The Fight for 15 (Percent)

I’ve been writing more and more lately about the backlash from developing countries, as well as coalitions and organizations representing them, to the Organization for Economic Cooperation and Development’s overall global tax project, especially the 15% global minimum tax. I guess it’s becoming a stronger part of the narrative–while the biggest threat to the endeavor politically remains its critics in the business community as well as right-leaning elected officials, dissatisfaction among those who feel it hasn’t gone far enough remains an important factor.

Some of these criticisms have to do with the complex details of these tax policies. Or just the fact that they are complex, a potential burden on strained tax administrations. But one of the biggest points of disagreement is simple enough: the chosen rate of 15%. While it’s higher than what the original project had intended, as well as its precursors such as the 10.5% U.S. tax on global intangible low-taxed income, many claim it’s too low to put a serious dent in tax competition for investment, or the incentives for taxpayers to move money to lower rates.

To give one example, the well-respected African Tax Administration Forum wrote in July that it was “very disappointed” that the OECD hadn’t settled on a rate of at least 20%, adding that it was unlikely to stem “illicit financial flows” from Africa through “artificial profit-shifting strategies,” as most African nations have tax rates between 25% and 35% (Though the organization has stressed how countries could use some aspects of the plan, such as the domestic minimum top-up tax, to their benefit.)

There’s some interesting history with how the OECD ended up agreeing to 15%. The number wasn’t drawn out of a hat. As with almost everything about the global minimum tax, this has a lot to do with the shifting goals and focus as it evolved.

There wasn’t much talk of a 15% rate before Joe Biden took over the White House in 2021, and the administration made a high-profile push to both sharpen the project’s teeth and bring it across the finish line. Achieving a higher rate was one of the main goals of the Biden Administration, along with dropping the substance-based carveout. (Which the OECD refused to do.) Not so coincidentally, this generally matched Biden’s own proposals for U.S. tax reform which he campaigned on in 2020.

I’m not sure it was ever written down, but before Biden it was generally expected that the OECD minimum tax would be around 12-13%.

Why that figure? In part, because it was inspired by the GILTI tax, which is set at 10.5%. (Until 2026, when it increases to 13.125%, unless Congress can do something about it.)

You can trace it down further. GILTI, a tax imposed on the foreign income of U.S. companies, had its roots in the international tax reform discussion drafts released in 2011 and 2014 by then-House Ways and Means Chairman Dave Camp, R-Mich. Technically nothing happened with those pieces of proposed legislation, but many of its individual provisions ended up in the 2017 Tax Cuts and Jobs Act, with significant modifications.

The 2014 draft included a new Subpart F category, foreign intangible income, which would be taxed at 15%, while the 2011 draft included several options for capturing intangible income at 10%.

Camp’s proposals were criticized at the time for being too light on tax avoidance, but its supporters said that taxing intangible income at 10% would be enough of a disincentive to discourage outright profit-shifting through intangible assets. During a 2011 hearing on the draft, a quartet of tax experts all seemed to agree on that basic idea–their disagreements focused more on how to best differentiate intangible income from normal income. (Something we’re still struggling with today.)

Most patent boxes at the time were in the single-digit range, so an additional 10% tax would likely change the calculus. Even if countries lowered those rates to zero–and there were many zero-tax jurisdictions back then–the amount of tax avoided would still be dramatically less if such an anti-avoidance rule were layered on top of it.

I think that generally, people tend to assume that base erosion is a lot more seamless than it really is. Income isn’t always like water, instantly finding the lowest place. A complex tax structure has a lot of costs–the salaries and personnel costs for the tax planners, as well as the risks of audit, litigation and public controversy. But there are also costs in the structure itself. If a U.S. company sets up a cost-sharing arrangement with an overseas entity, it usually will require some amount of payment back to the United States, to compensate for the use of those valuable pieces of intellectual property. (Assuming they were originally developed there.) That creates taxable income, which means more taxes. Maybe the amount of that payment isn’t enough to truly account for the valuables used–that’s what most transfer pricing controversies are about. But it still has to be factored in.

Companies will incur all of those costs if they see significant enough savings at the destination, which is probably more than a variation of a few percentage points in most cases.

