? Think about taxes on foreign dividends — partial taxation of those dividends or full taxation; inclusion of foreign entity income in a water's-edge or a worldwide return. All of those taxes attributed to the foreign entity's income in the U.S. state tax return, we need to think about how those might get allocated.

I think the last thing to say is really the last piece, which is foreign entities, because of the operation of nexus, may file on their own for state income tax purposes and incur their own state and local tax directly, and that tax may be allocated to that foreign entity for pillar 2 purposes. So those are all important areas to think about because — I know we're talking about this in the U.S. context — it's playing out on the global stage, and state tax being a covered tax, that's where it really starts to have an impact on that global minimum effective tax rate. 

Cara Griffith: It's so interesting how complicated it's going to be and how we're going to spend a couple of years trying to figure it out. It's going to be a huge challenge. Jeff, I have another question for you too, and I want to make sure we spend a little bit of time and get back to it. You've referenced credits and incentives a couple of times, but I wanted to ask more specifically to you, what impact will pillar 2 have on state credits and incentives, and what should taxpayers be doing now to evaluate their credit incentive strategy?

Jeff Burns: Great question. As I was talking through the initial framework of pillar 2, yes, I mentioned covered tax excludes nonrefundable credits and uncertain tax positions. And I'll come back to the latter in a second, but as we think about credits and incentives overall, that nonrefundable component certainly can and does have an impact on the covered tax calculation and ultimately on that global minimum effective tax rate. I think when we talk about credits and incentives, and there's a lot of commentary about incentives that's been published recently in the pillar 2 context, but taxpayers should really, again, take an inventory of your credits and incentives and determine what that impact is going to have on the global minimum effective tax rate in the constituent entity group.

And depending on the outcome of that, really determine, are those something that I should try to think about monetizing? Can they be monetized? Can they be converted to refundable or monetizable credits? Or how do I think about credits and incentives in the future? How do I want to earn them, utilize them? And now I've got this global measuring that I need to go through anytime I'm thinking about some of those attributes. And so while it's one line in the adjustment to get to adjusted cover taxes, I think it's a very important line and something that needs to be considered today on the inventory side and then in the future as to how taxpayers really want to earn or utilize them.

On the uncertain tax position piece, that's one area that I want to hit on too while we're talking about credits because it's a component of that adjusted covered tax, but I think there's also some relevance to looking at uncertain tax positions because there's an exclusion there from the covered tax calculation. The question is, depending on where I sit from a global minimum effective tax rate at my constituent entity group, if I have reserves that are on the books that are related to state and local tax, should some consideration be given to filing and paying because then I may draw that effective tax rate up or above the 15 percent, or should I continue with the path that I'm on with my reserves? So it's something that should be analyzed as well if we think about things that would want an inventory. There definitely should be a focus on credits, incentives, and on certain tax positions as well.

Steve Wlodychak: Jeff, along those lines, don't you think that we have to revisit the whole concept of income tax credits? And maybe state administrators who are trying to put together packages to track businesses should avoid them at almost any cost and think about doing it as property tax incentives or payroll tax incentives and jobs credits? Things like that are going to become much more prevalent and much more valuable than an income tax credit which offsets the minimum tax. I think that's going to be an interesting trend too.

Jeff Burns: Again, I think that plays into, what's my inventory look like? What am I sitting with as far as nonrefundable and refundable? And where does it fall in that covered tax? Maybe they're not even credits that fall in the covered tax calculation, depending on the underlying mechanism through which they're utilized. So it's certainly an important area that I think should be focused on.

Steve Wlodychak: Yeah, it's like Through the Looking-Glass, and What Alice Found There. Things aren't as they seem anymore.

Jeff Burns: Right.

Cara Griffith: But it's going to be interesting how the states respond too. Are they going to go through this exercise of saying, of looking at their — maybe it's the credits they're offering, maybe it's the tax type they have, and saying, "Does how this impacts with pillar 2 — does this matter? Should we change it? Should we do something different?" It will be interesting to watch the states' responses.

And in that vein, Steve and Margaret, I wanted to pose the same question to you, which is, we've been talking about the challenges there will be and how taxpayers are going to have to respond, but for the states, is there a benefit to the states from pillar 2? Is it the shiny new thing that is going to in some way make their life better?

