Muddled goals, broad scope lead to unexpected costs of OECD tax agreement

By Alex M. Parker, Principal, Capitol Counsel LLC, Washington, D.C.

Last year’s global minimum tax agreement at the Organization for Economic Cooperation and Development and the G-20 coalition—hailed by the White House as an historic accomplishment in the fight against tax avoidance—has revealed a scope much broader than most anticipated, and even the Biden Administration seems to have been taken off-guard by what it could affect.

Provisions of the agreement, revealed in technical commentary released by the OECD in the past months, could affect everything from green energy incentives to affordable housing credits in the U.S.

Growing domestic opposition to the deal threatens its U.S. implementation, and demonstrates that even after months of negotiations, the project’s participants still have conflicting visions for what the policy is meant to achieve.

The tension broke out into the open in recent weeks, as interest groups addressed the U.S. Treasury Department with their concerns.

On March 22, a coalition of business groups including the U.S. Chamber of Commerce, the Silicon Valley Tax Directors Group and the Business Roundtable penned a letter to U.S. Treasury Secretary Janet Yellen, expressing concern that the OECD’s model rules could target U.S. companies that use tax incentives such as the R&D tax credit and accelerated depreciation.

Thirty affordable housing advocacy groups followed with a letter of their own on April 5, claiming that the same policy could negate low-income housing tax credits, new market tax credits— even tax-exempt bonds used by state and local governments.

These come amid heightened criticism from Republican members of Congress, who have formed lockstep opposition to the agreement since it became a high-profile priority for the Biden Administration. The possibility that it could raise foreign taxes on U.S. companies gives the GOP new leverage to blast the administration with.

Both letters concern the UTPR of Pillar Two, the second plank of the two-part package of reforms. The rule initially stood for the undertaxed payment rule, and in 2020 the OECD promised it would have a “relatively narrow” scope in practice, so long as countries implement the primary income inclusion rule (IIR). But what started as a backstop to prevent scofflaw countries from attracting business by refusing to participate became one of the primary tools for harmonizing corporate tax rates across jurisdictions—apparently the project’s new goal.

The IIR was partially based on the U.S.’s own tax on global intangible low-taxed income (GILTI), a key provision in the international framework of the 2017 Tax Cuts and Jobs Act. Building on proposals to include a strong anti-abuse rule while shifting to a territorial system that exempts most overseas income, the GILTI tax targets income held by U.S. companies in low-tax foreign jurisdictions. It’s meant to capture income from valuable intangible assets, like intellectual property or branding rights, that companies often use in complex tax structures because they’re relatively easy to move from country-to-country, and can be hard to value. But rather than define those assets directly, GILTI uses a proxy formula based on how much the taxpayer holds in foreign tangible property—the less in physical assets, the more in intangible income.

The IIR of Pillar Two works in a similar way. If countries enact the recommended legislation, they will tax their own companies if those companies hold income that is taxed below 15% in a foreign jurisdiction, for an amount that would make up the difference. The policy includes a carveout for not only depreciable tangible assets, but payroll as well.

When the OECD first floated this proposal in January 2019, it said the goal was to address “the continued risk of profit shifting to entities subject to no or very low taxation.” But as the project has continued, the rhetoric around Pillar Two began to shift. Government officials, especially those in the Biden Administration, touted the policy as a way to end the “race to the bottom,” to put a universal floor to corporate tax rates and end the incentives to tax competition.

The UTPR was initially based on the U.S. base erosion and anti-abuse tax, as well as several other anti-abuse rules around the globe which affected outbound payments to low-tax jurisdictions. It, too, was originally limited to deductions on intercompany payments to jurisdictions with low effective rates, and which were not covered under the primary income inclusion rule.

Perhaps due to practical and administrative realities, the final UTPR is no longer tied to payments. It is, essentially, a mirror image of the income inclusion rule. The IIR is a tax on subsidiaries, carried out by the headquarters jurisdictions. The UTPR is a tax on headquarters companies, carried out by the subsidiary countries. Together, they ensure that the excess profits of all corporations are taxed at the minimum 15% rate, no matter where they are.

There’s an elegance to it. But not everyone seemed to have grasped the implications until it was put into writing.

There was a strong consensus among countries to eliminate tax havens—jurisdictions with low or permissive taxes, where corporations place large amounts of income but little or no physical operations. But countries may be more reluctant to tie their own hands and forgo domestic incentives for the sake of a new, multilateral tax landscape.

A big part of the conundrum is the new measure for taxable income that the OECD will use to enforce the global minimum tax. Pillar Two uses financial information, such as what corporations report to shareholders, as the basis for taxation. In many respects this is similar to the “book minimum” tax that the Biden Administration proposed as part of the Build Back Better agenda, to ensure that companies paid their “fair share,” according to Biden.

Pillar Two’s measure of income was adopted for convenience, not as a base erosion rule itself. Generally accepted accounting principles were the easiest way to come up with a single tax base all countries could agree to. But it ultimately creates a very similar policy, disregarding national tax incentives which countries enact into law.

This is why U.S. companies are worried that they could fall under the UTPR, even as the U.S. corporate tax rate is well above 15%. U.S. corporations may have low or negative effective tax rates due to incentives Congress enacted into law, triggering UTPR payments in other jurisdictions.

The record shows surprisingly little debate on whether to protect policy-based incentives before the agreement was announced, despite the potentially huge impact. And now with an agreement in writing, the OECD has sought to limit future discussions to implementation questions.

The administration has already shown a willingness to protect the R&D credits, agreeing to a carveout in the BBB’s proposed book minimum tax. Once again, it’s revealing a contradiction in heightened tax rhetoric—while there is a strong political urge to raise effective corporate tax rates for the sake of fairness, the individual policies that can keep the rates low are often even more politically favored.

Treasury’s recent Green Book proposed tweaks that could protect those incentives by conforming them to the OECD standards. If Congress changed the R&D credit, or other incentives, to be refundable it could limit the UTPR impact under the OECD guidelines. But Congress is typically loath to change its laws based on international standards. And many observers doubt that the legislature will be able to pass any tax changes at all this year.

While critics of the OECD project are calling on the U.S. to pull out of the agreement, the project may be at a stage that’s impossible to reverse. Other countries can, and no doubt will, enact the provisions regardless of what the U.S. does. Even if the OECD were to renounce its own agreement, countries could move forward with these rules as unilateral measures.

However, the controversy could threaten the stability and legitimacy of the new framework, raising the possibility of inconsistent application and even further trade tensions—what the agreement was meant to prevent.

The administration can hope that there’s still enough wiggle room in the OECD standards to limit the U.S. impact. The substance-based carveout, for instance, may cover research-heavy companies that would otherwise fall under the UTPR. In a sense, that’s its purpose—to allow countries to incentivize real economic activities rather than on-paper profit-shifting.

But the controversy could mar what the administration has touted as an historic global accomplishment. Everyone is getting a harsh reminder of one of the oldest maxims in tax policies—perhaps expressed best by Sen. Russell Long of Louisiana.

“A tax loophole is something that benefits the other guy. If it benefits you, it’s tax reform.”

·       Alex M. Parker is a Principal at Capitol Counsel LLC, Washington, D.C.

The views expressed here are the author’s own and do not reflect the views of Capitol Counsel or its clients.