Revised U.S. Tax Law: Potential Harm to UK Exports, Equal to or Exceeding Tariff Impact
The United States is pushing forward with new tax legislation, aiming to tackle countries with tax regimes deemed "unfair" by the administration. This development poses a potential threat to British service exports and the global tax cooperation under the Organization for Economic Cooperation and Development's Pillar 2, as per the perspective of Tim Sarson.
While tariffs have been fire blazing headlines, they seem to have receded swiftly, leaving the financial markets unmoved by fear of a global trade war. Yet, a less publicized but potentially equally concerning set of tax proposals is now making its way through the US legislature. These proposals could target the heart of our services-led export economy, imposing punitive taxes on companies based in countries with tax regimes that the US finds worrisome.
The US tax system is notoriously intricate, laden with jargon that only US tax experts can decipher. The latest proposals are linked to what is referred to as the "One Big Beautiful Bill". While I am familiar with the UK tax system, this terminology is as foreign to me as it is to you. Hence, a comprehensive technical analysis will not be provided; instead, we will focus on a layman's summary.
If you have followed global tax policy over the past few years, you might be familiar with the OECD's Pillar 2, a global minimum tax designed to ensure multinationals pay at least 15% tax on profits in the jurisdictions where they operate.
The Undertaxed Profits Rule
In essence, Pillar 2 enacts three steps: first, countries with rates below 15% have the option to impose a top-up tax on profits generated within their borders. If this is not exercised, the "income inclusion rule" or IIR goes to the parent company's jurisdiction, allowing them to impose a top-up tax on the profits of subsidiaries taxed at less than 15%. The last resort is the Undertaxed Profits Rule (UTPR), which enables other countries where a group operates to collect a top-up tax on any remaining low-taxed profits.
The EU, the UK, and several other major economies already have the UTPR in place. However, the current US administration opposes this measure, as it could negatively impact US headquartered groups, since the country has not implemented Pillar 2 and lacks a domestic minimum tax or IIR. The UTPR is viewed as extra-territorial and "unfair" to American multinationals.
Other taxes are also in the crosshairs. Digital services taxes ("DSTs") and the UK's Diverted Profits Tax are also on the list of offending taxes, as they are seen as discriminatory by the US.
These are the regimes the administration objects to, and their plans to retaliate are causing concern. Initially, there were two proposals to counter taxes disliked by the US Congress, but they have been combined into a single set of "remedies against unfair foreign taxes".
The first applies a ratcheting rate of extra tax on entities subject to US tax in some way, or those that are not, with increases of 5 percentage points happening over time until it reaches 20% above the statutory rate. The second modifies, broadens, and sharpens the application of a tax known as the Base Erosion Anti-Abuse Tax (BEAT), which has been levied in the US since 2018 and targets outbound payments. Based on conversations with UK multinationals, this seems to be the most expensive proposal for businesses with a significant US market presence.
Technically, tariffs cannot be imposed on services, but these measures have a similar effect. If your country is on the US's list of unfair taxes and you want to sell services into their market, there is a tax cost. The US lawmakers argue that DSTs are also akin to tariffs on services, and they have a point.
OECD governments, including our own, hope to strike a deal to mitigate the impact of these new tax measures. We are unsure of what they will agree to, but there is a reasonable likelihood they will pass through the House and Senate and into law. At stake is the main building blocks of Pillar 2, which could put UK service exporters at a competitive disadvantage if compromises are made.
As tariff discussions step aside (for now), attention should shift to these new tax proposals and their implications. They are every bit as significant as the tariff debates.
- The US tax legislation, dubbed the "One Big Beautiful Bill," contains proposals that could impose punitive taxes on companies based in countries with tax regimes that the US deems worrisome, posing a potential threat to the UK's services-led export economy.
- The US administration opposes the Undertaxed Profits Rule (UTPR), a measure under the OECD's Pillar 2, viewing it as extra-territorial and unfair to American multinationals.
- Two proposals have been combined into a single set of "remedies against unfair foreign taxes" by the US Congress, which includes a ratcheting rate of extra tax on entities subject to US tax and a broadening and sharpening of the Base Erosion Anti-Abuse Tax (BEAT).
- OECD governments, including the UK's, are negotiating to mitigate the impact of these new US tax measures, as they could put UK service exporters at a competitive disadvantage if compromises are made.
