Looking Beyond A Global Minimum Corporate Tax

Now that we know the Biden administration’s ideal rate for a global minimum corporate tax — 21% — it’s a bit easier to look at what that rate might mean, particularly for developing countries. At the high end, one estimate has pegged the potential global gains in unrecovered taxes at over $500 billion annually.

In a recent analysis, the Tax Justice Network said a 21% rate plugged into pillar 2 could generate $540 billion in global revenue gains, as well as benefit high-, middle-, and low-income countries. According to the organization, corporate income tax revenue would increase on average by 30% for high-income countries and 20% for low- and middle-income countries.

The numbers give new perspective to the debate over the OECD’s second round of base erosion and profit-shifting work. The organization’s calculations rely on most countries adopting a 12.5% minimum rate and the United States retaining its current global minimum tax regime, which includes a 10.5% headline rate.

Based on those numbers, BEPS 2.0 could generate $60 billion to $100 billion in global corporate tax gains.

Setting the Rate

For months, the OECD has mentioned in its pillar 2 consultations and calculations a 12.5% minimum corporate tax rate, but it seems the final rate for a global anti-base-erosion tax could trend upward, based on comments by OECD officials in the wake of President Biden’s Made in America Tax Plan.

Now that the Biden administration wants to double the rate on global intangible low-taxed income from 10.5% to 21%, the OECD is seemingly taking that into account for pillar 2.

If the world’s largest economy thinks the GILTI rate should be higher, “I think that would also have an impact on our discussions,” Martin Kreienbaum, director general of international taxation at the German Federal Ministry of Finance and chair of the OECD Committee on Fiscal Affairs, said at a March 25 panel of the American Bar Association U.S. and Europe Tax Practice Trends virtual conference.

Although there’s no indication where exactly the OECD might land on pillar 2, some commentators are already latching onto Biden’s 21% GILTI rate as a potential floor for the proposal. That’s less than the 25% minimum that some civil society organizations and scholars have called for, but it makes sense considering that the current average global corporate rate falls just shy of 25%.

The Independent Commission for the Reform of International Corporate Taxation has argued that a low global minimum rate could spark a “race to the minimum.” It’s hoped that soon it will become clearer what a race to a 21% minimum would mean, particularly for developing countries, many of which have corporate rates several points higher than that.

Over the years, it’s been argued that the race to the bottom may force developing countries to follow suit, even though they can’t afford it. In 2000, six of 38 countries evaluated by the OECD had corporate rates of 25% or less; by 2018, that number had increased to 22.

But some advocates for a lower minimum tax rate, such as World Bank president David Malpass, say a 21% rate could actually undercut the ability of some developing countries to attract investment.

Regardless of the eventual decision, there’s presumably nothing stopping countries from adopting a higher minimum rate than whatever the OECD lands on. That leads to questions about whether it might be prudent for individual countries to set minimum rates equal to their domestic rates — in other words, capital export neutrality.

Of course, the argument is salient to more than just developing countries. A coalition of civil society organizations including Americans for Tax Fairness has suggested that the United States use the Biden administration’s proposed 28% corporate income tax rate for the pillar 2 income inclusion rule (IIR) and undertaxed payments rule.

It offered a potential scenario with a 21% GLOBE rate, a 28% U.S. rate, and other countries applying the 21% minimum or whatever minimum they choose.

Under that scenario, the United States would tax its own multinationals at 28% under the IIR and apply an undertaxed payments rate of 28% to foreign multinationals operating in the United States that aren’t subject to at least a 21% IIR because their home countries opted out of GLOBE.

There’s also presumably nothing stopping groups of countries from banding together and setting a regional rate. In the spirit of global tax cooperation, that might be a viable solution where rates are considerably higher than whatever rate the OECD ultimately decides.

Some countries already have a minimum tax standard: The West African Economic and Monetary Union and Communauté Economique et Monétaire de l’Afrique Centrale both have established a 25% minimum rate for their member countries.

But the IMF has noted that while regional minimum taxes have been discussed, they’re rarely implemented. There’s perhaps no better example of that than the European Union, where the Ruding Committee in 1992 proposed a 30% minimum corporate rate for the EU market.

