The OECD and the Global South

The Organization for Economic Cooperation and Development’s 15% global minimum tax has endured withering criticism from the American right over the past few months. While it tries to withstand that barrage, there’s been a quieter but growing opposition from what’s often called the Global South–developing and emerging countries who feel their interests were neglected during this years-long process. They say that despite ostensibly having some say through the 140+-nation-Inclusive Framework, they were never really at the table.

Most recently, Indonesia Minister of Investment Bahlil Lahadalia called the agreement a “trick” that will only benefit “a select group of countries.”

Interestingly, Lahadalia’s main complaint seems to be that the agreement could discourage poorer countries from using tax incentives to attract investment–that’s the opposite of the criticism from many developing countries, that the minimum tax is too low and is not strict enough on incentives. This shows how the developing world doesn’t always speak with one voice, a dynamic that has also affected the negotiations.

Nevertheless, Lahadalia’s comments follow many recent criticisms from non-OECD and non-G-20 nations around the world–some of whom did sign onto the initial agreement in 2021. (Including Indonesia.) As the United Nations requested comments on its proposal for a new global tax forum earlier this year, countries and advocacy groups expressed many of these concerns. The African Union, for instance, said that “the recent tax discussion has missed the opportunity” to address Africa’s concerns about income allocation, and that nearly half of African nations didn’t even participate.

As I wrote last year, I think there may be some key issues that these criticisms miss. While the OECD’s project did focus on digital taxation and base erosion involving intangible assets–which tend to be a concern for more technologically advanced economies–it has the potential to significantly reduce tax avoidance in poorer countries as well.

That may not address their biggest problems, but it’s not something to sneeze at either. Especially as developing nations often face significant challenges in income tax allocation, with cash-strapped tax administrations that lack the expertise of their Western peers.

The global minimum tax targets low-taxed income, determined through its own formula, which includes a carveout for indicators of economic substance like payroll and tangible assets. The primary rule enables countries to tax companies based in their jurisdiction if they have foreign low-taxed income; if the parent country declines, there are enforcement provisions allowing other countries to pick up the difference. There’s also a qualified domestic minimum top-up tax that the source country can use to stop the low-taxed from ever being there in the first place.

It’s true that the primary rule is for what are called residence countries–where the multinational taxpayers base their parent companies. Usually these are the wealthier countries–the U.S. and U.K. account for a huge portion of corporate headquarters alone. Developed Western nations will be the first to benefit from this new regime, on its face.

But if Pillar Two works as designed, they may not end up using that primary rule (called the income inclusion rule) all that much. These rules are meant to change behavior and create disincentives for companies to ever seek low-income jurisdictions. Already, the classic tax havens (like Bermuda) are figuring out what to do with their tax systems now that acting as the world’s post office box doesn’t look like it will work much longer.

Of course, those companies could respond by bringing that money home, benefitting the residence jurisdictions that way. Maybe they would spread it out, seeing if they can avoid hitting the 15% mark in as many jurisdictions as possible.

The point is, source countries, where this income is earned, stand a better (though not guaranteed) chance of being able to keep some of that income as tax revenue in this new regime. Or put another way, the incentive to shift income out of poorer countries will be much smaller once these rules really get in place.

When it comes to base erosion, developed and developing nations really aren’t in such different situations. It all comes down to intangibles and low-tax jurisdictions. For the richer countries those intangibles may be patents and copyrights; for the poorer countries they may be management fees, certain royalties or just the right to own valuable commodities. The point is to use those non-physical functions to get income to the place with the lowest rate.

The problem with Pillar Two is, it’s really hard to predict how companies will respond, and what the international tax system will look like 5, 10 or 15 years in the future. We’re still working out the effects of the Tax Cuts and Jobs Act are, and that’s nearly six years old.

