Today the OECD Secretariat released a consultation document on the Secretariat’s proposal for a global minimum tax under Pillar 2 of the project to address the tax challenges of digitalization. The proposal raises a number of questions and will require significant work by the Inclusive Framework to get to a coherent proposal that does not lead to double taxation.
The OECD will be accepting comments on the proposal until December 2 and will have a public consultation meeting on December 9.
Pillar 2 has four separate features that lead to numerous policy considerations and potential outcomes:
- An income-inclusion rule allowing a country to include some foreign income in its tax base if that foreign income is taxed below a minimum rate.
- An under-taxed payments rule that would allow a country to disallow a deduction or apply a withholding tax to payments that are not taxed or taxed below a minimum rate.
- A switch-over rule that would allow a country to change tax treaty implications for profits of entities that are taxed below a minimum rate.
- A subject to tax rule that would change treaty benefits for certain items of income where payments are under-taxed relative to the minimum rate.
The design of the income-inclusion rule and the under-taxed payments rule draw inspiration from the U.S. international rules that were adopted in the 2017 tax reform law, Global Intangible Low Tax Income (GILTI) and the Base Erosion and Anti-Abuse Tax (BEAT). The Secretariat’s plan is develop new, strict, anti-avoidance measures in addition to policies that have been adopted since the initial BEPS project concluded.
Many countries have recently strengthened or adopted tax rules that apply to foreign subsidiaries, change the treatment of cross-border interest payments, and regulate the tax consequences of transactions between related entities. These policies have a variety of effects including negative impacts on business investment and increased tax revenue for some jurisdictions.
The magnitude of the problem created by tax avoidance raises serious questions, and it is worth considering whether that problem has been sufficiently addressed by recent policy changes. If, prior to recent policy changes, profit shifting amounted to an estimated revenue loss of 1.3 percent of GDP for non-OECD countries and 1 percent of GDP for OECD countries, how much of that has been addressed by BEPS-related policies?
The answer, for now, is that we do not yet know. The significant overhaul of U.S. international tax rules has reshaped international tax conversations in a variety of ways, and policymakers should cautiously approach new international standards before accounting for the impacts of recent tax changes in Europe and the U.S.
The Secretariat’s proposal offers a global minimum tax and a tax on base-eroding payments as a way to stop the race to the bottom on corporate tax rates and suggests that there is a risk of shifting the burden of taxes to less mobile tax bases. In a way, this is in contradiction to the OECD’s approach on Pillar 1 which clearly attempts to tie corporate taxation of some highly profitable companies to less mobile factors like customers. It also does not recognize the economic incidence of the corporate income tax including incidence effects related to profit shifting and how the corporate tax affects workers’ wages.
The Secretariat’s proposal mentions that minimum taxation can help “shield developing countries” from choosing inefficient tax policies like creating special incentives to attract business investment. Special tax incentives for particular industries or companies are certainly inefficient, and countries should seek to adopt neutral and competitive tax policies that follow a principled approach.
It is also doubtful that the proposal would stamp out tax competition. Even in the context of strict anti-base erosion rules, countries still face competitive pressures to create tax systems that are broadly attractive to and supportive of business investment.
It will be important for the OECD to explore how the global minimum tax and tax on base eroding payments will treat more streamlined and competitive corporate systems like those in Estonia and Latvia. Business investment in those countries faces very low marginal effective tax rates by design, even though they have 20 percent statutory rates on corporate income. If the minimum tax does not account for the way those systems treat retained earnings (which face no tax), then the advantages of those systems would be neutralized.
The OECD has many challenges ahead with this proposal including figuring out how to reconcile book profits with tax outcomes and coordinate domestic law and treaty changes. The economic impacts will also be important. The OECD and the Inclusive Framework should recognize that higher tax burdens on businesses (along with high compliance costs) could create various economic ripples throughout the international economy.
Addressing tax avoidance is a key political issue for many countries, but these policies should not be discussed without accounting for the size of the current problem, how recent policy changes have addressed it, and what potential impacts might come from this new approach.
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