Tax Tax Revolution

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Scholars argue that implementing a global minimum tax would help solve the tax competition issue.

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One year ago, 137 countries signed onto an agreement widely hailed as the most ambitious tax overhaul in a century: the Organization for Economic Cooperation and Development’s (OECD) plan to embrace a global minimum corporate tax.

That unprecedented milestone continues to show signs of promise, according to two scholars in a recent article.

Reuven S. Avi-Yonah of the University of Michigan Law School and Young Ran Kim of Cardozo Law posit that a successful implementation of a global minimum corporate tax—what is commonly referred to as “Pillar Two” of the OECD’s ongoing tax reform initiatives—would be an effective remedy for tax competition.

The importance of a global minimum tax has its roots in globalization—which has become a “double-edged sword” for many countries, according to Avi-Yonah and Kim. Although corporate tax cuts increase foreign investment, creating job opportunities and economic growth, these benefits are minor when the country has to offer meager tax rates to secure foreign investment from other jurisdictions’ competition. Consequently, countries face a “race to the bottom” where the tax rates needed to attract foreign investment are so low that countries might not benefit from the investments.

Furthermore, Avi-Yonah and Kim clarify that low tax revenues mean a low social safety net, which is an essential for protecting a country’s low-income population from poverty and hardship. Restraining tax competition will benefit all countries, they argue. Nonetheless, Avi-Yonah and Kim argue that, because multinational enterprises are highly mobile, ending tax benefits in one country will only cause them to relocate elsewhere. As a result, source countries hosting foreign investments cannot curb tax competition unilaterally.

Avi-Yonah and Kim argue that the best solution is to limit tax competition by adopting a global minimum tax. Under Pillar Two, every multinational enterprise that has annual revenue in excess of the €750 million threshold will be subject to a global minimum tax rate of 15 percent. The OECD plans to achieve this goal through two interlocking domestic rules and one treaty-based rule: the income inclusion rule, the undertaxed payment rule, and the subject-to-tax rule.

The income inclusion rule requires a parent company of a multinational enterprise to top-up its effective taxes paid in any tax jurisdiction it does business in through a subsidiary to yield a 15 percent tax rate. A supplementary rule to the income inclusion rule is the undertaxed payment rule, which requires the source country to deny the subsidiary’s deduction for payment to the parent entity, as long as the residence country does not impose this 15 percent tax rate on the parent entity. Avi-Yonah and Kim explain that the second measure serves as an insurance policy against countries that refuse to implement Pillar Two.

The subject-to-tax rule targets intercompany payments that exploit treaties to shift profits to low-tax jurisdictions. The rule allows source countries to impose an additional tax of up to 9 percent on payments that a subsidiary in their jurisdiction makes to a parent company in the residence country if the residence country taxes that payment at less than 9 percent. Nonetheless, the treaty rule only applies to certain payments, such as interest and royalty.

Pillar Two is a complex plan that requires international cooperation. Nevertheless, Avi-Yonah and Kim posit that once the countries cooperate, achieving the goals of Pillar Two is within reach. They explain that achieving the objectives of Pillar Two requires only the cooperation of G20 nations, which account for nearly 90 percent of global multinational enterprises, since Pillar Two relies on the residence countries’ taxation.

Moreover, Pillar Two’s fruits are rewarding. Avi-Yonah and Kim emphasize that approximately $150 billion in additional global tax revenue would be generated annually at a 15 percent global minimum tax rate. In addition, the various corrective measures imposed on both the countries of origin and the countries of residence will reduce the multinational enterprises’ motivation to engage in base erosion and profit shifting because they will pay a significant minimum tax, blindly to their location or profit source.

Nevertheless, Avi-Yonah and Kim express concern about certain significant carve-outs and reservations in the global tax deal. To wit, to obtain the consent of as many countries as possible, the agreement includes various carve-outs. For example, as a condition of its participation in the deal, China negotiated a clause that would limit the effect of the global minimum tax on companies starting to expand internationally, out of the fear that the expansion of the Chinese companies will decelerate due to Pillar Two’s effects.

Avi-Yonah and Kim explain that although compromise is needed to achieve a global tax deal with almost 140 member states, significant carve-outs are not desirable. These carve-outs, they highlight, are a stumbling block to achieving harmony in taxation, contending that it significantly weakens the effectiveness of the tax goals in countries fully committed to its rationale.

Despite what they perceive to be its shortcomings, Avi-Yonah and Kim argue that Pillar Two promises a feasible option for eradicating global tax competition. Ultimately, they recommend that all countries implement Pillar Two to overcome tax competition and maintain a robust social safety net.