The U.S. Chamber of Commerce (“Chamber”) strongly supports the legal action brought by the American Free Enterprise Chamber of Commerce (“AmFree”) in the Belgian Constitutional Court to challenge the undertaxed profit rule(“UTPR”) established by Council Directive (EU) 2022/2523 of December 14, 2022 (“EU Directive”). As set forth below, the Chamber shares AmFree’s concerns that the UTPR is fundamentally flawed in both design and implementation, and warrants judicial scrutiny.
- The UTPR will adversely impact many Chamber members by requiring EU member states in which large U.S. multinational enterprise (“MNE”) groups operate to impose a local “top-up tax” on the U.S.-source income of U.S. group companies.
- The UTPR will undermine the efficacy of U.S. tax credits and incentives that were designed to further legitimate U.S. public policy aims.
- The UTPR will inappropriately tax many Chamber members by failing to recognize the United States’ preexisting global minimum tax regime as a qualified income inclusion rule (“IIR”).
- The UTPR is unprecedented in its design and contemplates the extraterritorial taxation by EU member states of foreign companies’ foreign-source income without any genuine nexus to the taxing jurisdiction, in breach of customary international law.
- A significant UTPR liability could threaten the economic viability of a U.S. MNE’s European subsidiary, in breach of EU law.
The UTPR Will Adversely Impact Chamber Members
The Chamber is the world’s largest business federation and represents hundreds of thousands of companies and professional organizations of every size and in every industry sector—including many large U.S. MNEs with European subsidiaries. An important function of the Chamber is to represent the interests of our members in matters before national legislatures, executive agencies, and the courts. To this end, the Chamber regularly supports legal challenges, like AmFree’s, that raise issues of concern to the business community. Here, the application of the UTPR as adopted by EU member states will adversely impact many Chamber members.
The EU Directive implements a modified version of the OECD/G20’s global anti-base erosion (“GloBE” or “Pillar Two”) model rules within the EU. These rules aim to ensure that the profits of large MNE groups operating in the EU are subject to an effective tax rate (“ETR”) of at least 15% on a jurisdictional (country-by-country) basis. Under the UTPR introduced by the EU Directive, EU member states are generally required to impose a local “top-up tax” on the profits of companies within a MNE group—including U.S. companies—where the overall ETR of the group in a particular jurisdiction (e.g., the United States) falls below 15%. In other words, the UTPR will require EU member states in which large U.S. MNE groups operate to extraterritorially tax the U.S.-source income of U.S. group companies in certain circumstances.
Although the statutory corporate income tax rate in the United States is 21%, the overall U.S. ETR of many U.S. MNE groups could fall below 15% due to inconsistencies in the calculation of ETR for U.S. income tax and EU Directive/UTPR purposes. Consider the following example of a U.S. MNE group with a low-margin subsidiary in the EU. In this example, even though the EU subsidiary earns only $100 in income, it will be subject to a total tax charge of $115 by application of the UTPR—with $100 imposed on the U.S.-source income of its U.S. parent company.
Because many Chamber members are large U.S. MNEs with European subsidiaries, the application of the UTPR by EU member states will impact many of them—with potentially significant effects in some cases.
The UTPR Will Undermine Legitimate U.S. Public Policy Goals
As the Chamber and others have previously warned, a global minimum tax based on the GloBE model rules will hinder the competitiveness of U.S. MNEs in EU markets and potentially subject them to unmitigated double taxation of U.S.-source income by EU member states. For instance, material concerns have been raised about the more favorable treatment the EU Directive grants to “qualified refundable tax credits” than it does to nonrefundable tax credits, given that U.S. business tax credits are traditionally nonrefundable. In this regard, application of the UTPR would directly contravene well-established, bipartisan U.S. public policy to incentivize targeted investments in areas such as domestic research and experimentation activity or affordable housing construction.[1]
The UTPR’s application would also counteract legitimate U.S. public policy aims involving the deduction for foreign-derived intangible income (“FDII”). By subjecting FDII to a reduced effective rate of U.S. tax through this deduction, Congress sought to encourage U.S. corporations to locate and derive income from intangible property—and increase potentially valuable economic activity—in the United States. The FDII deduction has proven remarkably effective at furthering its policy aims but is now at risk of being nullified by EU member states’ application of the UTPR.