Steve Wlodychak: I hope not. I hope that the states avoid this. I'm already thinking that this is the Tax Accountants Full Employment Act. You overlay the state issues with respect to a state global minimum tax response, and it's just going to make things even more challenging with 170 jurisdictions around the world enacting something like this and then trying to get to the ETR rates book accounting. I think we should just be happy that the state taxes end up being covered taxes to avoid this problem. I certainly hope the states don't jump on this like some have done with digital services taxes, which I also don't think is a wise idea, but this is not something I think the states should jump on.

And I do think, as Margaret pointed out earlier, there are impediments, constitutional impediments, to states picking on foreign companies or foreign jurisdictions in the development of their tax policy. My view is, I think the states have already done a lot on BEPS way ahead of the government that are within the realm of constitutional principles. I'm not sure they really need it. I hope that they avoid it. I hope this is not the shiny new thing, as I point out in my article, that they jump on.

Margaret Wilson: I agree with Steve. I think the states are very happy. Well, to an extent, they're happy with the tools that they already have and that they've used to try to attack what they view as income shifting. I think they might point to pillar 2 as more evidence of the income shifting that they've been complaining about for a long time, whether rightly or wrongly.

I don't see them trying to adopt their own version, though, of a pillar-2-type tax. I think this stands in stark contrast to the TCJA where they had reason to or incentive to conform in whole or in part to a federal increase in taxable income. And we saw a lot of different responses from states in reaction to that, but I think it would be a very different thing for them to go out and try to create their own version of a pillar-2-type tax.

Steve Wlodychak: Margaret, along those lines, when TCJA came out, I still contend this is the issue, and I still haven't seen it decided by any court seven years later. And that is whether or not GILTI as it was constituted is something the states could even adopt because what you are doing, in essence, is treating foreign income differently to domestic income, and that is in violation of the Kraft General Foods Inc. v. Iowa Department of Revenue and Finance opinion. And I know my friend Michael Fatale has written a great article on whether the Kraft case is even good; it should be — it was written by Justice John Paul Stevens in the same year that Quill came out. And maybe it's incorrect for the very same reason that Justice Stevens wrote it, but that is the principle right now. I don't think the states can discriminate against foreign taxation the way the federal government can, and I think that's going to be an impediment to the states to do it.

I think that when you look at addback rules, the way they work, that's fine because you're not treating domestic or foreign companies any differently. Combined reporting, you're not treating foreign domestic companies any differently except if somebody elects into the water's-edge election. That's how it basically works for state purposes.

I think the states have their own tools right now. I don't think they're going to get anything out of a pillar 2 arrangement, and it's really just not worth barking up that tree. Take the benefits. Take the win. Use covered taxes as a way to offset the amount for MNEs that are operating around the world to avoid having to pay additional tax in the U.S., but I don't think there's a reason for the states to adopt this shiny new thing, a pillar-2-type tax.

Margaret Wilson: Steve, you raise a good point with Kraft, but even if Kraft were called into question, which I don't really see personally, it's not just discriminatory taxes that are precluded under the Constitution, right? We have the gloss of a lot of different U.S. Supreme Court decisions that tell us what the commerce clause, the foreign commerce clause, and the due process clause mean in the context of state taxes and the rules that are established under that.

And so in addition to not discriminating against foreign taxpayers or foreign commerce, the states also have to fairly apportion their taxes. They still have to have substantial nexus even in the wake of Wayfair. Wayfair just said that physical presence isn't an appropriate proxy for substantial nexus. Their taxes have to bear a rational relation to the benefits that the state provides to that actor.

So yes, Kraft struck down in what the Court viewed as a discriminatory tax on dividends from foreign subsidiaries. But Japan Lines, years before Kraft, actually struck a California tax that was agreed by all of the parties it was not discriminatory and it was apportioned, but it was under the foreign commerce clause, which also adds the overlay of not allowing states to tax in a way that results in a risk of multiple taxation that's unique to foreign commerce, and also guarding against the states impairing the U.S.'s ability to speak with one voice.

