The Internal Revenue Service (IRS) and US Treasury Department recently provided guidance anticipated by many corporations, clarifying some aspects of the foreign tax credit under the newly introduced global minimum tax deal titled Pillar Two.
According to the guidance, US multinationals will generally be eligible for a foreign tax credit for qualified domestic minimum top-up taxes (QDMTTs) affected by Pillar Two. Interestingly, the rules for the tax creditability of foreign taxes imposed under the income inclusion rule (IIR), applied to the majority-owned income of a US multinational, are less straightforward.
However, considering that QDMTTs are likely to hold more significance than the IIR for many US multinationals, the taxation concerns arising from Pillar Two largely revolve around the capacity to claim a foreign tax credit for enforced QDMTTs. If multinationals lack such capacity, primarily due to limitations in crediting QDMTTs on global intangible low-taxed income (GILTI) or branch basket income, the implications of Pillar Two warrant careful evaluation.
General Creditability
The standards of creditability within Pillar Two stem from the need for a foreign levy to meet certain requirements outlined in Reg. Section 1.901-2(b). Moreover, individual top-up tax creditability may vary case by case, independent of other levies. Despite the absence of a clear verdict in the guidance regarding the general creditability of Pillar Two taxes, it doesn’t raise major concerns about the creditability of QDMTTs, which generally mirror the net gain requirement.
Provisions laid out in Notice 2023-55, have also provided temporary relief easing the compliance requirements for some taxpayers. On the contrary, the creditability of top-up taxes imposed under the Undertaxed Payments Rule (UTPR) remains uncertain, subject to specific regulations and income considerations.
Final Top-Up Taxes
The guidance lays down principles for determining the creditability of final top-up taxes, which specify that such taxes may not be credited by a US taxpayer if considering the respective taxpayer’s US federal income tax liability forms part of the computed liability for the tax. Thus, while QDMTTs aren’t considered final top-up taxes, IIRs do fall within this category, potentially upending their creditability by US multinationals.
Credit Limitations
In addition to ascertaining the creditability of each relevant QDMTT or non-circular IIR tax, US multinationals are also tasked with ensuring they have adequate foreign tax credit limits to apply these credits. Multiple strategies can be considered to enhance this limitation, from analyzing asset allocation to reviewing value chains and foreign operations. Navigating these potential strategies, with an eye on the possible tax implications of Pillar Two, is paramount for businesses operating across borders.
This article provides a broad summary of the complex subject matter on the foreign tax credit under Pillar Two and the resulting implications for US multinationals. Further specialized queries can be directed to contributors Daren Gottlieb, Kevin Brogan, and Chris Riccardi, leading practitioners within KPMG’s international tax group in its Washington national tax practice.