A strict and robust minimum tax adopted by a critical mass of countries would help to address two significant problems of the international tax system: profit shifting by multinationals and tax competition amongst countries.
The challenge is to persuade a critical mass of countries to properly implement and administer such a tax. As we have argued in the past, this is a “tall order” because of the incentives faced by individual countries. The OECD should be congratulated both for its technical work and its diplomacy in bringing 132 countries to an agreement on July 1. However, despite the fanfare surrounding the agreement, at this point in time we still don’t know if the challenge will be met.
A country that introduced a minimum tax unilaterally, as the USA did with GILTI, could partly address problems of profit shifting by its multinationals. But doing so may raise concerns about tax competition. Companies headquarted in that country may seek to move abroad (which the US tries to counter with anti-inversion rules). If the minimum tax rate is too far below the domestic tax rate, it may fail to stop domestic companies shifting real activity (and jobs) elsewhere. And it may also put those domestic companies that do not move real activities at a disadvantage relative to companies headquartered elsewhere.
These problems would be mitigated if a critical mass of countries adopted a common minimum tax. Recognition of this seems to have determined the US position. To be most effective, a multilateral minimum tax would need to be strict and robust. To be strict, it would have a substantial rate and no substance-based carve out. To be robust, it would be difficult to game. Critically, it would have a mechanism that reduces the tax benefits for businesses that operate in countries outside the minimum tax agreement. In turn, this would reduce countries’ incentives to stay outside the agreement and to defect once they join.
Here’s the rub. The stricter and more robust the minimum tax, the fewer are the countries that might be willing to adopt it. But the fewer the countries that adopt the tax, the less effective it will be.
So, the main challenges for a successful global minimum tax are not technical - although there certainly are thorny technical issues, including the definition of the base. The main challenges are political - ensuring that a sufficient number of countries adopt a strict and robust minimum tax.
The self-congratulatory political statements and eye-catching newspaper headlines would suggest that the matter is now done and dusted. 132 countries have reached an agreement on a minimum tax! “A once-in a century tax revolution” according to French Finance Minister Bruno Le Maire and “an agreement which will really change the world” according to German Finance Minister Olaf Scholz. But what have they agreed to exactly thus far?
The July 1 statement describes the minimum tax as a “common approach”. The statement helpfully unpacks that phrase. It explains that Inclusive Framework (IF) members: “are not required to adopt the GloBE rules, but, if they choose to do so, they will implement and administer the rules in a way that is consistent with the outcomes provided for under Pillar Two, including in light of model rules and guidance agreed to by the IF” (emphasis added) and they “accept the application of the GloBE rules applied by other IF members including agreement as to rule order and the application of any agreed safe harbours.”
So countries have not agreed to adopt a minimum tax. They have agreed that if they decide to adopt a minimum tax, they will do so in a way that is “consistent with the outcomes” of Pillar 2.
Why does this matter? Because a global minimum tax will only achieve its objectives if it is strict, robust and adopted by a critical mass of countries. Of course, it is hard to know what a critical mass is. That depends on how easy it is for multinationals to escape the minimum tax – and that is likely to vary amongst companies. The global minimum tax could still achieve its objectives if a number of IF members do not adopt it, especially if they are smaller players. So the critical mass need not involve all 132 countries. But it must be more than the G7 countries which do seem to already be committed, and it would certainly be more robust if it included the G20.
Unsurprisingly, the July 1 statement does not tell us how many countries will actually adopt the minimum tax; and countries may be awaiting more details before making a decision. One could speculate that the language in the statement signals that some important players were not – yet, at least - ready to sign up to a stronger commitment.
And what about the substance of the “common approach”? Again, this matters because the global minimum tax must also be strict and robust to achieve its objectives.
A minimum tax of 15% will not prevent competition among countries with tax rates above 15%. Given the substance-based carve-out, it may also not prevent tax competition for “substance”, and hence real investment, among countries with tax rates below 15%. Secretary Yellen’s claim that after the July 1 agreement “the race to the bottom is one step closer to coming to an end” may be true, but there are many steps still to go. The US, and other leading countries, were clearly hoping for a stricter minimum tax.
The Under Taxed Payments Rule (UTPR) and Subject to Tax Rule (STTR), set out in the October 2020 Blueprint, appear to be tough mechanisms that reduce the benefit for businesses that operate in countries outside the minimum tax agreement. So, in this sense, the rules seem pretty robust. But, again, this depends on whether there is a critical mass. Also, note that since the agreement is only to adopt rules that are consistent with the outcomes of Pillar 2, should a country wish to do so, this appears to allow discretion (even considerable discretion) to countries when implementing and administering the UTPR and other features of the tax, thus undermining the robustness of Pillar 2.
There are many other issues. The minimum tax would increase the complexity of a system that is already in serious danger of caving under the weight of its complexity. Other anti-avoidance rules are unlikely to be removed, and other complex elements of the system, including profit allocation rules, will remain in place. The minimum tax may reduce distortions to the location of real economic activity, but it is also likely to dampen global investment. There are also concerns about its compatibility with EU law - and claims that this issue is cut and dried (one way or another) should be viewed sceptically.
The minimum tax is likely to primarily benefit developed countries, foremost among which is the US. We can understand low-income countries’ frustration with this outcome, even if it may be partially offset by the STTR, and we would be sympathetic to a different reallocation. But a significant part of the agreement is that IF members will respect the agreed “rule order”.
Finally, introducing Pillars 1 and 2 together also surely dash any remaining belief that the international tax system will follow any clear principle – other than perhaps to make sure that profit is taxed somewhere, anywhere.
Our views on a global minimum tax have not changed. A strict and robust minimum tax properly implemented and administered by a critical mass of countries would have a significant impact on the international tax system. But, given countries’ incentives, achieving this is a real challenge. Significant – even surprising - progress has been made, and this challenge may yet be met, but for now the challenge remains.