The Qualified Domestic Minimum Top-Up Tax--Corporate Taxpayers' New Nightmare, or Pillar Two's Missing Piece?

Back in January, I wrote that the UTPR had “clearly become the most important part” of the Organization for Economic Cooperation and Development’s 15% global minimum tax plan, also known as Pillar Two.

I think that’s a statement that accurately reflected how things seemed at the time–but today, I must (painfully) admit, I may have been wrong.

There’s another sleeper candidate for the key rule of the global min tax. That’s the qualified domestic minimum top-up tax, which countries can use to tax domestic entities (whether they’re subsidiaries of foreign companies, parents of a global organization, or just a purely domestic corporation) up to 15%, based on the Pillar Two tax base. It works like an alternative minimum tax, only kicking in when the regular corporate income tax doesn’t cover the amount.

Note the phrase “can use”--it’s not even necessarily required by the OECD for countries who implement the plan. But it’s crucial to their hopes of getting new revenue out of it. As many noted during the public consultation held on March 16, this could be the rule that most taxpayers come into contact with.

“QDMTT are likely to be the future of Pillar 2,” said Thomas Quatrevalet, deputy group head of tax at French industrial company Air Liquide S.A. and a member of the International Chamber of Commerce.

Quatrevalet noted that almost all of the countries that have announced they are moving ahead with Pillar Two implementation have also said they’ll be enacting the QDMTT. Because it comes first in the ordering rules, this means companies in those jurisdictions will pay the domestic tax before the rest of Pillar Two, if the latter part is even necessary.

Two other key elements of Pillar Two are the income inclusion rule, which countries can impose on the foreign subsidiaries of their own companies if foreign income dips below 15%, and the aforementioned UTPR, which applies for companies operating in jurisdictions which haven’t enacted a full IIR. The UTPR is often called the backstop enforcement rule, but in a sense both of these rules act as enforcement provisions for the 15% rate, while it’s the QDMTT that actually collects it–if everything goes according to plan. (Which it won’t, but this is still a useful thought exercise.) The UTPR and IIR could end up like powerful firearms that are always kept in their holsters, while the QDMTT is the operative rule that most companies actually interact with.

That the QDMTT should be so important to Pillar Two is a little strange, since it was a late addition that confused many observers. It makes basic sense to me, though, as part of the “minimum tax” concept that the OECD has used to pitch the policy. When the Biden Administration first announced that it has reached a “15% minimum tax agreement,” most laypeople probably thought that it would require all of the participating countries to raise their tax rates up to 15%. That’s kind of the idea–but the complication is that just raising the standard rate won’t necessarily stop the IIR from applying, because of the peculiarities of the Pillar Two tax base. So countries need to enact this new domestic minimum tax to avoid losing potential revenue to other countries, or being seen as a tax haven.

What's interesting about the QDMTT being the operative part of Pillar Two is that the OECD rules give countries the most leeway in designing and enacting it, compared to the rest of the system. There’s no limit to how restrictive it can be, for one–a country could impose it at 90% with fewer carveouts, if they really wanted. It can also be applied according to the country’s own financial accounting rules, even if they’re different from the rules that the company used for its overall report requested at the parent jurisdiction. Although to be considered in compliance it must “reliably produce outcomes that are consistent with the outcomes for the jurisdiction that are produced under” Pillar Two. (Pillar Two uses a tax base built from generally accepted accounting principles, meant to be as universal as possible.)

According to the revised commentary, this is because “the local tax authority would likely be "more familiar with accounting standards that are permissible in the jurisdiction than one applied” in another jurisdiction. Presumably, it’s also because this is a purely domestic tax, which countries have normally been able to design however they see fit. The OECD is on shakier ground when it tries to dictate domestic tax rules, rather than its normal province of foreign income allocation and treaty language.

For taxpayers, this raises the exhausting possibility of needing to calculate the Pillar Two tax based on slightly different rules in every jurisdiction they operate in, rather than using one measurement for all of the countries at the outset. And this is if the system is working as intended–in all likelihood this exercise will be on top of calculating overlapping IIR and UTPR payments as some countries fail to enact everything the OECD is asking for.

Fortunately, there’s a plan. The OECD has already said it’s working on a safe harbor to simplify QDMTT compliance. Safe harbors offer taxpayers a guarantee against audits or income adjustments if they hit certain benchmarks that are above and beyond what’s strictly legally required, but still within the basic estimation. Typically, if a company might be able to push for 10% taxation in court, and a tax authority could manage 30% through aggressive enforcement, then 20% might be a nice safe harbor rate which both could happily accept if it meant they could move on. They’re usually voluntary for the taxpayer, although some might argue that safe harbors can become mandatory in practice.

