Giving Back

Throughout the design, negotiation and implementation of the Organization for Economic Cooperation and Development’s 15% global minimum tax, a key tension has been distinguishing between unfair tax avoidance/competition, and genuine incentives used for economic development. The goal is to eliminate the former while respecting countries’ rights to perform the latter–but is there a principled way to distinguish the two?

This central question is behind most of the lingering questions and sticking points that the OECD is still trying to iron out–including the treatment of the U.S. research and development tax credit. For that matter, it’s behind the favorable treatment of “transferable” tax credits such as the green energy incentives in the Inflation Reduction Act.

Given the pressure that countries are under to lure investment that will bring jobs, one way or another creative lawmakers will find a way. The goal of the minimum tax, also known as Pillar Two, is to stop outright profit-shifting which separates income from economic activity, and to ensure that tax competition has some ground rules to keep it truly competitive. In theory.

In practice, these lines get blurry.

Most countries around the world have taken steps to create a domestic minimum top-up tax or raise their corporate tax rate, and ensure that they don’t lose out to revenue which other countries to target under the Pillar Two system. This includes jurisdictions historically seen as tax-favorable havens, like Bermuda, which enacted a 15% statutory tax rate, while also announcing plans to implement a “robust package of qualified refundable tax credits'' to “maintain Bermuda’s attractiveness.”

Under the Pillar Two system, refundable tax credits are treated as an addition in income, rather than a reduction in cost, reducing a company’s effective tax rate calculation less than a non-refundable tax credit would. The logic is that refundable credits are more like subsidies than tax breaks, and countries are free to use them to benefit their economies.

It’s led to debates about what this whole thing has accomplished, if haven jurisdictions can achieve the same results through changes that may seem, at first blush, to be mostly semantic.

That’s not how it’s supposed to work, however. The Pillar Two rules include the cryptic caveat that a qualified domestic minimum tax (or other Pillar Two taxes) won’t be qualified if the jurisdiction provides “any benefits that are related to such rules.”

Speaking at the Pacific Rim Tax Conference in Silicon Valley last week, OECD tax official John Peterson said the goal was to ensure that countries with a minimum tax “don't de facto return the benefits being raised, back to the same multinationals they're taxing.” Countries may look towards these types of giveaways to achieve the equivalent of the favorable tax regimes they achieved previously through a low corporate rate, generous tax incentives or lax enforcement.

The rules don’t say much more about how that would be evaluated, except that it will be part of the still-vague peer review process that participating nations will undertake to ensure compliance with the new standards. If the OECD determines that the benefit is just mirroring the tax payments under Pillar Two, the minimum tax will lose its “qualified status,” and other countries can tax the company’s income under the Pillar Two income inclusion rule or the under-taxed profits rule. The jurisdiction will become a lot less attractive, and presumably multinational taxpayers will flee. (I’m assuming here that subsidies identified by the OECD as givebacks will also lose their favored treatment as income rather than a reduction in tax–otherwise, the amount of overall tax paid may not change much. But that’s another thing the rules are unclear about.)

Often, the problem with a tax incentive is that it’s too generous. Here, the OECD will be trying to make sure that countries don’t offer tax breaks that are too narrow, and targeted to specific companies that are under the minimum tax. It’s always possible, however, that jurisdictions will find ways to curtail the benefits without referencing the Pillar Two laws specifically, and manage to offer attractive incentives without risking bankruptcy in the process. (Bear in mind, the OECD rules don’t say that tax credits must be claimed as refundable payments in order to be Pillar Two-favored, just that the option is available.)

To me, there is a difference between a favorable tax regime and generous subsidies, even if it’s hard to put a finger on. Part of it is about trust. There’s a reason why jurisdictions like Bermuda weren’t offering subsidies in the first place–they were hardly in a fiscal position to do so. And even if a minimum tax provides a better fiscal standing, companies would still need to rely on the assurance that they’d receive the money back after paying it as taxes. For smaller, resource-constrained governments, that’s not always a given. Many taxpayers will view parting with their cash, even briefly, as an unacceptable gamble.

To give one example, many developing nations have struggled to provide value-added tax refunds to corporations, even as they’re guaranteed in the law.

So the idea that the post-Pillar Two world will look pretty much the same as the pre-Pillar Two world seems unlikely. (To say nothing of all of the other reasons why pure tax havens have become less popular in recent years, including the OECD’s previous tax project and the Tax Cuts and Jobs Act’s anti-abuse rules.)

But it’s also unlikely that investments will now be guided by pure economics, without any tax distortions. Through rules which are admittedly imperfect and a bit ad-hoc, new incentives are being put in place for both countries and companies, and it may take a while to truly see how they’re going to work.

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

• Literally minutes before I hit send on this week's newsletter, the Supreme Court released its long-awaited decision in Moore v. United States. As widely predicted, the court upheld the TCJA's repatriation tax, ruling that it was well within Congressional authority under the 16th Amendment. So the feared cataclysm (taxpocalypse?) shattering the foundations of the U.S. international tax system is gone. The big remaining question is whether Justice Brett Kavanaugh, who wrote the majority opinion, included anything that might be used to challenge a wealth tax or tax on unrealized capital gains, should Congress enact one in the coming years.
• Meanwhile, OECD released a long-awaited package of Pillar Two guidance on Monday, addressing a few–although by no means all–of the outstanding unresolved issues. The guidance includes sections on flow-through entities (potentially including check-the-box structures) as well as timing differences and accounting for deferred tax liabilities (something I keep deferring reading up on–ha, ha.) Perhaps the most interesting update was in a revised question-and-answer page that introduces a “transitional qualification mechanism” for the first few years. Because “it will not be possible to conduct and finalize a full legislative review” of countries’ Pillar Two implementation, countries will “self-certify” to the Inclusive Framework that their regimes are in compliance, according to the page. Then other members of the Framework will be able to ask questions, and a working party will decide whether or not to accept the certification. In practice, this may mean that the OECD focuses on the controversial cases while others are floated until the full system is up and running. But it will be interesting to see how it plays out.
• The political left in the U.S. and abroad is continuing to put pressure on the Biden Administration to become more open to a global billionaires’ tax agreement, even after U.S. Treasury Secretary Janet Yellen threw cold water on the idea. A letter signed by U.S. senators Bernie Sanders and Elizabeth Warren, as well as U.S. House Progressive Caucus Chair Pramila Jayapal, Rep. Alexandria Ocasio-Cortez and several other high-profile progressives, urges the administration to support an effort by Brazil to forge an agreement on a wealth tax at the G-20. At this point, it’s still probably very theoretical, but Biden’s continued opposition to the idea would seem to contradict his own proposal for a “billionaire minimum tax,” at least a bit. But, certainly, the potential constitutional issues with an outright wealth tax are likely a big factor.

PUBLIC DOMAIN SUPERHERO OF THE WEEK

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

Martan the Marvel Man, first appearing in Popular Comics #46 in 1939. From the distance planet of Antaclea, an advanced civilization without war, poverty or illness, Martan and his wife Vana arrive on Earth after being sidetracked on a cosmic voyage by hostile Martians. With their seemingly omnipotent technology-driven powers, the couple helps the U.S. drive off evildoers both terrestrial and alien.

Contact the author at amparkerdc@gmail.com.