OECD estimates of the revenue gain from Pillar Two, which show developed countries benefiting slightly more, acknowledge that they rely on “simplifying assumptions” on how governments and corporate taxpayers will react and that there is great uncertainty for the predictions. They also have yet to include the Qualified Domestic Minimum Top-up Tax in the estimates, which could drastically swing the results.

It’s also just hard for anyone–tax expert or layperson–to envision complex systems in a dynamic, changing way. Given that, I understand why people will revert to the surface-level analysis–who gets the taxing rights, and who doesn’t? I understand it as a matter of national pride as well. For the smaller, poorer nations, to see rich countries get new tax tools, while you get the promise that some revenue will eventually slide your way, probably seems belittling and patronizing, if not somewhat imperialistic.

But the indirect nature of this revenue gain also can work in their favor, as they won’t have to be the ones administering these complex new rules. Many officials from the developing world, as well as nonprofit advocacy groups, have noted that the complexity of this new regime will be a major burden for under-resourced tax authorities. Not only will this part of the system be left to the more capable authorities, it could also relieve some of the pressure on transfer pricing and income allocation that’s a huge cause of concern for developing nations' tax enforcement now.

These countries may also collect more through the QDMTT, which does include much of Pillar Two’s complexity but also allows for more flexibility in practice. Tax administrator groups such as the African Tax Administration Forum are stepping up to help countries with implementation.

This isn’t to say that developing nations should be completely satisfied, or that they shouldn’t be asking for more. Indeed, it’s entirely possible that the next major international tax project, whether it's at the OECD or the UN, could be primarily focused on these issues.

Although how that might play out is still very much in flux. Administrative forums like the ATAF have risen in prominence in recent years, but they’re limited to issues of administration and enforcement–often very reluctant to stake out new ground on policy. I think one reason that many of these countries found the Inclusive Forum to be inadequate was that no single nation felt it could stand up and oppose the rest of the world alone. If the developing nations can form a stronger coalition that speaks with a single voice–well then the game could really change.

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

• Who loves Paris in the summertime? This holiday weekend, House Republicans are finally taking their long-anticipated fact-finding trip to Paris to meet with the OECD and air their grievances about the Two-Pillar plan. (As if they hadn't already gotten the message after multiple letters and a Congressional hearing.) According to media reports, they'll also be meeting with German officials, including the finance minister, in Berlin. These things tend to be pretty performative, but what makes this a bit more interesting is that this will likely be the first time that many of these lawmakers have heard a defense of the project from someone who isn't a Congressional Democrat or from the Biden administration. I wouldn't expect any converts, but maybe understanding the thinking behind these new rules will sharpen the debates a bit.
• Meanwhile, the march towards a world with digital services taxes continues, despite the recent agreement to hold off a year. New Zealand announced that it will introduce a proposed DST, that would take effect in 2025, to the legislature. Note that it's just an introduction--starting the process in the parliamentary system, but they won't actually be pushing for its enactment the delay is finished. So they're not refuting the OECD's timetable, like Canada is, but it's not exactly a vote of confidence either.
• During a meeting Wednesday, the Financial Accounting Standards Board, which sets generally accepted accounting principles for the U.S., voted to enact new country-by-country reporting requirements for income tax information. There are some differences between this and the reports required confidentially by the OECD, and what Australia is considering enacting as a public requirement. For starters, it only requires this information for countries which comprise at least 5% of the company's total income tax payments, and it won't include factors like workforce. Still, this is potentially a huge deal. As I wrote earlier this year, full public reporting of this info may be inevitable.

PUBLIC DOMAIN SUPERHERO OF THE WEEK

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

Crimebuster, first appearing in Boy Comics #3 in 1942. A military cadet whose parents were killed by the Nazis, Chuck Chandler combines his hockey uniform with a cape to seek vengeance. For a while he works under orders from "Jay Loover," head of the FBI's New York division.

NOTE: This newsletter will be out next week for vacation, and will return the week of Sept. 11.

Contact the author at amparkerdc@gmail.com.