Paul L. Caron

Friday, January 6, 2023

Weekly SSRN Tax Article Review And Roundup: Elkins Reviews Wardell-Burrus's State Strategic Responses To The GloBE Rules

This week, David Elkins (Netanya, visiting NYU 2021-2023; Google Scholar) reviews a new paper by Heydon Wardell-Burrus (Oxford), State Strategic Responses to the GloBE Rules (2022).

Elkins (2018)The ability of multinational enterprises (MNEs) to reduce their tax liability by exploiting fissures in the international tax regime prompted the OCED to launch its BEPS (Base Erosion and Profit Shifting) initiative. The most recent iteration of that initiative, known as BEPS 2.0, rests upon two pillars. Pillar 1 is designed to allocate taxing rights to countries in which the consumers of digital services are located. Pillar 2 (also referred by the rather inelegant acronym GloBE, for Global Anti-Base Erosion) is intended to guarantee that MNEs are subject to a global minimum tax rate of at least 15%. As Wardell-Burrus points out, one of the novelties of Pillar 2 is that that it treats states as strategic actors, competing with each other to attract investment. Accordingly, many of the rules are designed to limit the capacity of states to engage in certain types of tax competition.

In keeping with this theme, the article analyzes strategies that countries might undertake in response to the GloBE rules (on the assumption that are indeed implemented by a critical mass of countries). To do so, it distinguishes between two categories of countries: (a) low-tax countries, whose primary concern is attracting international investment and to that end are willing to forego taxing the income from such investment, and (b) high-tax countries, who also want to attract foreign investment but simultaneously desire to raise substantial revenue from the corporate tax. While fully acknowledging that there is no such dichotomy and that countries are situated on a spectrum with regard to the balance between attracting investment and collecting tax revenues, it nevertheless adopts the high-tax/low-tax prototype for the purpose of discussion.

With regard to low-tax countries, the article notes that although they place greater value on attracting foreign investment than they do on raising revenue, they are not indifferent to the collection of corporate taxes. In other words, if they can collect tax without deterring investment, they would certainly avail themselves of that opportunity. Therefore, it would behoove such a state to impose a Qualifying Domestic Minimum Top-Up Tax (QDMTT). Failure to do so would mean that the MNE’s country of residence would collect the tax under the GloBE rules. As adopting a QDMTT would not impose any additional financial burden on the MNE, it would not disincentivize investment but merely transfer tax receipt from the MNE’s home country to the source country. Along a similar vein, the article suggests converting non-Covered Taxes (those that are not to be taken into consideration by the MNE’s home country when imposing the top-up tax) into Covered Taxes.

The next set of strategies for low-tax countries involves methods of lowering the effective corporate tax rate while maintaining the pretense of imposing a corporate tax rate of at least 15%. The purpose of lowering the effective corporate tax rate is to make the country an attractive investment venue. The purpose of maintaining the pretense of a 15% corporation tax rate is to preserve that attraction by preventing the imposition of a top-up tax by the MNE’s home country. One strategy involves timing benefits. Under the GloBE rules, deferred tax liability is often taken into account as if the tax were paid in the current year. Due to the time value of money, the effective burden of a differed tax might be considerably less than the nominal tax obligation. Another strategy involves the use of refundable tax credits. Any attempt to measure tax burdens must take into account the possibility that a country will collect tax with one hand and return the tax to the taxpayer, directly or indirectly, with the other hand. In addressing this issue, Pillar 2 distinguishes between what it describes as Qualified Refundable Tax Credits (QRTCs) and other credits (non-QRTCs). Whereas non-QRTCs are considered a reduction of the tax paid, QRTCs are viewed as additional income. True, this additional income is potentially subject to the top-up tax, but as the article demonstrates, this effectively reduces the tax rate from 15% to 2.25% (which the source country itself can capture by means of an appropriate QDMTT). From the perspective of the source country, one problem with QRTCs is that, as their name implies, they must be refundable, invoking the specter of the country paying out in credits more than it receives in tax. The article describes how source countries might structure their QRTC regime to reduce that risk. In this vein, it also discusses transferable tax credits and tax equity partnerships.

The next part of the article discusses strategies available to high tax countries. One is bifurcating its tax system, imposing high tax on relatively immobile types of income and low tax on more mobile types of income. Doing so could enable the country to compete for investment while maintaining an average tax rate about the 15% minimal threshold. For example, a country with a 30% corporate tax could adopt a “patent box,” exempting from tax income derived from intellectual property developed in its jurisdiction. Such a regime could attract IP investment from diversified MNEs without triggering a pop-up tax in any other country. A second strategy for high-tax countries is to expand their Controlled Foreign Corporation (CFC) rules so as to secure revenue that might have gone to another country. The idea here is that Pillar 2 establishes an ordering rule for top-up rights. Generally, the source country goes first (QDMTT), then the jurisdiction of the ultimate parent (under the Income Inclusion Rule), then other countries to which a corporation has a substantive connection (in accordance with the Undertaxed Payments Rule). By imposing a 15% on the GloBE income of a CFC, the country could effectively “jump the queue” and collect tax that would otherwise have gone to another country.

Finally, the article considers some countermeasures that might be taken by the designers of GloBe to confront the strategies described.

To my mind, the most interesting aspect of this article is the parallel between classical tax avoidance on the one hand and strategies that countries might adopt in response to the GloBE initiative on the other. Deferring income, accelerating deductions, pooling high-taxed income with low-taxed income in response to limitations on the foreign tax credit, and so forth are time-honored techniques for reducing tax liabilities. To protect their tax bases, countries tend to respond with specific or general anti-avoidance rules (SAARs and GAARs). Now, the article suggests, with the global community attempting to restrict the ability of countries to impose taxes as they wish, it is to be expected that countries (whether more developed or less developed, “high tax” or “low tax”) will adopt similar techniques to circumvent those restrictions. The article also intimates that to protect the GloBE structure, its drafters may need to consider countermeasures. Whether these will follow the pattern of familiar SAARS and GAARs remains to be seen.

Of course, reasonable minds may differ with regard to the lessons that we should learn from this parallelism. I will refrain from expressing my own opinion. My goal here was simply to point out the parallels and leave readers to draw their own conclusions.

Here’s the rest of this week’s SSRN Tax Roundup:

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