Pillar Two and Taxation of Nonprofit MNEs

Jeremy Raphael has a useful article in Tax Notes (subscription required) this week.  It's about how the application of recently adopted international tax rules might impact multi-national exempt organizations. It is helpful to know a little about international tax first.  In very brief summary, 138 countries and jurisdictions have agreed to impose a minimum 15% tax on multinational enterprises (MNEs).  The goal is that MNEs pay the same tax no matter where they claim residence.  In this manner, the Global Anti-Base Erosion (GLOBE) tax discourages tax forum shopping by various means, such as corporate inversions.  You can probably learn all you need to know from the Pillar Two rules and the Pillar Two Commentary. 

It ought to make sense that nonprofit organizations already tax exempt in their home countries are not subject to Pillar Two.   They pay no taxes at home so there is no tax incentive for them to take up phony residence elsewhere.  Except for the unrelated business income tax.  But would a nonprofit really go through the trouble of setting up an unrelated business -- a necessarily minor part of its operations -- in a tax haven?  It is unlikely, but then what exactly is unrelated?  States and jurisdictions have different approaches to unrelated business income taxes.  If a university, like Raphael’s MIT, engaged in educational activities overseas who is to say that it’s associated ancillary services are or are not unrelated? Health care and even international disaster relief organizations probably have similar concerns.

That Raphael is a tax specialist at MIT is an indication that larger nonprofits doing good overseas are and should be concerned that the GLOBE rules might be too broadly interpreted, effectively revoking tax exemption for a lot of larger exempt organizations.  Here is the introduction to his article:

A fundamental question threatens to reshape how nonprofit organizations (NPOs) operate globally: Could a modest commercial venture strip away an organization’s tax-exempt status under the new pillar 2 tax rules? The pillar 2 global anti-base-erosion (GLOBE) rules exempt nonprofits from the 15 percent minimum tax, yet they contain a troubling disqualification clause. The clause’s broad language suggests that any unrelated business activity, no matter how small, could strip an organization of its nonprofit status. This article shows that when properly interpreted, the GLOBE rules permit nonprofits to engage in modest commercial activities while maintaining their protected status.

The OECD commentary and administrative guidance provide clear support for a limited reading of the disqualification clause. The commentary establishes that only organizations “exclusively dedicated” to unrelated business activities forfeit their nonprofit status. This standard parallels longstanding U.S. and Canadian tax principles, which revoke tax-exempt status only when unrelated business activities become an organization’s primary focus. While none of these systems define precise numerical thresholds between acceptable and excessive commercial activity, they firmly establish that charitable organizations can engage in business activities without losing their protected status.

Commercial activities have long served as legitimate tools for nonprofits to support their charitable missions. Universities operate bookstores, hospitals sell pharmaceutical supplies, museums run gift shops, and foundations manage investment portfolios. These activities shouldn’t jeopardize an organization’s protected status under pillar 2 when they remain ancillary to the institution’s charitable mission. Misinterpreting these rules would have far-reaching consequences. Nonprofits could be forced to choose between maintaining their tax-exempt status and pursuing funding strategies to support their charitable missions.

This article shows how textual analysis and policy considerations yield a balanced approach to assessing nonprofit business activities. While the technical details of the NPO definition and disqualifier form the core of this discussion, the broader implications for charitable organizations’ sustainability and effectiveness cannot be ignored. In an era when nonprofits increasingly need diverse revenue streams to fulfill their missions, ensuring these rules are interpreted appropriately becomes crucial for preserving the vital role of charitable organizations globally.

darryll k. jones