Of course, the TCJA’s design implicitly assumes that a 10% tax rate on foreign intangibles won’t always be enough to discourage moving them there. That's because it includes a domestic incentive, a 13.125% rate on foreign-derived intangible income (FDII or “Fiddy”), which is meant to achieve parity between foreign and domestic placement of intangibles. The idea is that without a tax motive, U.S. corporations will be likelier to keep them where they’re developed, which is probably in United States.

Regardless, it’s pretty clear the current debate at the OECD is about more than whether a 10% or 15% rate is enough to discourage a typical no-substance profit-shifting scheme.

Countries are worried that a 15% minimum rate will effectively become a 15% ceiling as well, limiting their ability to raise revenue for necessary expenses without curbing investment. It’s a fear that the rate is too low to truly stop harmful tax competition, as well as a basic disagreement about the ideal level of taxation.

I know I sound like a broken record on this point, but so many of the OECD project’s problems arise from the shifting goals, from an effort to stamp out outright profit-shifting in the tech sphere to a broader hope of synchronizing tax rates. The global minimum tax’s design, in many cases, seems to split the difference between the two visions, without always fitting them together.

This is further complicated by the fact that not all of the developing countries agree that a 15% rate is too low. That seems to be the majority opinion, but there are those, like Indonesia Minister of Investment Bahlil Lahadalia, who claim that the plan will restrict developing countries’ ability to offer incentives to lure investment. That implies that in at least some cases, countries ought to be able to give taxpayers an effective tax rate below 15%.

Ask the OECD–or the U.S. House of Representatives–about the challenges of maintaining a full consensus in these complex times.

DISCLAIMER: These views are the author's own, and do not reflect those of his current employer or any of its clients. Alex Parker is not an attorney or accountant, and none of this should be construed as tax advice.

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LITTLE CAESARS: NEWS BITES FROM THE PAST WEEK

• Following this debate about the 15% global minimum tax rate, the European Union Tax Observatory, a sort of EU-funded tax think tank, issued its “Global Tax Evasion Report 2024” on Sunday. Among its findings were, you guessed it, the 15% rate is too low. But it also singles out the plan’s substance-based carveout and preferential treatment for refundable tax credits as “loopholes” undermining the project. (It does note that some of those tax credits are part of a “subsidies race” for green energy production, which has “a crucial positive-sum aspect,” but also “depletes government resources” and “risks increasing inequality.”) OECD officials have already pushed back on the “loopholes” characterization. Again, which side you fall on has a lot to do with how you conceive the overall project and its goals.
• The 2022 Inflation Reduction Act included $80 billion in new funding for the Internal Revenue Service, with most of it earmarked towards enforcement. The agency made it clear in a Friday announcement that a lot of this new crackdown will be in the international sphere. The IRS said it is launching a new compliance initiative on foreign companies doing business in the U.S. who do not pay their “fair share” of taxes, through “report[ing] losses or exceedingly low margins year after year through the improper use of transfer pricing.” It will be interesting to see who ultimately gets targeted in this campaign. The IRS will also be expanding its existing Large Corporate Compliance program, which uses data analytics to best target areas of compliance risk for the largest corporations.
• Shortly after the above announcement, new IRS Commissioner Danny Werfel, who's worn out his shoes (although not yet his welcome) with multiple trips to Capitol Hill, testified before the House Oversight Committee. Lawmakers from both sides of the aisle seem to still be giving him the benefit of the doubt–though that's bound to run out before too long, given the controversial nature of his position. Most of the hearing focused on domestic issues like improving taxpayer service and ensuring taxpayer privacy. But Werfel did continue to tout the agency’s new enforcement efforts and noted that the IRA funding will allow it to increase audits of complex partnerships, as well as novel issues like digital assets.

PUBLIC DOMAIN SUPERHERO OF THE WEEK

Every week, a new character from the Golden Age of Superheroes who's fallen out of use.

The Woman in Red, first appearing in Thrilling Comics #2 in 1940. Believed to be the first female masked crimefighter, the Woman in Red flips the vigilante trope on its head–rather than a lawbreaker, she's actually an undercover policewoman. (Unlike, say, Batman, who in some storylines was deputized by Gotham PD after becoming a masked hero.) Not totally obvious to me what she gains by dressing up as a druid-like figure but it's still pretty cool. She uses not only a gun but other gadgets she invents like a "tear gas pen."

Contact the author at amparkerdc@gmail.com.