Green Energy and the OECD Tax Pact

The Organization for Economic Cooperation and Development released more than 100 pages of guidance last week on the 15% global minimum tax, “Pillar Two” of its “Two-Pillar Solution” to address tax issues in the digitalization of the economy. The guidance is, allegedly, the last for the “Implementation Framework” that had been announced in October of 2021 to carry out the roughly 140-country agreement.

But the most significant development may have been what wasn’t in the guidance.

The OECD laid out a new type of tax credit, the “qualified flow-through tax benefit,” for some structures involving an equity investment and some kind of government tax credit. Presented more as a clarification of accounting principles than a carveout, this new definition is expected to protect low-income housing tax credits from being negatively affected by the global minimum tax. They won’t count as a direct reduction in taxes for the calculation to see if an entity is above or below the 15%.

It won’t only count for housing, though. (Indeed, the term “housing” doesn’t appear in the guidance at all.) It’s expected to cover other types of credits, including some for renewable energy construction. But not all.

In fact, it doesn’t seem to cover the bulk of the green credits in the Inflation Reduction Act, the largest piece of legislation to confront climate change in history. Despite a puzzling statement from the U.S. Treasury Department insisting otherwise, most experts agree that the guidance doesn’t protect most of the IRA’s credits, as well as a plethora of similar ones enacted earlier. It’s not that the OECD ruled unfavorably on these issues--they didn’t rule at all. At least, not yet.

The weird void and silence seems to indicate yet another new layer of complex international politics enveloping the project, which has already been twisted into near unrecognizability from changes in the political winds. This latest wrinkle not only threatens the viability of the OECD project, it also threatens to diminish one of the Biden Administration’s key first-term accomplishments.

The global minimum tax project is ostensibly to deal with income-shifting and tax avoidance, which is normally defined as when taxable income is separated from the economic activity which created it. The income normally ends up in a low-tax jurisdictions—in the case of a pure haven, likely with a post office address and little else. Just as the U.S. set out to do with its 10% tax on global intangible low-taxed income in the 2017 Tax Cuts and Jobs Act, if someone taxes that pure haven income, even at a relatively low rate, the incentive to shift it in the first place is drastically reduced.

With prodding from the Biden Administration, the OECD members eventually agreed that 15% was the right rate. But the harder question was, 15% of what? Countries all use slightly different tax codes to define taxable income, and the agreement only works if they can arrive at a common definition. The organization ultimately opted for a system based on financial accounting principles, with an abundance of tweaks.

This is about when the project also saw some mission creep. Rather than staying laser-focused on true profit-shifting, officials began to talk in more expansive terms about ending the “race to the bottom,” the pressure that countries, especially poorer countries, feel to offer more and more lavish tax breaks to attract real, bricks-and-mortar investment. The policy ultimately landed somewhere in between the two goals.

But the OECD has run into an old truism in taxes, that the Biden Administration recently had to re-learn—there’s no tax break out there without a constituency and a justification. One man’s loophole is another man’s hard-earned and worthy incentive.

The agreement is enforced through two rules, the income-inclusion rule, a 15% tax countries would apply to their own taxpayers, and the UTPR, which countries could apply to taxpayers in countries that neglect to follow the rules.

To the apparent surprise of U.S. stakeholders and Treasury officials, the UTPR was designed in a broad, expansive way that could potentially hit U.S. taxpayers—and, very confusingly, on their domestic, U.S. income. Like an over-sensitive home security alarm, the UTPR system is set to go off any time it sees lowly taxed income, even if it’s not income that would be involved in tax avoidance or tax competition. And countries would no doubt jump at the chance to tax massive U.S. companies in an OECD-sanctioned way.

This potentially put all of the tax credits Congress has enacted over the years in jeopardy of being negated. Companies could still claim the credit, and maybe most of the time there’d be no problem. But in some cases where it lowered their effective tax rate to below 15%, they would see foreign subsidiaries or permanent establishments taxed by foreign tax authorities, purportedly on their U.S. income. Whatever benefit they’d get from the domestic tax credit would be partially negated by the increase in foreign taxes, and they’d have less of an incentive to pursue the credit in the first place.

Faced with this awkward situation, the OECD began to feel for solutions. OECD officials began to hint that there may be some ways to at least soften the blow.

