Forget tariffs – this US tax law could be just as damaging for UK exports
The US is advancing new tax measures targeting countries with “unfair” tax regimes, threatening UK service exports and global tax cooperation under OECD’s Pillar 2, says Tim Sarson
Just a couple of weeks ago, tariffs were dominating the news agenda. Now they seem to have disappeared from the front pages as rapidly as the financial markets shrugged off fears of a global trade war. Besides, Britain doesn’t export much to the US, except a few cars and some jet engines, and those got what they needed from this month’s trade agreement. Good news all around, right?
Think again. A less heralded but potentially no less worrying set of tax proposals is now making its way through the US legislature. Proposals that, if they come to pass and nothing changes here, could strike at the heart of our services-led export economy, throwing a cocktail of punitive taxes at companies based in countries with features in their tax regimes the US administration isn’t fond of.
US taxation is complicated. It’s written in a language only US tax experts can understand, dotted with obscure section numbers and usually dressed in a floridly descriptive moniker. This one is part of something called the “One Big Beautiful Bill”. I learned my trade in the UK tax system and this terminology is as exotic to me as it is to you. So don’t expect a comprehensive technical analysis of the bill. Instead, read on for a lay person’s summary.
If you’ve been following global tax policy over the past few years you will know about the OECD’s Pillar 2, a global minimum tax designed to ensure multinationals above a certain size pay at least 15 per cent tax on profits in the jurisdictions where they operate.
The Undertaxed Profits Rule
Three steps make this happen: first dibs go to those countries with rates below 15 per cent. They can opt to charge a top-up tax on profits generated in their country. Failing that, the second bite (the “income inclusion rule” or IIR) goes to the parent company’s jurisdiction. If that country has adopted the IIR it can charge a top-up tax on the profits of subsidiaries that have been taxed at below 15 per cent. The last resort is something called the Undertaxed Profits Rule, or UTPR, which allows 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 on their books. The current US administration doesn’t like this measure. It could hit US headquartered groups, because the country hasn’t implemented Pillar 2 and has no domestic minimum tax or IIR. The UTPR is viewed as extra-territorial, and “unfair” to American multinationals.
There are other taxes in the firing line too: I wrote about digital services taxes (“DSTs”) in my last column. Because they’re an extra tax that generally targets the largest technology companies which are mostly US headquartered, they’re also viewed as discriminatory by the US. Our soon-to-be-repealed Diverted Profits Tax is also on the tax offenders’ register.
These are the regimes the administration objects to, and its plans to counter them are a little concerning.
There were originally two proposals to retaliate against taxes that the US Congress doesn’t like, but they’ve been combined into a single set of “remedies against unfair foreign taxes”. The first applies a ratcheting rate of extra tax on entities that are already subject to US tax in some way (and a few that are not). There is a pile of complexity I’ll not attempt to go into, but in essence if you’re based in or connected to a country with one of those unfair taxes but generating US income then you are still within reach. The ratchet goes up in five per cent increments over time until it reaches 20 per cent 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, it’s this one that looks the most expensive. The modelling I’ve seen suggests the impact of this bill would be very significant for several businesses based here with a significant US market presence.
Technically you can’t have tariffs on services, but these measures have a similar effect
Since the tariff announcements I’ve been asked repeatedly whether you can have tariffs on services. The technical answer is no, but these measures have a similar effect. If your country is on the US unfair taxes list and you want to sell services into their market, there’s a tax cost. The US lawmakers argue that DSTs are also akin to tariffs on services, and they have a point.
So, a scary set of proposals. There is a reasonable likelihood they get through the House and Senate and into law, from what I hear from my American colleagues. This is the fiscal version of unstoppable force meeting immovable object. So what gives?
OECD governments including our own think they can strike some sort of deal. We know what they and their US counterparts say they want. We don’t yet know what they will be prepared to agree. There’s no simple answer.
DSTs will probably be dropped, adapted or renamed. But if the EU and UK drop the UTPR we are putting our multinationals at a competitive disadvantage to their US counterparts. And versus Chinese and Indian companies too, because neither has adopted the minimum tax yet. At that point the whole edifice of Pillar 2 could start to collapse. Yet unlike with tariffs, China-style retaliation-against-the-retaliation isn’t straightforward. For a start any international tax measure in the EU would need to be voted on unanimously.
If there is a way to preserve the main building blocks of Pillar 2 but compromise on the key US demands, there will probably still be some competitive benefit for the US. That won’t be the end of it, but at least the initial panic will be over.
As tariffs step out of the limelight (for now), turn your gaze towards these new tax proposals and what they might mean. They’re every bit as significant.
Tim Sarson is head of tax policy at KPMG