The US cuts a big tax loophole into Pillar Two

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Earlier this month, the United States secured a significant opt-out for US multinationals from the OECD’s Pillar Two minimum tax rate. Zorka Milin, the policy director of the FACT Coalition, delves into the complexities of what this means.

Including:

· A brief history of the US and the global minimum tax (to 06:35)

· How will US multinationals gain from the new opt-out? (to 13:14)

· US bullying has weakened Pillar Two, but it should survive (to 18:00)

· Are other new exemptions a Trojan Horse? (to 21:50)

· What does this mean for the UN tax convention? (to 26:20).

 

Here is a transcript, edited for length and clarity.

Diarmid:

Hello, this is Critical Takes on Corporate Power and I'm Diarmid O'Sullivan.

Five years ago, a group of countries led by the OECD produced a set of global rules for a minimum tax rate on corporate profits of 15 per cent, known as Pillar Two.

Pillar Two was a breakthrough at the time because it offered to end the ultra-low taxation which is enjoyed by some multinationals. More than a hundred countries have signed up to it and some have enacted it into law.

But earlier this month, the OECD announced an exception to those rules for multinationals from the United States, which include some of the biggest companies in the world. They're calling this a “side-by side agreement”.

To make sense of what this means, I'm delighted to be talking to Zorka Millin, who is policy director at the Fact Coalition in the United States. FACT stands for Financial Accountability and Corporate Transparency.

Zorka, thanks very much for making time to talk.

 

Zorka Milin:

Thank you.

 

Diarmid:

So perhaps you could start by giving us a very brief history of Pillar Two. What was it intended to achieve and how did it work before this new agreement?

 

Zorka Milin:

That's a great place to start. It was meant to stop this global race to the bottom that we had in international corporate taxation where large multinational companies were paying rock-bottom effective tax rates because they were able to play games with tax havens. This agreement was quite revolutionary at the time.

I want to take a step back though to just a few years before that, because I think it’s interesting context that is often not a part of these discussions that the precursor for this idea of having a corporate global minimum tax rate is actually a US idea. It comes from [US] Republican policies, actually.

As part of the 2017 tax reforms that were passed during the first Trump term, there was a new tax policy concept included in the legislation with the charming acronym of GILTI, which stands for Global Intangibles Low Taxed Income.

So it was targeting the income of US multinationals that was parked in tax havens, especially intangibles income [income from intellectual property and other non-physical assets] because that’s the easiest to move around. Much easier than moving factories and jobs and other kinds of tangible assets.

A lot of these tax games were played with intangibles in places like Ireland and other tax havens and the US Congress with a Republican majority decided to do something about this. So they introduced a minimum rate rate that applies on foreign income.

And then there was a sense that “why should only US companies be subject to this?”, so they went to the OECD and they said “everyone else should do something like this, we think it’s a good idea.”

So the origin of this is actually a Republican one and I think it’s important not to lose sight of this, because of what happened after that. The OECD had these negotiations which took place mostly under the Biden administration and US Treasury Secretary [Janet] Yellen at the time was a huge champion and the [Pillar Two] agreement was signed.

And then there was a snag with the US not being able to enact the agreement into its own law. There are some important differences between how the US regime works and how the globally agreed Pillar Two rules work. They’re similar concepts but the technical details are different.

Fast forwarding to what just happened a couple of weeks ago, we had this so-called “side-by-side agreement”. You could call it a compromise. I might use some other words. But countries agreed to treat US companies differently than companies from other countries, so there was this introduction of a double standard which poses all kinds of questions, both in terms of “is there a competitive advantage [for US firms]” and “what are the revenue impacts?” but also legitimacy questions for the OECD. Its critics have been quite vocal about challenging the OECD’s legitimacy and I think this is only going to intensify that.

 

Diarmid:

We'll talk in a minute about the mechanisms of all this because for an outsider, like most of the stuff that comes out of the OECD, it’s an infernally complex set of interlocking mechanisms.

I think you raise a really interesting point about the Republican origins of the US approach. What was the US approach in the case of the side-by-side agreement? Is the Trump administration’s logic that: “we already have these rules so we don’t need to do the OECD’s as well”? Although, as you point out, the rules don’t do exactly the same thing.