First of all, the guidance already made clear that refundable tax credits would be protected, somewhat, from Pillar Two. Those are more like direct subsidies than tax benefits, so it makes some sense to count it as an increase in the beneficiary’s taxable income, not a decrease in its tax payments. The accounting tax base could be made to cover equity structures.

And transferable credits—those that the recipient can exchange to another for cash or some other benefit—could be considered the equivalent of refundable, some hinted. That would at least provide some, though not total, relief. (Since refundable credits increase the taxpayer’s taxable income, it decreases their effective tax rate.)

Hoping to attract more investment into green energy, transferability is baked into the Inflation Reduction Act's very design. Many of the tax credits are nonrefundable but transferable to other parties. If those were to be considered refundable, it could give the OECD an easy way to avoid a political headache.

But it’s absent from the latest guidance.

“What about all of the green energy credits that were adopted in the Inflation Reduction Act last year, in particular, and those other categories of credits, transferable credits, which you would not typically expect to go through a tax equity structure?” asked Pat Brown, a partner at PricewaterhouseCoopers LLP and co-director of its Washington National Tax Services in a recent webinar. “On that, the document is simply silent.”

It's hard to know what to make of the absence. But given the apparent vow of silence that all officials involved in the matter seem to have taken, it’s hard not to wonder if the recent diplomatic kerfuffle between the U.S. and the European Union over those same IRA tax credits has spilled over into the OECD process. That’s over trade and subsidy issues, technically unrelated but certainly connected to the tax agreement.

Thus the OECD is engulfed in an ever-more complex web of international diplomacy and intrigue—one that this single observer is having trouble comprehending.

But there’s a substantive issue too that shouldn’t be missed. As I said earlier, the OECD project has been troubled by blurred goals, and expansive promises that it would end all tax competition. (It won’t, the OECD concedes—but sometimes it seems like it’s trying.) Green energy and low-income housing are certainly worthy goals, unlike a tax haven or real loophole. But there are a lot of worthy goals out there, and if the perception sticks that the U.S. got its own carved out, other countries will surely want to pursue what they perceive as equally justified benefits. OECD officials have maintained that coming up with a list of favored tax breaks is impossible, and that are just clarifications. But that’s the kind of distinction that could get lost. And it could force policymakers to re-answer the question of just what this project is hoping to achieve.

It's a tricky knot to unweave—especially through a consensus process and while insisting that the policy questions have been answered, and that further guidance is only implementation. Diplomacy often requires twisting and stretching words as far as they’ll go—but sometimes they break.

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

• Speaking of the OECD project, the International Monetary Fund recently released a report which gave it some qualified, reserved praise. The policy will increase corporate tax revenue by 6%, or 0.15% of GDP, it claimed. It will also dampen “spillover” effects like profit-shifting. The OECD’s own analysis shows a 9% increase. Of course, given how little is known about the true current scope of profit-shifting and tax avoidance, those figures could turn out to be little more than guesses.
• Not everyone was in a totally generous mood regarding the OECD project, however. The National Foreign Trade Council published a comment letter for the proposed information return for companies to comply with Pillar Two. While the policy will be implemented at the national level, if countries collect the same information they could exchange it with each other to save corporations the trouble of filing dozens of returns one-by-one. The NFTC praised the idea but said that parts of the proposed form were “unnecessarily burdensome” and recommended further simplification.
• Not strictly international-related, but the Senate Finance Committee announced it would hold its first hearing with Daniel Werfel, the administration’s nominee to become Internal Revenue Service commissioner. Expect him to be grilled on the IRS ramp-up of enforcement activities in connection to the IRA’s $80 billion boost in funding, including on international tax evasion. GOP lawmakers may also ask him about the global min tax agreement, although that’s an issue more relevant for Treasury.

PUBLIC DOMAIN SUPERHERO OF THE WEEK

Black Angel, who premiered in Air Fighters Comics #2 in 1942. Yet another "weak in public, butt-kicker in private" superheroine with a double identity. Sylvia Manners lives in an ancient castle with her aunt after the Nazi bombings of London, but she secretly keeps a plane in the castle's underground lair and battles the German planes as Black Angel. One of her key enemies is Baroness Blood, a Nazi pilot.

Contact the author at amparkerdc@gmail.com.