And so in that instance, even though California said, "Look, the Moorman Manufacturing Co. v. Bair decision in the U.S. Supreme Court told us that it was OK for there to be some double taxation" because that can happen when states each pick their own apportionment formula. But Japan Lines said, "That may be true in the U.S. where we've got control over all of the states, but when Japan is the other side of that, California can't tell Japan how to tax, and the U.S. Supreme Court can't tell Japan how to tax." So in that instance, the California tax was struck under the foreign commerce clause.

Cara Griffith: We got an interesting audience question that I'm going to pose to all of you that relates to what we've just been talking about. The question says, "States have largely punted on taxing GILTI in subpart F, yet follow foreign-derived intangible income. Does this mean that MNEs are being undertaxed compared to their domestic entities?" Anyone want to venture a guess whether that the states haven't really jumped on the bandwagon of GILTI and subpart F?

Steve Wlodychak: Cara, I think there's a constitutional impediment. This is my humble opinion, and I've been saying this since GILTI came out. States can't follow GILTI because, in essence, what you're doing is you're taxing foreign income differently than you are domestic. You're accelerating income into the American tax system faster than you would if it was a domestic company because a domestic company would only recognize it if there was a dividend made, and GILTI is actually accelerating income.

The same thing with subpart F. That's been clear for many, many years that the states would decouple from that. People get confused about California; the subpart F is actually incorporated but only for apportionment purposes. It has nothing to do with the inclusion of income — it's just used for apportionment purposes. So no state really incorporates subpart F income, and just a handful have been getting GILTI. I think Nebraska — and it's confusing why they did it — they threw it out there to say, "Let's litigate this issue."

On FDII, that's a little different because FDII is deemed to be an incentive for bringing income into the United States. Consequently, I don't see that being in the same vein as GILTI because, in essence, what it is is mimicking an incentive to attract investment in the United States, just like any credit incentive. And I don't think anybody would challenge that.

But GILTI is different because — GILTI and BEAT are different because effectively you're taxing foreign income differently than domestic. FDII is just attracting income to the United States and then treating it essentially the same. So I don't see there to be an issue between the two concepts.

Jeff Burns: To add to that, that question almost gets back to some of the discussion we've been having, which is, how are or will the states respond to pillar 2? And I think the answer is right now, they're technically not. But Steve, to your point, we are seeing jurisdictions that have proposed legislation to varying success around mandatory worldwide reporting regimes or really different variations on that, on taxing foreign income.

I think we've seen recently New Mexico enacted legislation which will effectively tax subpart F income and then modifies the 80/20 provisions, which previously excluded some of the U.S. organized or incorporated entities based on percentage of foreign income and activity. I do see maybe some shift. Whether pillar 2 is driving that or not is up for debate, but we are seeing that shift, and so I think it potentially could change.

Cara Griffith: It'll be interesting to watch. Another question that we got in is another forward-looking one on how the states are going to respond to pillar 2, and it asks whether states that consider tax havens in their system will need to reassess whether those jurisdictions remain within their state tax definitions in a post-pillar 2 environment.

Steve Wlodychak: There are no tax havens, Cara. There won't be, right? Because in essence, by establishing the qualified domestic top-up taxes, which Lichtenstein has created, and Luxembourg and Switzerland have all created, there's no longer a tax haven, right? I never understood why the states jumped onto a provision that had defined things as tax havens when even the OECD rescinded its principles on that so the whole tax haven concept seems like it has to disappear.

Cara Griffith: I think that's true. I wonder if the states will respond in that way. Are they going to say, "Actually now there are no tax havens?" Are they going to wait until more countries have adopted pillar 2? I don't know.

Steve Wlodychak: There's still Delaware, right?

Cara Griffith: There will always be one. We'll keep going with a couple of additional audience questions, and then we'll get back to a few others. Another question we got, and this is more on the policy line, is how will pillar 2 help in reducing the issues of tax competition and the base erosion of profit shifting experienced by the states? Is there going to be a response from the states that it reduces competition in and among states?

Margaret Wilson: I don't see a natural avenue for that, frankly. I don't know if Jeff or Steve disagree, but I think among the states, it's going to be largely business as usual. Now, state taxes have an impact for taxpayers on what their profile looks like for pillar 2 taxes abroad, but I don't think as between one or more different U.S. states, I don't see that. Steve or Jeff, do you have other thoughts?