There have already been many proposed safe harbors for the Pillar Two system, and in December the organization released a consultation document on the topic. One is a safe harbor based on the country-by-country reporting that companies already must do–taxpayers are hoping that a simple effective tax rate calculation from that could spare the need for further compliance.

But so far, there’s little that’s been released publicly, or that has been proposed by taxpayers, about how a QDMTT safe harbor would work. We just know that the OECD is working on one. It would presumably help ensure that if a company pays a QDMTT at the local level, it won’t have to go through the exercise of proving that it doesn’t owe IIR tax on top of that as well.

That sounds reasonable–although is it only a matter of time before a clever company figures out how to arbitrage slight differences in the tax bases?

But will there be a safe harbor that gives companies a simplified global measurement, so they won’t have to become familiar with each and every GAAP base in the countries they operate in? Is such a rule even possible, and if so how would it work? Would it use metrics similar to the CBCR safe harbor? (Which isn’t perfect–it doesn’t include deferred tax accounting, how the Pillar Two system deals with timing differences.) And would this be separate from the peer review process that will determine if a Qualified Domestic Minimum Top-up Tax remains qualified?

And so far, the safe harbor is presented as an option for jurisdictions–will it be an attractive enough one that all choose to include it?

These are just some of the outstanding questions. Taxpayers everywhere are eager for answers, since this rule could have huge implications for their upcoming years of foreign tax compliance.

And it has huge implications for the feasibility of the Pillar Two project as well. As complex as it’s gotten, as unwieldy as it seems, as much of a Frankenstein’s monster it has grown into, it’s still not that hard to imagine that its enforcement could be carried out relatively simply through a network of the right safe harbors and threshold requirements. The complexity would still be on the books, but it might not have to be part of the daily reality for multinational corporations.

But that would mean that despite how many years this project has dragged on through, much of the most important work has yet to come.

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.

LITTLE CAESARS: NEWS BITES FROM THE PAST WEEK

• Congressional Republicans are keeping the heat on the OECD amid their fight with the Biden Administration about the 15% global minimum tax agreement and the Two-Pillar Solution. Ten representatives with the House Ways and Means Committee, all Republicans, last week signed a letter sent to the appropriations committee suggesting that funding for the OECD be axed. On the one hand, this is hardly a new issue, lawmakers have been threatening the organization's budget for decades, mostly as a symbolic issue. On the other hand, it's rarely been with this degree of coordination or adamance. With no deal in sight for the debt limit or government funding, this could become part of the chess game. It's a microscopic part of the federal budget, but it could be the kind of symbolic fig leaf cut an agreement would need to win over hardcore Republicans. One starts to wonder if this could be the time that anti-OECD forces prevail. For the Paris organization--which does a lot more than tax work, including data research used by experts all over the world--this could become an existential crisis.
• A reminder that the OECD does much more than the Pillars, even within the tax space--the organization released Tuesday seven new status updates as part of its "peer review" of countries' compliance with the tax information-exchange system, part of the Common Reporting Standard that has revolutionized anti-tax evasion enforcement. One interesting note--Mexico was downgraded from "Compliant" to "Largely Compliant," which the OECD partly attributed to tax administration staffing issues and "difficulties to respond to all requests in a timely manner."
• Credit Suisse may not actually exist anymore, but don't think that'll get them off the hook from Congressional scrutiny for their tax practices. Senate Finance Chairman Ron Wyden, D-Ore., released Wednesday a study claiming that the Switzerland bank violated its 2014 plea agreement for tax evasion by keeping "nearly $100 million in secret offshore accounts belonging to a single family of American taxpayers." Wyden promises to keep pressing on this issue even as Credit Suisse is acquired by UBS as part of a government-led rescue against insolvency.

PUBLIC DOMAIN SUPERHERO OF THE WEEK

Captain Flash, first appearance in Captain Flash #1 in 1954. Keith Spencer was a professor who gallantly took a blast of radiation from a malfunctioning experiment to save his students. Since then, whenever he claps his hands, it creates an atomic explosion which endows him with super-strength and other powers. "America's Ace Defender" fights an array of Atomic Age-era villains, from Russians to aliens.

Contact the author at amparkerdc@gmail.com.