The EU Directive’s prejudicial treatment of these legitimate U.S. tax credits and incentives compared to the treatment of comparable credits and incentives offered by many EU jurisdictions is fundamentally unfair and puts affected Chamber members at a material disadvantage relative to their EU-based competitors. This is despite the fact that the U.S. tax credits and incentives are designed for legitimate public policy reasons that align with U.S. government priorities. U.S. MNE groups that make investments based on U.S. tax credits or incentives are engaged in legitimate business behavior, not abusive conduct aimed at shifting profits to low-tax jurisdictions. As such, an EU member state’s application of the UTPR to tax the U.S.-source income of a U.S. MNE group company would be without justification as an anti-tax avoidance measure.
The UTPR Will Inappropriately Tax Chamber Members by Failing to Recognize the United States’ Preexisting Global Minimum Tax Rules
Under the EU Directive, the UTPR will not apply in cases where the ultimate parent entity of an MNE group is subject to a “qualified IIR” in its jurisdiction. But despite initial intimations by OECD/G20 officials that the U.S. global intangible low-taxed income (“GILTI”) regime—the prototypical global minimum tax—would be respected as a qualified IIR under Pillar Two, the EU Directive does not so provide. This will have significant, adverse consequences for Chamber members that are U.S. MNEs with European subsidiaries.
The United States was a first-mover in introducing global minimum tax rules to discourage profit shifting to low-tax jurisdictions. Congress enacted the GILTI regime in 2017 as an anti-base erosion measure aimed at highly mobile income subject to low effective tax rates.[2] And like the IIR established by the EU Directive, the U.S. regime is intended to ensure a global minimum effective tax rate on GILTI through the imposition of a residual U.S. tax on the U.S. parent entity of an MNE group. Notwithstanding their similar policy objectives—and capacity to achieve those objectives—the U.S. GILTI regime is not recognized as a “qualified IIR” under the EU Directive due to the difference in how they’re applied: the former’s application is calculated on an aggregate (global) basis while the latter’s is calculated on a jurisdictional (country-by-country) basis. As a result, many Chamber members that are already subject to global minimum tax rules in the United States will also be subject to top-up tax under the UTPR, leading to the inappropriate—and potentially double—taxation of their U.S. source income.
The UTPR’s Application Would Breach Customary International Law
It is a fundamental principle of customary international law that tax may be imposed by a jurisdiction only on income that has a sufficient nexus to the jurisdiction (i.e., income derived from the jurisdiction or income derived by a person resident in the jurisdiction). The UTPR established by the EU Directive will contravene this fundamental legal principle through its undue extraterritorial application, which is of great concern to Chamber members.
The principle of territoriality implies that states enjoy full sovereign powers only within their territories.[3] This principle of territorial jurisdiction requires the existence of a “genuine link” with the state asserting jurisdiction. According to settled international law, extraterritorial jurisdiction is permissible only in exceptional circumstances.
In the context of international tax law, a country may exercise prescriptive jurisdiction based on a personal or territorial link such as nationality, citizenship, residence, or, in more limited circumstances, source (e.g., based on different forms of investment or business activities within the state’s territory). This principle has been recognized by EU courts.[4] In such cases, it is typically clear that there is a “genuine link” or nexus with the taxing state’s territory (i.e., the income being taxed was either earned there or by a person resident in the jurisdiction). In the case of the UTPR, however, an EU member state may be required to tax U.S.- or other foreign-source income that has no “genuine link” or nexus to that EU member state.
It is generally accepted in international tax law that the power to tax can expand beyond the traditional links of residence and source in certain limited cases with the aim of preventing tax fraud or abuse.[5] As described above, however, the UTPR can apply in the absence of any fraud or abuse (e.g., when companies make investments that the U.S. government deems desirable and for which U.S. policymakers have created tax credits or incentives).
A “nexus” has also been found in cases where countries impose taxes on the undistributed profits of foreign subsidiaries (known as controlled foreign company or “CFC” taxes) to discourage artificial arrangements that divert profits from controlling companies to their foreign subsidiaries.