Steve Wlodychak: I don't see a huge change in state tax competition with respect to rates here. You'll still have the same states trying to attract business the way that they do. They'll try to be competitive with respect to having different rates. This has no impact on personal income taxes, which seems to be the focus these days for states trying to reduce their rates on the personal income tax side.

Because again, the OECD rules — pillar 2 is only dealing with multinational enterprises that have €750 million, on today's exchange rate, that's like $803 million worth of revenue. So it's not something that's going to have a huge impact, I think, at the state level. I just don't see it.

Jeff Burns: Yeah, I would agree. I think it all comes down to that quantitative aspect where state taxes play into the covered tax calculation. I think, Margaret, you said it well.

Cara Griffith: I think that that's the point. The one that I keep toying around with is are states going to move away — and this doesn't affect, impact, competition between the states — but are states going to move away from some of these in-lieu-type taxes or the gross receipts taxes because large taxpayers would prefer a tax that helps them with pillar 2? That's a long way down the road to think that something like that is going to happen. It's not going to be an immediate response, for sure.

Steve Wlodychak: Yeah, Cara, could you imagine trying to, with all the political decisions that were made in Ohio, to untangle from the CAT and then reenact the income tax? And it's to benefit, again, companies with a global turnover of €750 million or more. You think about all the consequences to small businesses in Ohio, I don't think there's the incentive to try and create something like that. Could they create, say, an alternative tax that qualifies as an income tax for large organizations? I don't know if the Ohio Department of Taxation wants to deal with that brain damage. That would be an awful lot of work to try and figure something like that out.

Cara Griffith: Yeah, that seems like a very challenging option for states that already have limited resources with respect to their tax administrations. It does lead me to one other question that we had on our list, which was given the speed with which pillar 2 went from a concept to something that we have many countries already enacting, and how long the states have tried at some level of conformity and muddled down the road, should states attempt to follow suit? So should states attempt their own? And we discussed it briefly earlier, but we'll bring it more head on, should states attempt to create their own interstate minimum tax system?

Margaret Wilson: Oh, gosh.

Jeff Burns: No.

Cara Griffith: I'm guessing the answer is no, given the immediate response that I got. But I'm going to ask it anyways because — go ahead, Margaret.

Margaret Wilson: I think, Cara, if it brought along the uniformity, then maybe there would be a system that was more cohesive. I just don't see that happening. I remember, to Steve's point about Ohio and Texas, when they started marching down the gross receipts tax road, that there was a concern that a lot of states were going to go that direction. And New Jersey, for a while, had an alternative minimum assessment that was a flavor of that, but it never really became fully in vogue.

But I do think that if the states tried to do something like a pillar 2, it would need to also have — and I'm not saying that it's a good idea — it would need to also have some level of uniformity attached to it, because uniformity is still a concern. Burden is still a concern. I know Wayfair reversed Quill, and a big part of the Quill decision on nexus was the burden of sales and use tax compliance across the country. But burden is still an issue, and it's still a constitutional issue.

For any foreign taxpayer trying to deal with our U.S. state systems and the variation and the complexity of them, it's a big deal. And so I think one good aspect of pillar 2 is that it's a uniform system that, at least in principle, it's supposed to be a uniform system, but with the states, there's so much devil in the details. It's very unwieldy.

Steve Wlodychak: And Cara, the state taxes have to be taken into consideration with the federal taxes. Remember, the federal government is a "jurisdiction," and the states are not. The state taxes are, however, part of the covered taxes. I don't think that the United States — the combined United States and state rates — would ever be below the 15 percent ETR that would require the imposition of an additional qualified top-up tax in the United States. Maybe GILTI provides that in other countries, but not here. So I don't see where there's an incentive for the United States to do that, other than tax competition with other states.

And then that runs all afoul of our whole concept of federalism, that every state divides its own tax system and work within its own tax environment without having the intrusion from other states here on what they do. So I think trying to devise a pillar 2 equivalent at the state level where you could challenge the tax rates in other states and exact additional payments out of those states, I just don't see it going in that direction.