 

Zorka Milin:

That's right, exactly. There was the argument that the US is already doing a good job taxing its multinationals which is,  I’ll just say as an aside, hard to take seriously if you follow the tax debates and the tax rates of American multinationals.

But yes, that was a part of their argument. And then it was framed in terms of the importance of tax sovereignty for the US, that the US and only the US should get to decide how its companies are taxed.

Now there are a lot of issues with that framing because it glosses over the fact that this agreement is not really a win for the US government. The US is not going to increase its own tax revenues as a result of this. It’s really only a win for US corporations who get to play by a more lax set of rules than companies from other countries. So the idea that this is tax sovereignty is quite problematic. It’s more accurate to call it a win for corporate sovereignty than public sovereignty.

 

Diarmid:

I think we probably now have to get a little bit into the machinery.

The original Pillar Two proposal basically said that if profit is not being sufficiently taxed somewhere then one or another country will get the right to tax it up to the level of 15 per cent, and there are three interlocking tax mechanisms for doing that which would give different countries the rights depending on the circumstances.

What I understood from your coalition's excellent briefing is that the US has basically got its companies let off two of these mechanisms but the third one is the Qualified Domestic Minimum Top-Up Tax (QMDTT) and that mechanism for ensuring that profits are taxed at at least 15 per cent would still be intact even with this change, but the other two wouldn’t be.

Have I understood that correctly?

 

Zorka Milin:

That's right. It’s important to note that it’s not a full carte blanche for American multinationals. In some ways the foundational building block of this very complicated architecture is that every country should set up this floor and have a minimum tax on the activities which happen within its borders. And indeed close to fifty countries have enacted and are collecting these taxes. So that sea change in international tax is here to stay.

I do think it is critical US companies will still have to pay 15 per cent in those countries which have signed up to Pillar Two and implemented it into their law.

However, the issue is that there is an exemption from the other elements of Pillar Two – it is a total alphabet soup – the IIR (Income Inclusion Rule) and UTPR (Under-Taxed Payments Rule). Those were seen as the most controversial by the Trump administration and some members of Congress. They were seen as infringements on US tax sovereignty if other countries dared to impose these essentially top-up taxes.

These other two elements were meant to kick in if there is an issue somewhere in the system with the domestic minimum taxes not doing the job, because a jurisdiction hasn’t adopted it or whatever the case may be.

And so US companies now no longer worry about having to pay these top-up taxes which frees them to continue playing the kinds of profit-shifting games that we have seen over the years.

Now I have to get a little bit technical to explain the difference between how the US rules work and what Pillar Two requires, which is that in the US the minimum tax is imposed on aggregate foreign income, globally, whereas the Pillar Two formula applies for each country.

Why this matters is it means that American companies can arrange things so that they have income in jurisdictions with different tax rates, including a tax haven and a high-tax jurisdiction, then average it out and blend that income such that even if the blended income may be taxed at a rate above 15 per cent, there is still the ability to park their income in tax havens in a way that their competitors from other countries will not be able to do because the Pillar Two formula applies for each country.

I think the heart of the problem is that there is a double standard and US companies, which have been some of the most egregious and aggressive tax avoiders that we’ve seen, can continue playing some of the tax games they’ve been playing. That’s really unfortunate.

 

Diarmid:

Imagine for a moment that you are the tax director of a US multinational and you're determined to pay as little tax globally as possible. How would you structure your global operations to try and take advantage of this new side-by-side agreement?

Would you be trying to book profits in jurisdictions that don't have a QDMTT? On the basis that if there’s no QDMTT, you can get a low tax rate there and then the US back-up is weaker relatively than the Pillar Two top-up taxes.

 

Zorka Milin:

That's it precisely. There is an incentive for companies to do this and that also means there is an incentive for jurisdictions that want to court and attract American multinationals to not enact QDMTTs.

That’s the risk we have to monitor: what happens now? How do countries respond? Some but not all of the historic tax havens have adopted QDMTTs and the question is whether that will hold or how shaky this whole system is. That’s the big question.

Importantly, there is an opportunity to revisit this because the side-by-side agreement includes a provision that requires what they’re calling a “stock take” [in 2029] to look at some of these impacts on how many jurisdictions have kept their minimum tax regimes and whether there are any competitive imbalances.