CFC taxes have been formally introduced in the EU through its Anti-Tax Avoidance Directives.[6] CFC taxes are imposed on an EU parent company that owns a foreign subsidiary. As such, the parent company indirectly or economically owns the profits of that subsidiary. There is a nexus, therefore, between the EU member state in which the parent company is resident and the profits of its foreign subsidiary, which are indirectly or economically owned by the parent company resident in the EU member state.
In contrast, the UTPR allows—indeed, requires—an EU member state to impose local tax on U.S. profits that have no nexus to that EU member state. As such, the UTPR bears no resemblance to CFC taxes that are understood to satisfy the nexus principle by taxing the economic owner of such profits.
The UTPR is unprecedented in requiring EU member states to impose taxes extraterritorially without any genuine nexus or link to the relevant profits and therefore breaches the principle of territorial jurisdiction under customary international law. Furthermore, unlike CFC taxes, the UTPR’s extraterritorial reach cannot be justified as necessary to prevent tax fraud or abuse.
The UTPR Could Threaten the Economic Viability of EU Subsidiaries
Applying the UTPR, a U.S. MNE’s European subsidiary could be liable for significant local top-up tax on the U.S. parent company’s profits. But such a subsidiary that is levied with a significant UTPR liability may not have sufficient means to settle a large tax bill levied by reference to the U.S. profits of its U.S. parent company. As a result, the UTPR could fundamentally undermine the European subsidiary’s financial situation or even make the company insolvent.
In short, imposing a UTPR liability on the European subsidiary of a U.S. MNE could give rise to a clear breach of the subsidiary’s right to property and right to undertake a business freely under EU law.[7] This risk raises serious concerns for Chamber members.
Conclusion
The UTPR established by the EU Directive will inappropriately subject Chamber members to local top-up tax in the EU on income that has no genuine territorial nexus or link to the local taxing jurisdiction, in breach of customary international law. This will generally arise due to inconsistencies in the computation of ETR for U.S. income tax and EU Directive/UTPR purposes.
Where it applies, the UTPR will harm the competitiveness of U.S. MNEs in European markets and potentially subject them to unmitigated double taxation of U.S.-source income by EU member states. Moreover, significant UTPR liabilities could threaten the economic viability of a U.S. MNE’s European subsidiary, in breach of EU law.
In view of the above, the Chamber strongly supports the legal challenge brought by AmFree in the Belgian Constitutional Court.
[1] Article 3(38) of the EU Directive defines a “qualified refundable tax credit” as a credit that is refundable in cash or cash equivalents within four years, which is not traditionally the case for U.S. tax credits.
[2]See S. Comm. on the Budget, 115th Cong., Reconciliation Recommendations Pursuant to H. Con. Res. 71, S. Prt. No. 115-20, at 370 (Comm. Print 2017).
[3] Island of Palmas (or Miangas) (United States v. The Netherlands), Hague Court Reports 2d 83 (1932), (Perm. Ct. Arb. 1928), 2 U.N. Rep. Intl. Arb. Awards 829). See also Kamminga, M., Extraterritoriality, in Wolfrum, R. (ed.), The Max Planck Encyclopedia of Public International Law, Oxford University Press.
[4] Joined Cases C‑555/22 P, C‑556/22 P and C‑564/22 P United Kingdom v Commission and Others, Case C-196/04.
[5] In Cadbury Schweppes plc and Cadbury Schweppes Overseas Ltd v Commissioners of Inland Revenue (Case C-196/04), the Court of Justice of the European Union held that “a national measure restricting freedom of establishment” may be justified only “where it specifically relates to wholly artificial arrangements aimed at circumventing the application of the legislation of the Member State concerned,” at paragraph 51.
[6] Council Directive (EU) 2016/1164 and Council Directive (EU) 2017/952.
[7] Protected under Articles 16 and 17 of the Charter of Fundamental Rights of the European Union.
About the authors
Watson M. McLeish
Watson McLeish is senior vice president for Tax Policy at the U.S. Chamber of Commerce, where he serves as the primary adviser on all tax policy-related matters.
