The divergence between US and European approaches to Pillar Two raises a question for US multinationals that have traditionally located holding companies in Europe: Should these holding companies be re-shored or relocated?
The strategic decisions made today will have long-lasting implications for tax efficiency and compliance. Multinational groups must continue to study developments in international tax regulations and seek expert advice to navigate the complexities of holding company structures considering Pillar Two and economic substance requirements.
US-headquartered groups historically have used European holding companies to invest in resource-rich Latin America, using preferential holding company structures and extensive treaty networks. But new requirements introduced by the traditional holding jurisdictions to achieve tax parity have complicated the analysis of potential tax benefits and costs of restructuring decisions.
For example, holding companies increasingly face stringent economic substance requirements, which include demonstrating substantial activities such as having a physical office, employees, and active business operations within the jurisdiction. Compliance has made it more expensive to maintain European holding companies and has occasionally required a restructuring of the company's operations.
The potential application of Pillar Two has raised the specter of further increased costs due to the undertaxed profits rule, or UTPR, which ensures companies are taxed at a minimum rate of 15%. European jurisdictions adopting the UTPR, for example, will impose top-up taxes to the extent there are subsidiaries whose effective tax rate falls below 15%.
Re-shoring or Restructuring
To address the increased tax burden and compliance costs associated with maintaining European holding companies under Pillar Two, a US multinational group can restructure its holding companies by doing one of the following:
- Causing its European holding companies to become US holding companies (re-shoring)
- Dissolving its intermediate European holding companies and bringing the Latin American (or other foreign) operating subsidiaries directly under a US company (out-from-under restructuring)
Restructuring of the holding company could also enable UTPR deferral based on the adoption of Pillar Two in the US, assuming none of the group's subsidiaries are in jurisdictions that adopt it. There are several potential outcomes.
US implements Pillar Two in 2025. Because the US parent company wouldn't immediately be subject to the Pillar Two minimum tax until the US enacts its own version of the rules, the additional tax will be deferred for approximately one year. During this period, the US multinational can benefit from the existing tax system.
US never implements Pillar Two and foreign jurisdictions enforce the UTPR. The UTPR allows foreign jurisdictions to impose top-up taxes on profits that are taxed below the minimum rate. If the US doesn't adopt Pillar Two, the US parent company may avoid immediate taxation under UTPR, as the rule primarily targets low-tax jurisdictions.
US never implements Pillar Two and foreign jurisdictions don't enforce the UTPR. The additional tax will be deferred indefinitely, avoiding immediate tax implications. In this scenario, the US multinational could continue to operate under the current system without facing the additional tax burdens imposed by Pillar Two, including the UTPR.
In addition to potentially mitigating Pillar Two costs and complexity, the holding company restructuring strategy (re-shoring or eliminating it) would simplify the corporate structure.
This could reduce administrative burdens and compliance costs. However, this strategy could trigger significant US and Latin American tax costs, as the Latin American subsidiaries would become direct subsidiaries of the US company.
In the US, the US group's Subpart F (due to foreign base company income) or global intangible low-taxed income may increase. The elimination of the European holding company may result in the recognition of income or gains that were previously sheltered or deferred.
In Latin America, eliminating the European holding company may result in the loss of treaty benefits, which can reduce withholding taxes on dividends, interest, and royalties.
While the dissolution of an intermediate holding company may be tax-neutral at the level of the US parent and European holding company, many Latin American jurisdictions treat such planning as a direct or indirect and taxable transfer of shares.
Tax deferral may be available for intra-group transfers under domestic reorganization provisions or tax treaties, but these options require detailed analysis and adherence to strict formal requirements. The following are examples of transactions in which the indirect transfer tax rules apply.
Argentina. A US multinational sells or transfers 10% of a holding company's equity, which derives 30% of its value from Argentinian assets.
Chile. A US multinational sells or transfers 10% of a holding company's equity, which has a Chilean subsidiary whose fair-market value is $200 million.
Colombia. A US multinational sells or transfers shares in a holding company where Colombian assets represent 20% of the book value and fair-market value of all assets owned by the holding company.
Mexico. A US multinational sells or transfers shares in a holding company, and more than 50% of its accounting value is Mexican real estate.
Peru. A US multinational transfers 10% or more of the shares of its holding company within a 12-month period. And either 50% or more of its fair-market value derives from Peruvian entities indirectly transferred or the total amount of Peruvian shares indirectly transferred is equal to or greater than approximately $51 million.
Instead of re-shoring the holding company, the US multinational group may choose to relocate the holding company to another jurisdiction. In evaluating jurisdictions, companies should consider potential treaty benefits and associated economic substance requirements, as well as potential Pillar Two adoption.
Looking Ahead
US multinational groups must navigate complicated tax regulations and economic substance requirements as they consider restructuring their holding companies in response to Pillar Two.
By carefully evaluating their options and understanding the implications of local jurisdictional rules, Pillar Two, economic substance treaty qualification, and indirect transfer rules, these groups can make informed decisions to optimize their tax positions and ensure compliance with evolving international tax standards.
Originally published by Bloomberg Tax on 29 July 2024
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