So that is welcome, although ideally some of these questions should have been considered before the agreement was reached, rather than the rushed and not transparent way in which these negotiations took place whicih really draws attention to the OECD’s legitimacy challenges.

That’s another issue here, beyond what does [the agreement] mean for companies and the tax revenues of different countries. There is also this broader question of who should get to decide our international tax rules.

 

Diarmid:

Absolutely. And I'm going to pick up that point a little bit later on.

One of the difficulties with working this stuff out is that there are time lags, aren’t there, because they introduce a rule and it takes a while to be implemented and there are various transitional provisions, which mean that not everything has to be done at once.

So actually it can take a while before you even find out what the effects are at the company level.

One point you make in your briefing, which I really encourage interested listeners to read because it sets this out very clearly, is that all this hinges on the US not dropping its effective tax rate below what it is at the moment. And the [Trump] administration is prone, to put it politely, to changing its position from time to time irrespective of what other countries think.

So has the OECD, in its attempt to placate the US and keep Pillar Two on the road, has it made a concession which could simply fall apart because the [Trump] administration decides to cut the effective domestic tax rate in in the US in one way or another?

 

Zorka Milin:

I would say the risk is there. But because of the US’ difficult fiscal situation that we have with ballooning government debt and a very divided Congress … ultimately it’s Congress that calls the shots on tax policy issues and what the rate should be, so they would have to agree and I don’t see room for that any time soon.

And I would emphasise that this part of this agreement is quite important in that it still sets up some floor for the US. What other countries are saying to the US is that if you want to have this special treatment, we still want to make sure that you cannot go below 21 per cent [the current US statutory tax rate] and you need to retain GILTI, which has now been tweaked and renamed, and you also need to maintain a Corporate Alternative Minimum Tax.

All these things that we have in US law have to be maintained. They cannot be rolled back or else US companies will be exposed to Pillar Two taxes again. I think that is important and for sure a silver lining.

From my perspective, if we look objectively at the substance of the agreement, it could have been far worse for other countries and companies from other countries. Even though on the whole it is regrettable, and we have been criticising it vocally, I think it is important to note that the system is still preserved.

To be sure it has its flaws and can be improved in some ways, but it is still far better than nothing, than what we had before where we had a complete global race to the bottom.

So the outcome itself is a mixed bag. Where I have more concerns is the process that led to this. There hasn’t been much transparency or any real impact assessment. That can is being kicked down the road.  

But also, the main reason that this happened were US threats of retaliatory taxes with incredibly high punitive rates. There were proposals in Congress which in my view were a bit of a bluff but nonetheless were taken very seriously by policymakers in Europe and at the OECD and essentially it worked.

The US essentially came into this process as a bully, not constructively. Whatever may have happened behind the scenes to try to convince other countries that the US tax system is robust enough, the real factor here was the huge stick of retaliatory taxation that they were threatening. I just don’t think that can be seen in any way as a win for international tax multilateralism going forward.

To me that’s probably the most problematic part of the whole story: how it happened. The OECD was trying to develop a set of rules which, as I explained, took this American, Republican idea and tried to develop a global version of it and the US turned around and said: “No, we didn’t mean it like that and we’ll punish you if you do it.”

 

Diarmid:

There are two other what they call “safe harbours”, basically loopholes. It’s a horrible term, safe harbours, kind of gaslighting really. You know: these poor multinationals needing to be protected from the terrible stormy weather of fair taxation.

Anyway, one of them is what looked to me like a generous opt-out, linked to a certain extent to economic substance. That made me wonder whether there were some other countries sort of sneaking along behind the US because they're getting lobbied by their multinationals who would like to unpick some of this.

So what do you make of the other exemptions?

 

Zorka Milin:

You’re right, it’s not just the side-by-side so-called Safe Harbour.  I think by the way that’s a term of art under EU law, so that’s why they’re using that terminology, but it is pretty funny.

There are several safe harbours but the substance-based tax incentive one you that are alluding to is the most important and it opens the doors for other countries to introduce tax incentives that could potentially undermine the goals of the whole project.

