Today, the Organization for Economic Co-operation and Development (OECD) released Model Rules for the Global Minimum Tax (also known as Pillar 2). These rules are designed to apply to multinational companies whose aggregate turnover exceeds 750 million euros and impose a minimum effective tax rate of 15% on the profits of such companies.
In the coming days, countries will reflect on how to incorporate these rules into their national tax codes. The rules are complex and some countries may choose to put them in place in addition to the pre-existing multinational corporate tax rules. However, countries should also consider ways to reform their existing rules in response to the minimum tax.
Global minimum tax rules do not require any change in national tax legislation. The approach is voluntary, but if enough countries adopt the rules, then even countries that do not adopt them should assess their tax policies for simplification, revenue neutral reforms, and policies that support investment. that would not be eroded by the minimum tax.
Many jurisdictions around the world offer tax preferences or structure their tax rules to allow businesses to be taxed at rates below the 15% rate contemplated by the minimum tax.
The global minimum tax, however, can create problems for these policies. For example, let’s say a large multinational corporation headquartered in country A makes an investment in country B that is eligible for a 10-year corporate tax exemption. Even though the profits from the investment will not be taxed by country B, the overall minimum tax would allow country A to apply the minimum rate of 15% to these profits.
Country B may choose to change its tax exemption policy to tax these profits locally rather than allowing tax revenues to go to country A. If country B applies a high corporate tax rate to companies that are not not eligible for a tax exemption, the additional income from the end of the preferential policy could support a more general tax reform (broadening the base and lowering rates, according to the mantra).
However, not all tax policies will follow such a simple analysis, and the model’s rules are only useful for evaluating policies to the extent that they result in effective tax rates below 15% for large multinational companies.
At the risk of oversimplifying, I have crafted a rough categorization of policies that countries will most likely choose to change in the context of minimum tax rules. Policies facing a red light are primarily those that provide for a zero effective tax rate. Yellow Light policies provide for reduced effective tax rates of less than 15 percent but not zero. Green light policies are those that reduce the cost of investment without triggering the minimum tax, unless the general corporate tax rate is very low.
While the list below is not exhaustive, policymakers can use this framework to prioritize the type of assessments that will be needed to determine the direction tax policy should take when minimum tax rules are in place. Once this assessment is complete, policies that generally encourage capital investment and local hiring should be prioritized, as they align with areas where the minimum tax has significant exceptions.
Even in the context of the global minimum tax, countries can and should pursue principles-based, competitive and growth-friendly policies that provide sufficient income while minimizing economic distortions.
- Tax holidays
- Zero tax free zones
- Zero-rate corporate tax systems
Countries that have rules that provide for a zero tax rate on corporate profits either through tax exemptions, free trade zones or because there is no corporate tax face a clear choice in the context of the global minimum tax.
As described in the example above, countries can choose to change their policies and collect the revenues themselves (potentially in the context of a broader reform) or they can allow a foreign jurisdiction to collect the associated revenues. at the minimum effective rate of 15%.
The choices may be easier for jurisdictions that have a general corporation tax that applies outside of tax holidays or certain areas than for countries that do not apply corporation tax at all.
The latter will have to assess whether the additional revenue will be worth the administrative costs of establishing new rules and systems for collecting a tax that they had previously chosen not to include in their laws. In our recent report, we noted that 15 jurisdictions around the world do not have corporate income tax.
- Reduced rate incentives (e.g. patent boxes)
- Business tax credits (including refundable credits)
- Direct funding programs
- Corporate tax rate below 15 percent
This category of policies will likely prove more difficult for governments to assess given the global minimum tax.
If a country has a patent box rate of 10% (and the patent box conforms to the OECD guidelines), it can be assumed that the country should simply increase the patent box rate to 15% or repeal it altogether. . However, if the country has a general corporate tax rate of 25 percent, a business could see some of its profits subject to the 10 percent patent box rate and the rest to the general 25 percent rate. Even so, one option that should be considered is to repeal the patent box and lower the corporate tax rate for overall revenue neutral reform.
Nineteen OECD countries have a policy that provides either an exemption or a lower rate for revenues from certain patented technologies, and in each case the applicable rate is less than 15%. However, Italy has already opted for the elimination of its patent box in favor of new deductions for research and development costs.
Under the rules of the global minimum tax model, refundable tax credits and direct financing will increase a business’s income and reduce the measured effective tax rate. If a business benefiting from these policies is in a jurisdiction where the corporate tax rate is low enough, the size of the credits and funding has the potential to push a business below the overall effective tax rate threshold of 15%.
It will also be necessary to assess general business tax credits, as a country offering tax credits for certain activities may find that the businesses receiving these credits simply pay additional taxes elsewhere.
Countries with tax rates below 15% should consider implementing the new rules only for large companies targeted by the minimum tax or increasing the general corporate tax rate. In a recent study, we found 20 jurisdictions that have a corporate tax rate of less than 15% (but greater than zero).
Ireland is expected to adopt minimum tax rules for large multinationals while leaving its 12.5% rate in place for all other businesses.
Yellow Light policies will be difficult to assess as they will depend on many factors, including the overall corporate tax rate, the number of businesses benefiting from the preferences, and the ambition of lawmakers to undertake general reform that could eliminate or reduce several policies aimed at improving the tax system as a whole.
- Accelerated depreciation (full load shift)
- Last In, First Out (LIFO) inventory processing
- Unlimited loss carryforwards
Global minimum tax rules do not mean that all corporate tax policies need to be rethought. In fact, how the rules calculate the minimum tax rate is very important. The rules use the concepts of tax deferred assets and loss carryforwards which allow some important characteristics of good tax systems to be outside the area of policies that may need to be reconsidered.
These policies include the accelerated depreciation (or full expensing) of assets, like the rules currently in effect in the United States and Canada. Super-deductions for business investments like the UK would also be spared. Many countries use depreciation allowances to stimulate investment in times of economic downturn. The policy response to the pandemic has seen eight OECD countries adopt accelerated depreciation under certain circumstances.
Last-In-First-Out (LIFO) inventory deductions allow businesses to deduct the cost of inventory from the price of the most recently acquired items and thus help mitigate the impacts of volatile prices or inflation. This reduces the tax cost of acquiring inventory. Fourteen OECD countries allow companies to use LIFO for tax purposes.
Finally, policies allowing companies to carry forward their losses indefinitely would not need to be reassessed. The model rules specifically allow loss carryforwards. This allows the tax rules to minimize the likelihood that a business will fall under the minimum tax rules simply because it is in the start-up phase with significant up-front costs. As with capital deductions, many countries have relaxed their loss deduction policies in response to the pandemic.