Pillar 2: Rule Order, Incentives, and Tax Competition


Two of the most controversial questions relating to Pillar 2 are the extent to which it will allow countries to engage in tax competition, and which countries will collect the tax revenues it generates. The Model Rules published by the OECD/G20 Inclusive Framework on 20 December 2021 provide somewhat unexpected answers to both questions. 

This Policy Brief focuses on two critical elements of Pillar 2: the Substance-Based Income Exclusion (SBIE) and the Qualified Domestic Minimum Top-up Tax (QDMTT). It makes three main points. (i) The addition of the QDMTT effectively alters the rule order of Pillar 2, and thus its distributional consequences. (ii) Pillar 2 effectively creates a floor on “source” country tax competition, but it does so in a roundabout manner. Countries still have an incentive to compete by reducing the Corporation Tax liability they impose on companies, perhaps even down to zero. However, countries now have an incentive to collect a QDMTT equivalent to 15% of Excess Profit. (iii) Pillar 2 increases the incentives for (at least some) countries to reduce the Corporation Tax liabilities they impose on companies, thus increasing the probability that countries reduce Corporation Tax liabilities perhaps even all the way to zero. Importantly, however, as noted, these countries have an incentive to impose a QDMTT. The substitution of Corporation Tax with the QDMTT would be a significant development and the creation of these incentives merits careful consideration.