Estimating the OECD Min Tax's Indirect Effects

The debate about the Organization for Economic Cooperation and Development’s 15% global minimum tax has been like a game of tennis without a net.

Everyone has opinions about it, everyone knows how they think it will play out, but there’s virtually no hard data to prove a side right or wrong. And there may not be for years to come, making these endless arguments impossible to resolve.

Part of this is because there’s no telling what Congress will do in the next few years, so an essential part of the minimum tax model is missing. But even if we can assume that current law will continue indefinitely, there’s too many unknowns to draw a clear picture. There are things we don’t know about the future, and there are things we don’t know about the present either.

One question that’s lingering over the entire debate is to what extent companies will respond to the new minimum tax by shifting, or declining to shift, income from the low-tax jurisdictions where it would otherwise be targeted by the minimum tax. In other words, will the minimum tax, also known as Pillar Two, mainly function as a revenue-raiser, or as a disincentive?

A disincentive would achieve the goals of the program, while perhaps changing who will reap the main benefits. There’s even the chance that the U.S. could see its revenue increased beyond what it would otherwise be, even if it doesn’t ever change its laws to participate in the program.

But will it?

The following quote, from a Penn-Wharton Budget Model’s October 2023 working paper, should give you a sense of how little is known about this question.

“Initial estimates suggest that the impact on federal tax revenues could be as high as $200 billion over the next 10 years,” the study states. “Although this could materialize as a net increase or decrease depending on a number of factors.”

(Emphasis mine.)

The report goes on to note that because offshore earnings are concentrated among the largest U.S. taxpayers, “the net effect on federal tax revenue may therefore depend on the decisions of a handful of the largest” companies.

The Joint Committee on Taxation’s June 2023 scoring doesn’t shed much more light here, because it uses a set of different assumptions about taxpayer responses for different revenue estimates, without indicating which one is more probable.

Coming to any kind of conclusion about this requires more deductive logic—how should it work?

The primary rule for Pillar Two is the income inclusion rule, which countries apply to foreign income earned by subsidiaries of their own taxpayers, if the income is taxed at below 15%. Most of the time, those taxpayers are going to be parent organizations—but there is an exception. In case of uncooperative jurisdictions (like the United States), the IIR can be applied to regional headquarters, which are subsidiaries to a foreign parent but have their own foreign subsidiaries as well. If the parent is based in a country not applying its own IIR, the countries can tax foreign income earned by the subsidiaries of those regional entities.

There’s also the under-taxed profits rule, which countries can apply to foreign subsidiaries when there’s an under-taxed entity anywhere else in the overall corporate group. (This is after the IIRs have been applied, as described above.) Much of the UTPR discussion has focused on when it could apply to the corporate group’s home jurisdiction, but it also can apply to other foreign entities or those second-tier regional subsidiaries.

So one way or another, when U.S. companies hold low-taxed offshore income it’s going to be captured by Pillar Two.

But how much low-taxed offshore income are U.S. companies holding, currently? The 2017 Tax Cuts and Jobs Act enacted measures to prevent base erosion and capture income that has been shifted. This includes the 10.5% tax on global intangible low-taxed income, which became a model for Pillar Two. But whether the TCJA’s anti-abuse provisions are working remains a hotly debated topic, without a ton of data to prove or disprove. Critics claim that because GILTI allows companies to aggregate foreign income—and because its 10.5% rate is lower than the OECD’s 15%—some profit-shifting is slipping by.

No doubt, pockets of income held in low-tax jurisdictions by U.S. multinationals remain. But there’ve also been plenty of GILTI tax payments, which the OECD considers to be part of the effective tax rate calculation in the foreign low-tax haven. When those payments are “pushed down” to the subsidiary, the income may be low-taxed no more.

The tax avoidance would also need to slip by the pre-existing U.S. base erosion rules, including Subpart F. Most of this profit is earned passively through interest or royalties from valuable intangible assets, which would automatically be Subpart F income—unless it’s shielded by check-the-box, which applies to transactions between foreign subsidiaries.

When you consider all of these factors together, it seems likely that passive income earned by U.S. multinational companies captured by Pillar Two would probably remain in foreign structures, if those companies unwind the transactions that shield it from taxation. If it’s income earned through foreign-to-foreign shifting, held either by local entities or regional HQ subsidiaries, it’s likely not income that would be “naturally” earned in the U.S., generating U.S. tax revenue.

That doesn’t mean, though, that there wouldn’t be some secondary effects. The check-the-box regulations ended up being important to U.S. tax collection, even though they only covered foreign-to-foreign shifting, because they created an enormous incentive to push U.S. income into that chain. If a U.S.-developed patent or copyright can make it easy for a U.S. company to earn income in France from economic activity in Germany, the company will find a way to make that happen.

This isn’t something that the company could immediately switch off when it’s no longer cost-effective, though.

Indeed, an ironic possibility for Pillar Two is that it may face some of the same pitfalls that the TCJA’s foreign tax provisions experienced—complex international tax structures have proven to be far stickier than many expected, even when the incentives dramatically flip.

Which means, we could be debating this for a long time.

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

• Speaking of OECD Two-Pillar estimates, the Joint Committee on Taxation released an estimate of Pillar One, the other part of the project which creates more destination-based taxation, including for purely online transactions. JCT found that the policy would have cost the U.S. anywhere between $100 million and $4.4 billion in tax revenue in 2021, had it been in place. (But with a mid-range estimate of $1.4 billion.) This would come from U.S. multinational companies which allocate more income offshore (leaving less in the U.S.), as well as when those companies claim more foreign tax credits for Pillar One taxes they pay elsewhere. It’s not clear if the report includes the effects of digital services taxes that would be canceled if Pillar One takes full effect. The report was prepared for a House Ways and Means Tax Subcommittee hearing on Thursday, entitled “OECD Pillar 1: Ensuring the Biden Administration Puts Americans First.” The U.S. Treasury Department doesn’t have a representative scheduled to testify, so this one may produce more rhetoric than angry yelling–but still probably worth tuning in.
• This year, the 2021 Corporate Transparency Act took effect, requiring millions of business owners to report the ultimate beneficiary of their legal entities. This was a major bipartisan push to enforce more transparency on international corporate structures, including to crack down on tax fraud. But the movement faced a setback Friday, when the United States District Court for the Northern District of Alabama ruled that the act is unconstitutional, claiming that it exceeds Congress’ powers. Experts expect this to be quickly appealed, so we’ll see how important this ends up being. But the experience with Moore shows that cases like these shouldn’t be ignored. See here for a response from the FACT Coalition, one of the act's main promoters.
• The OECD presented its Secretary-General Tax Report at the G-20’s Finance Ministers and Central Bank Governors meeting in Brazil on February 29. The report includes the usual update on the progress of the Two-Pillar project. Of note: the OECD says that they estimate “a substantial share of large MNEs will be in-scope by the end of 2024,” which could be close to the “critical mass” that officials have said it will need to be effective, even if not all jurisdictions are cooperating. Worth a look.

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