The Global Min Tax Administrative Challenge

The Organization for Economic Cooperation and Development held an online conference last week, “Tax and Development Days 2024,” which examined international tax issues for the developing world. Based on the videos, which the OECD released Friday, the event covered a broad range of tax topics–but first off the bat was the Pillar Two 15% global minimum tax plan, and how it affects the tax administrations of poorer nations.

Panelists from Jamaica, Papua New Guinea, Senegal and Azerbaijan emphasized a message that we’ve heard often during this whole process: the plan will create a strain on their existing capacity, as they try to implement these complex new rules.

That’s not new, although perhaps it’s still important to hear.

But a presentation that followed from OECD official Pierce O’Reilly, on the revenue estimates for the Two-Pillar plan, shed some additional light on how these rules will present a challenge for developing countries. In particular, it showed the potentially dramatic effect that the plan could have on the various tax incentives used by struggling countries to attract investment, and how meshing those policies with the new plan will present both administrative and political hurdles.

One key point that O’Reilly emphasized, drawing on information from the OECD’s recent revenue estimate for Pillar Two, is how low-taxed income isn’t always found in a low-tax jurisdictions. With different industries or companies receiving benefits not available to taxpayers at large, low-taxed income can exist in countries with high statutory tax rates–even countries where the average effective tax rate is high. This is especially true in the developing world, where jurisdictions compete for investment through favorable tax treatment.

“A thing that's true about a lot of developing countries is that they have quite high tax rates on businesses, but they combine these high tax rates with tax incentives that mean that even though the average tax rate may be high, some businesses may be paying a very low tax rate,” O’Reilly said.

Drilling down into the data reveals more about how widespread low-taxed income is in the developing world. According to the OECD, 28% of the income in lower-income jurisdictions is taxed at below 15%, which is the same for higher-income jurisdictions. But for income that is taxed at below 5%, the figure is 16% for lower-income countries–higher than any of the other group of countries except for “investment hubs,” the OECD’s euphemism for tax havens.

This is relevant for Pillar Two because it means that with one big caveat–that I’ll get to in a second–the economic benefits that these companies are receiving through these incentives will likely be negated, regardless of whether the country offering it responds or not. It will be taxed away either by the company’s headquarters country or other countries where the company is present, through the Pillar Two rules.

That’s unless the local country with the incentive takes care of the low-taxed income itself, either by enacting the qualified domestic minimum top-up tax or by removing the incentives.

The caveat I mentioned is the substance-based carveout, an exemption for payroll and tangible assets in the Pillar Two calculation, which is meant to give countries some leeway to still offer incentives tied to real economic activity.

O’Reilly said that using a percentage of assets and payroll gives a benefit to taxpayers with a large footprint in the jurisdiction, but blocks countries from using incentives that are “too generous.”

“What the minimum tax then does is that it says, ‘OK, if you aren't implementing a big investment in a country, but you still have a lot of profit that's low-taxed, then you will pay top-up tax,’” he said.

In a sense, the substance-based income exclusion is an attempt to reconcile opposing views in the developing world, between those countries who want to see tax competition stopped, and those who view it as their right and necessity.

It’s not hard, though, to see how meshing these new rules with existing rules and incentive structures will be challenging–for most countries but especially those whose tax administrations are already overwhelmed.

A persistent complaint during the Two-Pillar process was that while developing countries ostensibly had input through the 140-nation Inclusive Framework, they barely had the capacity to participate, let alone to play a significant role. Now those officials have to go back to their home countries and explain this to their colleagues, as well as the elected officials who need to enact these rules.

“We need to ensure that the relevant officials within the tax administration are cognizant, well-versed with the mechanics of the Two-Pillar solution,” said Vanessa Mamu, a tax official from Papua New Guinea, during the OECD panel. “Only a handful of officials within the tax administration have been privy to the discussions regarding the two-pillar solution.”

The African Tax Administration Forum also noted this issue in its guidebook for implementing the QDMTT. It also noted that this may require coordinating with other agencies in the government.

“Those agencies may not be aware of the complexities of whether another jurisdiction may be able to collect the tax given away under the tax incentive, and providing that context may be helpful in taking the DMTT through legislative processes successfully,” the ATAF wrote.

The bright side of this is that many of these countries stand to gain from Pillar Two, if it does discourage outright profit-shifting as much as the OECD says it will. According to O’Reilly, the organization estimates that 50% of profit-shifting will be blocked or disincentivized by the minimum tax, which means a lot of that income will be left in the source countries where it was generated. That would often mean developing countries, and they won’t even be the ones implementing the rule here–other countries will be doing it for them.

But those countries face a daunting task, even as nonprofit organizations and the OECD step in to help. Whether it will ultimately be worth it to them could remain an open question.

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

• Like “Lord of the Rings,” Caterpillar Inc.’s tax saga just doesn’t seem to ever end. The American construction equipment conglomerate’s Switzerland tax strategy has been under the microscope since a whistleblower lawsuit was filed back in 2009. There’s been a Congressional investigation, an Internal Revenue Service audit, a Securities and Exchange Commission inquiry, a criminal investigation, and a shareholder lawsuit. Almost exactly 10 years ago I sat through a 5-hour Senate hearing about this, and it was an old case even then. It seemed like the whole thing was quietly put to bed two years ago when the IRS settled with Caterpillar with no penalties, after the Department of Justice criminal investigation abruptly halted. A little too abruptly for some, and now Democrats on the Senate Finance Committee sent a letter to the current attorney general for information about whether there was political interference from the Trump Administration. This follows a New York Times piece alleging that the investigation was stopped after President Trump nominated William Barr to be attorney general. Barr had represented Caterpillar in the case. The whole thing has to do with royalties for replacement machine parts that the company sells to its customers over decades, similar to the way printer companies make more from the ink than they do from the printers. If you’re interested in this (admittedly fascinating) case, there’s a 100-page Senate report and 350 pages of exhibits, and that’s just the beginning.
• Another round of meetings are underway at the United Nations this week, pertaining to its proposal to create a new multinational forum for tax matters. (Among a host of other issues.) Since, as stated above, many developing countries have significant issues with the OECD’s recent proposals, a lot of eyes will be on the UN’s outputs, even as there’s still significant skepticism that it will ultimately be able to challenge the OECD’s role. To give just a sampling of input from outside groups, here are new comments from the Tax Foundation and the South Centre, two think tanks.
• There’s more turnover at the OECD, as David Bradbury announced on Tuesday that he would be leaving his position as deputy director of the organization’s Centre for Tax Policy and Administration. Bradbury, a former member of the Australian House of Representatives and government minister, was originally hired by the OECD to be head of the Tax Policy and Statistics Division in 2014. He was involved in not only the Two-Pillar Solution but its new climate change work as well. It will definitely be interesting to see who the OECD picks to fill this role.

PUBLIC DOMAIN SUPERHERO OF THE WEEK

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

The Black Orchid, first appearing in Tops Comics in 1944. By day a secretary to the district attorney, at night Diana Dawn solves crimes as the Black Orchid, armed with a ring that dispenses knockout gas. Pretty rad!

Contact the author at amparkerdc@gmail.com.