Update: US retaliatory taxes to be abandoned following G7 agreement on Pillar Two

Background

OECD BEPS Pillar Two and the UTPR

BEPS Pillar Two or “global minimum tax” is a tax regime agreed between the OECD inclusive framework to ensure that in-scope multinational enterprises (“MNEs”) pay a minimum rate of corporate income tax.  The regime applies to MNE groups with annual consolidated revenue of €750m or above.

Entities in an in-scope group must calculate their income and tax under special Pillar Two rules.  Top-up taxes are usually payable if the effective tax rate (tax divided by income) for a jurisdiction is less than 15%.

There are three possible ways in which the top-up tax amount might be collected:

• domestic top-up tax in the jurisdiction where the low taxed entity is located;
• tax on a parent entity of the low taxed entity under the income inclusion rule (IIR);
• tax on a group entity tax resident in a jurisdiction where tangible assets and / or employees are located under the undertaxed profits rule (UTPR).

The rules interact to ensure that the same amount is not charged to tax twice, meaning that the UTPR is only applicable if the top-up tax has not been collected in full under a domestic top-up tax and the IIR.  A jurisdiction must have implemented the tax charging rule(s) into domestic law in order for a top-up tax to be charged in that jurisdiction.  Those jurisdictions who have opted to implement a UTPR have generally done so with effect from 31 December 2024 or 1 January 2025.

The U.S. has not implemented the Pillar Two rules.  Although U.S. MNEs are currently shielded from the impact of the UTPR on their domestic profits by the temporary UTPR safe harbour which shelters the profits of ultimate parent and other entities in the same jurisdiction (provided the ultimate parent jurisdiction has a corporate tax rate of at least 20%), this safe harbour was expected to be only available for accounting periods commencing before 31 December 2025.

Executive Orders

Two executive orders were issued by President Trump on 20 January 2025 stating that Pillar Two had no force within the United States and directing the U.S Treasury Secretary to investigate whether any foreign country subjects U.S. citizens or corporations to discriminatory or extraterritorial taxes pursuant to section 891 of the U.S. Internal Revenue Code. Section 891 is a provision that allows the President to double the rate of tax on foreign companies and individuals' U.S. income if the companies or individuals are located in countries subjecting U.S. citizens or corporations to discriminatory or extraterritorial taxes.

What was originally proposed?

A wide-reaching bill (The One Big Beautiful Bill or “OBBBA”) was introduced to the House of Representatives on 20 May 2025.  The bill included a provision for a new section 899 of the U.S. Internal Revenue Code which was aimed at combatting  “unfair foreign taxes”.

Section 899 would have operated by increasing rates of U.S. taxes on certain U.S. source payments where the payment was received by a foreign person who has a prescribed connection with a “discriminatory foreign country”.  A discriminatory foreign country was defined as a country other than the United States (or a U.S. possession) that has one or more “unfair foreign taxes”.  The definition of “unfair foreign taxes” was broadly drafted and included the UTPR, digital services tax and diverted profits taxes.

It was proposed that the increased rates would apply to withholding taxes (e.g., on FDAP income such as dividends, interest, and royalties, subject to certain exceptions), income taxes on effectively connected income of non-U.S. persons and tax on dispositions and distributions involving U.S. real property interests (as governed by FIRPTA).  The rates would have increased by 5% per year, capped at 20% above the statutory rate.  For example, withholding tax on U.S. source interest payments would have been capped at 50%.

What has been agreed?

On 26 June 2025, the US Treasury Secretary announced that G7 countries had reached an understanding that Pillar Two taxes wouldn't be levied on U.S. companies in exchange for the U.S. abandoning the section 899 retaliatory taxes.

On 28 June 2025, G7 countries issued a joint statement on Global Minimum Tax.  Following consideration of the agreed upon removal of section 899 in the Senate version of the OBBBA and the successful implementation of domestic top-up taxes by other jurisdictions, G7 members have agreed to a “side-by-side system” whereby the U.S. tax system (in particular, the global intangible low-taxed income regime or GILTI) will sit alongside Pillar Two rules.  The statement sets out the following agreed features of the side-by-side system:

• U.S. parented groups would be fully excluded from the UTPR and the IIR in respect of both their domestic and foreign profits. 
• A commitment to ensure any substantial risks that may be identified with respect to the level playing field, or risks of base erosion and profit shifting, are addressed.
• Consideration of changes to the Pillar Two treatment of substance-based non-refundable tax credits to ensure greater alignment with the treatment of refundable tax credits.
• Work on the side-by-side system would be undertaken alongside simplifications being delivered to the overall Pillar Two administration and compliance framework.

On 29 June 2025, a revised version of One Big Beautiful Bill which did not contain section 899 was introduced to and voted on in the U.S. Senate.

An open question is how a side-by-side system would apply to U.S. companies in non-U.S. headed groups where those U.S. companies own CFCs.  It is unclear whether GILTI and Pillar Two would apply simultaneously in this scenario.

Next steps

• The statement issued by the G7 countries is non-binding and will need to be approved by other members of the OECD inclusive framework.
• Details of the “side-by-side system” will need to be fleshed out – for example, the nature of the exemption for U.S. headed groups and when this would come into force.  The timing of this work is not yet clear.

Authored by Laura Hodgson and Scott Friedman.