Measuring Compliance with the OECD's Global Min Tax

As I’ve said before, 2024 is the year that the Organization for Economic Cooperation and Development’s Pillar Two 15% global minimum tax takes flight. Even if it still needs work.

Countries across the world are enacting and implementing laws to carry it out. Already, some of the taxes are due. Even as the United States continues to stall its own implementation, the system has gone from theoretical to very real.

Which is starting to make the lack of a formalized procedure for peer review more glaring. Unlike so many other aspects of Pillar Two, this won’t be completely new–the OECD has been doing peer review on the Base Erosion and Profit Shifting minimum standards, and the prior rules on harmful tax practices, for more than a decade. So they have some experience to lean on.

But this ain’t your father’s peer review. A whole lot more is on the line. The Pillar Two peer review will determine who’s in and out of compliance with the OECD standards, which then determines the ordering rule of whose Pillar Two taxes will apply. The participating nations will need to get into the nitty-gritty details of the national laws implementing the policy, and consider questions that the OECD’s own guidance never thought to explore. Tiny variations in language could swing billions of dollars of revenue from one jurisdiction to another.

Though it might sound like an afterthought, the Pillar Two peer review process will soon become the crucial step to ensuring whether or not the minimum tax works.

One key role of this peer review will be to determine whether a qualified domestic minimum top-up tax will in fact be qualified. This is the rule–created somewhat late in the Pillar Two design process–that follows the same formula as the income inclusion rule and the under-taxed profits rule, but which a country can apply to its own domestic income, if it chooses to. That way, it won’t lose out on revenue that’s going to be taxed one way or another, by other jurisdictions.

Because it was a late development, some commentators and observers were puzzled that the QDMTT took precedence over all of the other Pillar Two taxes. But that was likely inevitable. The OECD would have a hard time arguing that a local jurisdiction shouldn’t get first dibs on its own income. That was probably never in question, but the QDMTT answered a quandary that inevitably rose during the process–how does a country ensure that it won’t have local income caught up in the global minimum tax? Just raising the rate to 15% won’t do it, because of the peculiarities of the Pillar Two definition of taxable income. So the OECD came up with an option anyone could, in theory, follow.

If income is taxed by a QDMTT, it’s automatically not taxable by the income inclusion rule, the primary tax provision that a jurisdiction imposes on the foreign subsidiaries of its own taxpayers if it’s taxed below 15%. That’s why the "Q" part is so important–so long as the QDMTT is under the Pillar Two regime, and qualifies for the QDMTT Safe Harbor, a taxpayer doesn’t even have to see if it has additional IIR or UTPR income. But if it’s just a DMTT, that broad exemption is turned off–and since there’s some discrepancy, there could be some amount of income it isn’t picking up, which would get captured by another country’s IIR or UTPR.

Another way to look at it–the peer review will likely spend a lot, if not most, of its time fine-tuning the definition of taxable income under Pillar Two. That could have effects all throughout the system, but the first and likely most important impact will be on QDMTTs. In effect, the peer review will decide whether a country’s little carveouts and exemptions will stay exempt, or if they’ll be negated.

(I should note the huge asterisk here, the U.S. and its own exemptions, since it’s not likely to pass a QDMTT soon, if ever. More on them in a bit.)

The OECD released Friday consolidated commentary on Pillar Two, more than 300 pages combining the original commentary released back in March 2022 and all of the administrative guidance since then. In all of that, there’s few mentions of the peer review process, although it does state that a Peer Review Process to determine a QDMTT Safe Harbor “is still to be developed.”

Before the OECD and the 145-jurisdiction Inclusive Framework complete a formal peer review framework, they will likely have to create something for the transitional period, which leans more heavily on safe harbors as the system’s quirks are ironed out and countries get used to it. That could end up being a test drive for how peer review will work indefinitely–something that will likely be as much about global politics as tax policy.

For instance, the United States will no doubt want to play a significant role in this, as it has throughout the entire Pillar Two project. Even though it won’t have a QDMTT, the peer review could determine how the IIR and UTPR would apply to the U.S. tax system, especially its credits.

But as former Treasury official Michael Plowgian pointed out last year, so long as the U.S. is out of compliance, it may find itself taking a back seat in the peer review. Other countries are becoming less and less patient with U.S. demands as it refuses to implement any of the Pillar Two legislation itself. That may or may not be fair, depending on one’s perspective, but it’s inevitable.

As this whole process has shown, as policies evolve they can begin to take on new functions that weren’t imagined at the start. In the future, the peer review could be the main place where this transformation happens.

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

• If the OECD’s Pillar One project–the companion to Pillar Two that’s supposed to supply an alternative to digital services taxes–continues to falter, then DSTs will become more and more of a focus in international tax policy debates. As everyone waits to see if the Biden Administration will re-start the process for retaliatory tariffs, countries are set to make the digital levies law, unless they reconsider. One voice for repealing DSTs, while maintaining the focus on consumption-based taxation, is the conservative-leaning Tax Foundation, which published a report Tuesday on the subject. The think tank advocated that countries replace the DSTs, which target the revenue from select online activities, with broad consumption taxes. This could avoid distortions between digital and “real” businesses, while still pinning down the tax base to the location of consumers.
• Tax Inspectors Without Borders, a joint OECD-United Nations project to assist developing countries with tax collection and enforcement, published an annual report Monday which showed that the initiative has resulted in $2.3 billion in additional taxes over the past nine years. According to the report TIWB has begun to focus more on criminal tax enforcement as well as data management from new information-sharing agreements and country-by-country reports from corporate taxpayers. Interesting that as the OECD and UN continue to bump heads over the direction of global tax policy, they’re still working together productively when it comes to administration.
• Inflation has become the primary economic enemy in much of the Western world over the past two years, as rising prices have diminished or often eliminated outright gains in wages. An OECD report issued Monday shined new light on this dynamic, stating that taxes on labor rose slightly in 2023, in part due to inflation effects. (Many income tax brackets are not indexed to inflation, and cash benefits set to specific amounts will lose their value if prices rise.) The report also includes an analysis of how this affects different genders.

Happy May Day! I'll be at the American Bar Association Tax Section's Annual May Tax Meeting in Washington, D.C. on Friday. If you'll be attending, don't hesitate to say hello, or let me know your thoughts on how this newsletter is doing.

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