The OECD's Impact Assessment presents its international tax reform proposal as the least worse-case scenario rather than a significant improvement on what we already have. The proposal is based around two pillars: Pillar One seeks to re-allocate taxing rights to market jurisdictions whereas Pillar Two is intended to ensure a minimum level of effective worldwide corporate taxation.
Despite running to 283 pages, the Impact Assessment does not make clear who the winners and losers will be (which is partly because no jurisdiction-specific estimates were published and partly because behavioral changes resulting from the proposal may bring additional benefits that are not easily quantifiable). One expected outcome does, however, stand out: the negative effect of the proposal on investment and economic activity. While this negative effect - a less than 0.1% reduction in global GDP over the long term - is modest, any negative effect is surely undesirable in the current economic climate. On the other hand, this modest decrease in global GDP may seem a price worth paying to avoid the counterfactual scenario of multiplying unilateral measures with ensuing disputes and trade tensions, leading to an even larger decrease in global GDP. But let's look at some aspects of the Impact Assessment in more detail.
How much tax is expected to be raised?
Pillars One and Two combined could increase global corporate income tax (CIT) revenues by 1.9% to 3.2% (USD 50-80 billion), depending on various factors, including the final design and parameters of the Pillars. The lion's share of this increase is attributable to Pillar Two: expected direct revenue gains from the introduction of a minimum effective tax rate are in the range of USD 23-42 billion and a reduction in profit shifting is expected to raise USD 19-28 billion.
These figures do not include potential gains related to the application of Pillar Two by US MNEs, however, as they are expected to remain subject to the US GILTI regime which will coexist with Pillar Two (although this is yet to be agreed). Adding in the revenue gains of the GILTI regime would take the total effect to up to 4% of global CIT revenues. But importantly, these figures do not take into account the following factors which could mean that revenue gains will be less than estimated:
- any decrease in MNE profitability because of COVID-19
- reductions in profit-shifting resulting from the implementation of the BEPs project
- the effect of changes to the US tax code made in 2017 or of certain provisions that may already allow jurisdictions to levy taxes on profit that would otherwise be subject to low levels of effective taxation (e.g. withholding taxes, CFC rules)
Which jurisdictions stand to gain the most?
As there was no consensus on whether jurisdiction-specific information should be made public, the Impact Assessment groups jurisdictions together as low, middle and high income.
- The combined revenue gains of Pillars One and Two are estimated to be broadly similar across the three categories, but investment hubs (those jurisdictions whose inward foreign direct investment exceeds 150% of GDP) are expected to lose tax base, although not necessarily tax revenue.
- Higher income jurisdictions are likely to get more out of Pillar Two because gains from the income inclusion rule accrue to the jurisdiction of the ultimate parent of MNE groups, which will often be a high income jurisdiction.
- Investment in jurisdictions which currently offer low effective tax rates may suffer, but the negative effect could be reduced if Pillar Two includes a formulaic substance-based carve-out that excludes a fixed return for substantive activities from the scope of the rules.
Who will be paying more tax?
Large and profitable MNE groups in the digital-oriented and intangible intensive sectors will experience the main impact of Amount A of Pillar One. The impact of Pillar Two would fall on large MNE groups with low-taxed profits, including due to profit-shifting behaviour, but not on US MNEs if it is agreed, as the US proposes, that the US would collect revenues from GILTI, instead of under Pillar Two, on the low-taxed foreign profit of US MNEs.
Who will bear the cost of the additional tax?
As an indication of whether the additional tax to be paid by MNEs will be borne by shareholders, employees or customers, we should perhaps look to the approach that MNEs have so far taken to digital services taxes . The largest MNEs have responded to the UK’s digital services tax by announcing they intend to pass on this cost to customers, e.g. by increasing the price of digital advertising, or the price for third party sellers who sell on the platform.
What are the non-tax benefits of Pillar Two?
The non-tax benefits of Pillar Two were already touched upon in Andrea's and Francesco's earlier post.
Noting that a key objective of Pillar Two is the prevention of profit shifting in order to level the playing field for smaller groups or companies which do not engage in profit shifting, the Impact Assessment reports that MNEs have in the past used tax savings from profit shifting to crowd out other firms, predicting that Pillar Two would help end this anti-competitive practice.
It is expected that, when the influence of corporate taxes on investment location is removed, non-tax factors are expected to have more impact on location. Investment would be more likely to be located where it is the most economically productive, rather than in the jurisdictions that provide the most favourable corporate tax treatment. This would benefit jurisdictions with good workforce education, skill supply, infrastructure, and strong legal and regulatory systems. Jurisdictions which are not so strong in these areas would no longer be able to use low corporate tax rates to generate investment.
How will paying more tax impact the volume of MNE investment?
The impact on the volume of MNE investment is not expected to be significant. Although research has shown that MNE investment in a jurisdiction is negatively affected by effective corporation tax rate increases in that jurisdiction, large, highly profitable MNE groups, which are more likely to be impacted by the proposals, appear to be less sensitive to taxes in their investment behaviour than the typical MNE group.
This means that increases in group-level investment costs as a result of Pillars One and Two may result in only a limited reduction in global investment levels which is why overall, the negative effect on global GDP stemming from the expected increase in tax revenues associated with the proposals is estimated to be less than 0.1% in the long term. The Impact Assessment suggests that this may be offset by other less quantifiable channels, such as the positive effect of the proposals to increase tax certainty, the increased efficiency of global capital allocation, and avoiding the more damaging effect on global GDP which unilateral measures would have.
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