Peter Barnes of Caplin & Drysdale considers the questions raised by critics of the OECD's Pillar Two initiative, and argues that Pillar Two could ultimately be beneficial for the US.

Analyzing the OECD's Pillar Two proposal that all countries impose a 15% minimum tax on corporate income is like playing a multidimensional chess game. Each element of the proposal, and each country that adopts it, creates waves that affect all other players, both governments and corporate taxpayers.

So, there is an urgency to simplify that process and look at three questions.

Will US multinational enterprises pay more tax under the proposal? Yes. Higher corporate income tax rates around the world mean US companies will pay more tax.

Will the US fisc lose tax revenue under Pillar Two? Probably, yes. Revenue estimates are extremely difficult, especially when the rules aren't finalized. But higher foreign taxes on US companies means that companies will have more foreign tax credits to use in the US. The US fisc may lose revenue compared with current law.

So, is Pillar Two a good deal for the US? Most critics see the answers to questions one and two and conclude that Pillar Two must be a bad deal for the US.

But that is simplistic. And, in my view, wrong. Remember, this is multidimensional chess, not arithmetic.

First, the US is the only country in the world today to impose a minimum corporate tax annually on the foreign income of its multinational enterprises. US multinationals pay at least a 10.5% tax on this income under the global intangible low-taxed income rules. Most other countries apply a participation exemption to exclude from home country tax most or all income from active businesses of its companies' foreign subsidiaries.

That means that when a US company has a low-taxed subsidiary in Singapore, the US company will pay tax of at least 10.5%. A competitor company owned by Singaporeans will pay low or no tax (depending on incentives). A competitor company owned by, say, a Netherlands corporation will likewise pay low or no tax.

In this case, Pillar Two ensures that the US-owned subsidiary will compete on an equal footing with its competitors. And when US companies compete on an equal footing, they often win. Under current law, the US company will try to eliminate or mitigate the US tax under GILTI on its Singapore income by using foreign tax credits from high-taxed income in other foreign countries. But there's no assurance the company can achieve self-help. With Pillar Two, we know the US company won't be disadvantaged by foreign tax rules.

Second, Pillar Two will narrow the differential in the tax burden on income earned by subsidiaries abroad (currently 10.5%) and income earned in the US (currently 21%). Under Pillar Two, that differential is reduced to 5.5% (20.5% minus the new 15%).

This change may not help US companies, who would always prefer to pay lower taxes on foreign income. But the change will likely help the US as a country. There's less benefit and therefore less incentive for companies to move assets and activities offshore. There's less economic pain when businesses expand in the US (and therefore earn more income in the US), rather than offshore.

If critics of Pillar Two believe that taxpayers respond to tax rate incentives, then they should not complain when the incentives increase the likelihood of investment in the US. Indeed, these behavioral effects could make Pillar Two a revenue gainer for the US.

Joining Pillar Two will give the US a larger voice in the debate over how the Pillar Two rules (and other international tax rules) are shaped now and in the future.

The Organization for Economic Cooperation and Development and the Inclusive Framework have been responsive to US concerns regarding the undertaxed profits rule and differences in how tax incentives are structured. But some of the concessions to US interests are in the form of short-term rules (expiring in 2026) and aren't permanent features of the Pillar Two proposal.

Will Pillar Two benefit the US? Yes, for the two reasons discussed above. Further, joining Pillar Two will give the US a stronger voice in negotiating permanent rules that benefit (or at least do not harm) US interests.

Most US critics of Pillar Two are careful not to argue that the US should walk away from the negotiations, although that is the position of some opponents. More frequently, the criticism is couched in diplomatic terms: The US should insist on favored reforms before agreeing to join.

That linguistic formulation dodges the important question: If the US does not get all the reforms that it wants, what next? Walk away at that point? And how many changes are enough changes to attract US support? A safe harbor that prevents the UTPR from taxing US income of US companies? Equal treatment of tax incentives in the form of nonrefundable tax credits and refundable tax credits? Reduction in the administrative burdens? Or, most boldly, a declaration that the GILTI rules as they stand now are sufficient for the US to be compliant with Pillar Two?

Some commentators argue that the US loses bargaining power on these important issues if it agrees to adopt Pillar Two and then tries to negotiate the changes it wants. I disagree. Refusing to commit to Pillar Two—and/or threatening retaliatory legislation, which would harm foreign-owned US companies that hire US workers and invest in US communities—will stiffen resistance against the US priorities.

Who is right? "My way or the highway" rarely works in personal relationships or international diplomacy. Pillar Two is an extraordinary step in collective action by sovereign nations with respect to taxes. It may turn into a colossal failure or collapse because of excessive ambition.

But there are substantial benefits to the US if the effort succeeds. To argue otherwise, just because of a company's higher taxes or an uncertain revenue estimate, is bad math.

Originally published by Bloomberg Law.

This article is designed to give general information on the developments covered, not to serve as legal advice related to specific situations or as a legal opinion. Counsel should be consulted for legal advice.