I don't see there being a huge benefit for it. And I think it goes against the way our whole history, 100 years of state taxation, has worked on the concept of apportionment, allocation, and nexus. I just don't see it as a workable solution.

Cara Griffith: Yeah, I would 100 percent agree, and it's an interesting question to be asked. I do wonder if there are lessons that have been learned by the states that will ultimately be very useful on the international stage. Because I think that as pillar 2 is implemented in various countries, in the more countries it gets implemented in and it has to go through their systems, you're going to get some level where there's a lack of uniformity. And I wonder if the worldwide tax landscape will fall prey to some of the same things that the state tax landscape has fallen prey to. Are there lessons from the states that would be applicable to the international community?

Margaret Wilson: I think one interesting way in which the states have really — the states wanted to solve a problem, which was Quill in their view. The Quill decision said that an out-of-state company doesn't have to collect the use tax from its customers if it doesn't have a substantial nexus in the state. And that meant physical presence. And so that was 1990, I forget exactly when, the early 1990s. And so for several decades, the states have worked with taxpayers on the Streamline Sales Tax Project to try to create uniformity with the goal, admittedly, of trying to overturn Quill. But recognizing the pushback from the taxpayer community, the states said, "OK, we can work together as a community of states and with the taxpayers to try to achieve some level of uniformity and to give the taxpayers less of a reason to complain about this burden." And so I think that is a pretty unique example, and it's one that the Supreme Court in its Wayfair decision pointed to in terms of justifying a change in the prior position under Quill.

Steve Wlodychak: Cara, one thing that is actually in pillar 2, which I found fascinating, was the tertiary level for the taxes. The first level of taxes, the jurisdictions with the low tax rates, they do a qualified domestic top-up tax. The next one is if there's no qualified domestic top-up tax, it then goes to the host country of the multinational ultimate parent enterprise. Let's do the United States. If neither got to the 15 percent, then what happens? It goes to all the other countries in the world.

And guess what they use to decide which country gets what? A form of apportionment, just like what the states use. It's not perfect. It's always been a problem at the state level, but it's the first time I'm seeing it on a global level. We've seen policy papers in Europe where they're talking about trying to use apportionment there, but they're going to set up some method based on property and payroll. And payroll will be bifurcated into the actual salaries paid in the number of employees in a country as a backup to the tertiary level of the top-up tax.

I found that somewhat interesting that the international realm recognizes a value of apportionment, value good or bad of apportionment, in a way to allocate among separate sovereigns a piece of the pie in that regard. I don't know how often that will actually be applied, because frankly, I think the primary level of the qualified domestic top-up taxes is probably going to take the lion's share, if not all, of the income here. But again, it's interesting that the OECD thought about a tertiary level of applying state apportionment principles similar to what the states do to divide the base at a third level. That was interesting to see.

Cara Griffith: That is really interesting.

Jeff Burns: Yeah, I think it's interesting to see the borrowing of concepts of apportionment and not necessarily using the word nexus, but nexus-like activities in some of the jurisdictions.

Cara Griffith: Jeff, I'm going to come to you for a final question, which really is, for state tax practitioners out there, as they're looking at the next six to 12 months, how can they add value for their clients in evaluating pillar 2?

Jeff Burns: I think I'll bring it all the way back home to the beginning of the conversation. It's those two areas. It's really helping getting involved in that quantitative aspect, helping companies capture those covered taxes, making sure they have the right inventory, and what do they do with that information. And it's the qualitative aspects. As structures change, and we need to think about what are the impacts or benefits at the state level, really being focused on that and integrating across the table to our international and federal tax counterparts. And then that third foundational piece of just continue to get information on pillar 2, understand where it's headed, get educated on it, and really, really take hold of it because it is tax reform on a global basis.

Cara Griffith: This is going to be an area that — and even for those of us, for Tax Analysts and Tax Notes, in news — that we're going to have to cover more of because there are a lot of issues that we're going to see and some that we aren't aware of yet. I look forward to having you all back. I'm sure there are going to be additional state tax issues with respect to pillar 2.

But I want to thank you for your time today, and I want to thank you, Jeff and Margaret and Steve, for sharing your opinions, and I hope everyone enjoyed this as much as I did. Have a wonderful day.

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