An OECD-led global agreement continues to impact the international corporate taxation landscape, with the new regulations due to take effect on January 1 and heralding significant changes, particularly with the introduction of Pillar Two.
Pillar Two focuses on introducing guidelines tailored to ensure multinational companies pay minimum level taxation, with a nuanced treatment of tax credits being a decisive component. The difference between the treatment of refundable and non-refundable tax credits potentially presents a loophole, linked to the principles of equitable tax.
Theoretically, treating refundable credits as income instead of a reduction in taxes creates a potential opening for state-supported tax-avoidance strategies, which the Organisation for Economic Co-operation and Development’s (OECD’s) Base Erosion and Profit Shifting initiative aims to eradicate. A policy solution may involve a broad overview of total state fiscal concessions to specific multinational taxpayers.
Tax credits play a crucial role for states aiming to draw foreign investment via their tax codes. Value transfers processed through a tax credit system can effectively neutralize a higher tax rate. If there is a tax credit linked to 10% of profits, this theoretically halves a 20% tax on gains. Besides, given its long-standing use, the tax credit system helps save significant administrative overheads and provides an attractive effective tax rate for potential foreign investors.
Under Pillar Two, low-tax countries are under pressure to provide adequate taxes on multinationals who might view them as wealth-reservoirs. If a sufficient number of countries agree to a global minimum taxation initiative and gain the power to tax multinational entities managed under-taxed by another nation, a kind of decentralized enforcement effect is foreseeable. The competitive tax advantages offered by one country to a multinational could be neutralized if another country—where the multinational operates—decides to collect the difference. Consequently, a detailed policy concerning credits is required, depending on their refundability.
A highlight of Pillar Two is its distinct treatment of refundable and non-refundable tax credits. For instance, a qualified refundable tax credit—considered income—is not treated as reduction in taxes paid under Pillar Two. In contrast, non-refundable tax credits reduce taxes paid.
While nations trying to draw foreign income via tax sheltering have clear incentives to maintain high nominal tax rates and reimburse investors by other means, states seeking to leverage their tax codes to attract investment must look at value-transfer from the state to taxpayer tactics. Cash grants could help maintain a high covered tax rate, avoiding other countries capitalizing on any left-over tax revenue, while simultaneously minimizing the taxpayer’s effective tax rate.
Essentially, a comprehensive, universal approach to value transfers is deemed necessary to ensure covered tax rates’ compliance with the global minimum tax. Such a course of action would challenge traditional tax shelter states’ methods of reducing a nominal tax rate to a more attractive effective tax rate.
The column by Andrew Leahey, tax expert and principal at Hunter Creek Consulting, suggests that, propelled by Pillar Two’s diktats, policy-makers need to reconsider how value can be transferred to taxpayers to reduce their contributions back to societies where they operate. It’s these types of state fiscal concessions that should correspond with global income in deciding whether a multinational taxpayer is paying their equitable share.
To read more from Andrew Leahey, access Technically Speaking.