That’s not to suggest that harmonization would be easy. For example, both African groups place restrictions on members’ corporate tax bases, but in the union’s case, there’s been some tax competition outside the bounds of the agreements, according to a 2013 IMF working paper.

Exploring Options Beyond Pillar 2

While the OECD’s minimum tax provision holds promise for developing countries, it’s not a complete salve for the corporate tax problems that developing countries face, nor should it be treated as one.

Some countries are anticipating that their yields might not be particularly high.

For example, Colombia is home to only a few multinational groups that meet the OECD’s potential €750 million revenue threshold for pillar 2. Thus, it might not see a substantial increase in tax revenue, according to Natalia Quiñones of the Colombian Institute of Tax Law.

That means developing countries should be thinking about other measures as well. For example, anti-base-erosion measures like caps on the deductibility of some expenses to related parties are important, as are rules denying local deductions for base-eroding payments if the recipient entity isn’t subject to a minimum tax rate, according to the IMF.

Another solution would be to apply withholding taxes, an angle the U.N. Tax Committee is exploring via its proposed model treaty article 12B on automated digital services.

The Ordering Question

But discussions about appropriate minimum tax rates are ultimately moot if developing countries, under the OECD’s proposed sequencing rules, aren’t able to appropriately tax income under pillar 2.

Under the ordering rules, the IIR, which would tax the income of a foreign branch or controlled entity that’s subject to tax at an effective rate below a minimum rate and require a shareholder-level inclusion when there is undertaxation, would be triggered first.

The undertaxed payments rule, which would deny a deduction or impose source-based taxation (including withholding tax) for a payment to a related party that’s not subject to tax at or above a minimum rate, would be triggered second as a backstop to the IIR.

Ordering is important, because some source states say the IIR could affect the amount of additional tax they pick up from pillar 2 because it protects the tax base of the parent jurisdiction and is thus far more likely to benefit residence countries.

The South Centre Tax Initiative, a nongovernmental organization of developing countries, argued in a public consultation document that the undertaxed payments rule should get priority because it would allow source countries to deny deductions or make an equivalent adjustment on intragroup payments.

After that, given its focus on taxes at source, the next rule to be triggered should be the subject to tax rule, which would complement the undertaxed payments rule by subjecting a payment to withholding or other taxes at source and adjusting eligibility for treaty benefits on some items of income when the payment isn’t subject to tax at a minimum rate.

“If these rules do not come first in the rule order, then their being there or not has no impact as the revenues would be taken away by the developed countries,” the organization said.

Incentive Concerns

On the other side of BEPS 2.0, important pillar 1 questions that must be resolved are how and whether all countries with unilateral digital services taxes will need to unwind those provisions once the OECD finalizes its solution.

Part of that hinges on what constitutes a “unilateral measure,” which the OECD has yet to define. That decision partially rests on the ultimate scope of pillar 1, according to Grace Perez-Navarro, deputy director of the OECD’s Centre for Tax Policy and Administration.

In March Mike Williams, HM Treasury’s director for business and international tax, argued that there must be a coherent policy determining why some tax measures are unilateral measures.

“It can’t be just a list of whatever other countries do that U.S.-based businesses don’t like,” he said. “We’re not going to agree to that; it’s not realistic.”

Similar arguments could be made for pillar 2. One of the many expectations is that the pillar will dissuade countries, particularly developing ones, from relying on potentially counterproductive tax incentives.

Although GLOBE seeks to level the playing field, it doesn’t — and can’t — remove governments’ sovereignty to make the tax policy choices they feel best fit their needs.

A few alternatives have been offered. The South Centre has said that applying the undertaxed payments rule first could neutralize the effects of harmful incentives.

In February 2020 the International Centre for Tax and Development suggested that the IIR’s choice to blend either globally or jurisdictionally could be a way to maintain the OECD’s policy goals while giving countries space to implement the incentives they prefer.

But the OECD models assume jurisdictional blending for pillar 2, and it’s unlikely that a global blending option will be adopted, particularly with the Biden administration’s plans to move GILTI to a per-country regime. Another suggestion offered by the International Centre for Tax and Development would be to tax incentives widely regarded as not abusive.

But as with defining unilateral measures under pillar 1, that option raises questions about how the term “abusive” would be defined.