The statement issued by the G7 on 28 June 2025 signals that there are more changes to come to the Pillar Two rules. While the statement was broadly welcomed, it raises a number of questions about some fundamental elements of the existing Pillar Two framework. We have set out below the four principles underpinning the shared understanding, the areas of negotiation those principles will likely open up and an outline of the next steps at the level of both the OECD and the EU.
What’s been agreed?
The statement confirms a shared understanding amongst G7 countries that a side-by-side solution can be agreed to address the concerns raised by the US regarding the Pillar Two rules. The shared understanding is based on four principles:
- US headquartered groups will be excluded from Pillar Two’s income inclusion rule (the “IIR”) and undertaxed profits rule (the “UTPR”) on both US and foreign profits.
- Risks of an uneven playing field and base erosion and profit shifting will be addressed.
- Material simplifications will be made to the Pillar Two rules.
- The treatment of tax credits under Pillar Two rules will be reconsidered.
The undertaking to remove section 899 from the US tax reform legislation was crucial to reaching the understanding. Overall this development is good news for international businesses, but it marks only the beginning of a process of negotiation and implementation.
What needs to be worked out?
As well as excluding US headquartered groups from the IIR and the UTPR, the G7 statement identifies four areas of focus.
Maintaining a level playing field
The baseline for the global minimum tax under the existing Pillar Two framework is an effective tax rate of 15% tested on a jurisdiction-by-jurisdiction basis. The most significant difference between the Pillar Two rules and the US system is that the US system applies on a blended basis whereas the Pillar Two framework applies on a jurisdictional basis. The different baselines will create winners and losers. We expect that discussions at OECD level will need to consider whether the baseline under the existing framework should be reassessed to level the playing field.
Addressing base erosion and profit shifting
This workstream will likely focus on ways of ensuring that low-taxed income of large multinational groups will remain subject to some form of top-up tax. Under the existing Pillar Two regime, the UTPR achieved this by adopting a ‘bottom-up’ approach which operated as the ultimate backstop to the ‘top-down’ approach of the IIR (i.e, ensuring that low-taxed profits would be included regardless of where a multinational group was headquartered). Removing US headquartered groups from the charge to UTPR gives rise to two infrastructural issues:
- The combination of the IIR and the UTPR produced a complete system which ultimately incentivised low-tax jurisdictions to adopt qualifying domestic top-up taxes (“QDTTs”). Jurisdictions that have introduced QDTTs may begin to re-assess their position under the side-by-side solution – while that would mean giving up tax revenues and potentially opening up the possibility that the profits generated in that jurisdiction by local subsidiaries of non-US groups being taxed in other countries under the UTPR and IIR, they might be in a better position to attract US foreign direct investment.
- Discussions at OECD level will have to consider how the side-by-side solution will apply to groups that are headquartered outside the US in jurisdictions that have not implemented Pillar Two. Would the UTPR be retained under the Pillar Two framework for groups headquartered outside the US? Would that difference of treatment open the UTPR to legal challenges? Could something other than a UTPR be used to address the risk of base erosion and profit shifting under the side-by-side solution?
Simplification
Material simplifications to the overall Pillar Two system are promised – that will be welcomed by all taxpayers and likely tax authorities too.
Substance-based tax credits
Under the existing regime, the Pillar Two rules draw a distinction between refundable tax credits and non-refundable tax credits. A number of commentators have criticised the distinction and argue that the refundability of a tax credit should not be determinative of its classification as ‘good’ or ‘bad’ for Pillar Two purposes. It seems that those criticisms have been heeded, at least by the G7, and it is now proposed that changes to the Pillar Two treatment of substance-based non-refundable tax credits will be considered. How substance will be defined for this purpose will be another discussion point. Will it draw on existing concepts in the Pillar Two framework, for example, the substance based income exclusion which measures substance by reference to payroll costs and tangible assets?
What happens next?
In the first instance, the discussion will move to the OECD’s Pillar Two working group which comprises over 140 jurisdictions. That group will consider the G7 shared understanding and, if it agrees with the four principles, it will identify and agree changes that are required to the Pillar Two rules to implement the side-by-side solution.
In this context, it’s worth noting that fewer than 50 of those jurisdictions have taken steps to implement Pillar Two. We would expect that those jurisdictions will have different priorities in the negotiation compared to those jurisdictions that have not yet implemented Pillar Two, with the US representing a different position again. As the G7 shared understanding only reflects the views of jurisdictions that have implemented Pillar Two and the US, it could result in the negotiations moving beyond the confines of the four principles identified in the G7 statement.
What happens at EU level?
While negotiations are on-going at OECD level, EU Member States have at least one urgent Pillar Two issue to address – the expiration of the UTPR safe harbour on 31 December 2025. If the EU takes no action, the UTPR will begin to apply to the profits of US headquartered groups from 1 January 2026. That would conflict with the G7’s shared understanding.
Helpfully, the UTPR safe harbour included in Article 32 of the Pillar Two directive can be extended without a change to the directive provided all Member States consent to its extension. Work on that should be expected to commence shortly if it is to be implemented.
More broadly, whatever is agreed at OECD level will require consideration by the EU, given all EU Member States are bound under the Pillar Two directive to apply the existing Pillar Two system. Those discussions will likely follow the OECD negotiation.
Concluding remarks
Although the G7 shared understanding and the removal of section 899 from the US tax reform legislation were welcome developments, it’s clear that we’re still early in the process of understanding the full impact on the global minimum tax. There are lots of new open issues: how to rebalance the playing field under a side-by-side system; how to encourage jurisdictions to participate in the global minimum tax when the framework has been destabilised; will the special status conferred on US groups preclude countries from applying the UTPR to non-US groups; can the side-by-side solution be operated within the EU where Member States are restrained from preventing free movement of capital and establishment? These issues will take time to work out. The full parameters of the new global minimum tax may not emerge for months, if not years.
In the meantime, taxpayers will have to comply with the existing Pillar Two rules as implemented and will continue to work towards the first filing date which, for many, is less than twelve months away. Should you wish to discuss the implications of the G7 shared understanding or any aspect of Pillar Two, please speak to your usual Matheson contact or to any of our Tax partners.