On Friday, the Organisation for Economic Co-operation and Development (OECD) hosted the second of two days of a public consultation on changes to international corporate taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. rules. The consultation is in the context of the Inclusive Framework on Base Erosion and Profit ShiftingProfit shifting is when multinational companies reduce their tax burden by moving the location of their profits from high-tax countries to low-tax jurisdictions and tax havens. which is made up of delegates from more than 135 countries and is focused on policies that reduce opportunities for tax avoidance by multinational companies. The current proposals being considered would change both where and how much companies pay in corporate taxes.
Friday’s session was focused on Pillar 2 of the OECD proposal, regarding bringing about a global minimum tax.
The consultation highlighted the real challenges in designing such a tax. Countries around the world have diverse approaches to taxing business income. That diversity is represented in the range of corporate tax rates, but it also shows up in tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates. definitions like the treatment of capital expenses or business losses. Also, some countries do not even have a corporate tax.
This means that the OECD is faced with a challenge of defining a tax base and a tax rate that accounts for the underlying approaches taken by countries. The OECD has proposed to build the tax base using financial records like those reported to shareholders as a foundation. Calculations would rely on the reported profits and cash taxes paid to determine whether a company has paid a sufficient level of tax.
The consultation highlighted the need to ensure that relying on financial records does not result in businesses paying an inordinate amount under the global minimum tax. Examples were given by businesses that have investment projects that only pay off over long horizons. In the early years, much capital investment or research and development is done before a project or product is profitable in later years. Using financial profits and cash taxes would have these businesses appearing as though they have very low effective tax rates in the investment and research phases while facing high effective tax rates in later years.
One suggestion to adjust for this timing difference was to use deferred tax accounting rather than cash taxes to determine whether an appropriate level of tax has been paid. To the advocates for this approach, it seemed to be the key solution for addressing timing differences. However, a counterview was that deferred tax accounting is based on potential future tax liabilities while cash tax is based on actual payments for tax.
It was highlighted that one reason to ensure this issue is resolved is because the decision will directly impact business investment costs. If a company is faced with a minimum tax during a project’s beginning years and pays normal corporate taxes when that project is profitable, the combined tax costs may erode the project’s profitability to the extent that it is not worth undertaking.
This may seem abstract, but it is worth grounding the discussion in the immense research investment that goes into products like vaccines or medical equipment that over the last year have been even more recognized for their importance.
The consultation also covered questions of overlapping rules and implementation challenges. The OECD proposal includes three main rules for the minimum tax: the income inclusion rule, the under-taxed payments rule, and the subject to tax rule. The potential for overlap of the three rules and the need for a coordination mechanism like a multilateral treaty instrument was mentioned by several participants. Without coordination and simplification, it is likely that Pillar 2 will mean significantly higher business compliance costs and not just extra tax costs.
From a U.S. perspective, it was made clear that U.S. businesses are already subject to an effective minimum tax regime on Global Intangible Low Tax Income (GILTI) which is paired with an 80 percent limit on foreign tax creditA tax credit is a provision that reduces a taxpayer’s final tax bill, dollar-for-dollar. A tax credit differs from deductions and exemptions, which reduce taxable income, rather than the taxpayer’s tax bill directly. s and further complicated by expense allocation rules. The OECD has outlined the potential for GILTI to be deemed an approved income inclusion rule under Pillar 2.
This opens the question for whether other minimum tax or anti-base erosion rules in other countries would need to be amended, repealed, or allowed to coexist with Pillar 2. As with Pillar 1, there are many open issues that countries will need to evaluate as they move toward the summer deadline for an agreement.
If not designed well, Pillar 2 has the potential to increase investment costs for businesses all around the world. In the context of the coming global recovery from the pandemic, policymakers should be especially cautious to avoid unnecessarily burdening business investment.
You can also read about Day 1 of the OECD Consultation on International Tax Reform Blueprints.
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