So that’s a concern. Although to be fair here, this exception is also driven by US demands and quirks of US tax law which rely on these kinds of incentives. Given that US companies don’t have to worry about two out of three elements of Pillar Two, I do think it is fair that you have an even playing field for US subsidiaries of foreign companies that are claiming these tax credits so they don’t have that exposure.

In a sense I do think something like this is necessary: if we’re going to take US companies off the table then we don’t want to treat their competitors differently and take away those tax incentives from foreign companies that are operating in the US.

I think that’s underlying this, but the concern is: will other jurisdictions go on and adopt these kinds of tax incentives that could potentially reduce the revenues [from Pillar Two] quite dramatically, depending on how they’re framed and how many countries introduce them. There’s a real risk that the larger goals of this project could be undermined.

 

Diarmid:

That's really helpful because it’s quite a nuanced explanation. When I look at this, I'm very influenced by being aware of the way in which parts of the European big business lobby are lobbying for other regulations and directives to be watered down [like the] Corporate Sustainability Due Diligence Directive.

I was actually told by a legislator about one Dutch company which said “yes, [the CSDDD] is great legislation, we’re in favour of it” and a few weeks later said “oh no, it needs to be watered down.”

So there’s this push from parts of big business in the European Union and when I look at what’s happening at the OECD I think: “it’s only a matter of time before they go for Pillar Two.”

And even though you say this [safe harbour] is crafted to reflect the particular conditions of how tax credits work in the US, some cunning minds in other parts of the world are probably looking at this and thinking: “how can we lobby our politicians to use this as an open door?”

 

Zorka Milin:

Precisely.

 

Diarmid:

Let’s look, to finish off, at the other process the tax justice movement is putting a lot of faith in, which is of course the negotiations for a UN tax convention.

You’ve alluded the way that this shows the OECD being pushed around and trying to accommodate the US; the OECD has a long-standing legitimacy problem which this is going to make worse.

Do you think this is going to give impetus to the UN negotiations because a lot of countries don’t like the way things are being done? What do you see as the relationship between these two things?

 

Zorka Milin:

That's a really important and hard question. I am probably going to be in a very small minority when I say that I don’t necessarily see the two processes as being in tension. I think  we can have a strong Pillar Two, stronger than it is now hopefully, while also trying to build a set of rules that will be more aligned with the interests of developing countries.

I don’t necessarily see those as either/or. I know that’s how the issue is typically framed. I also think, as we were just discussing, the OECD Pillar Two [although it is] incredibly complex, quite flawed in some ways, is still a huge, huge win.

It’s a huge win for the tax justice movement and it wouldn’t have happened without all the dogged work of exposing these dodgy corporate games and raising awareness about the issue and how companies get away with these transfer pricing games.

I see it as a flawed win, but still it’s far better than the status quo that we had before. It’s still worth preserving even as we work to build something better through the UN, in particular when it comes to transparency.

That’s one area where the OECD has been lacking and the UN has the opportunity to do a much better job, not only in terms of how the process is run but in improving tax transparency because the way in which the OECD is addressed these issues is with very complicated rules which are very costly and onerous for countries to implement to exchange corporate tax information or bank account information.

The UN can reconsider: is that really the best way or can we have more true transparency? The way in which vthe OECD uses the word “transparency” can sometimes be a little bit Orwellian. It’s not publicly transparent.

 

Diarmid:

Yes, it’s not public disclosure. It means “transparency to us.”

 

Zorka Milin:

So I think that’s one really concrete and important area where the UN can improve and do a better job than the OECD. Fix their mistakes.

 

Diarmid:

So to finish off then: if we look at this side-by-side agreement, would you see it as one step back for corporate tax reform, or two steps back, or one step sideways? How would you characterize it?

 

Zorka Milin:

It's a hard question to try to draw a line under it. The way I see it is that we live to fight another day. It’s a win that the [Pillar Two] agreement has been preserved even though it’s been weakened. So it is a step forward and also step back.

How that all shakes out, it’s a bit too soon to tell. We will have this stock take in 2029 under, perhaps, a different US political context and so things could look very different. And we will know the impact on how much tax US companies are paying and not paying. So we’ll know more in a few years but I think for now it’s a mixed bag. Sideways, as you said.

 

Diarmid:

Corporate tax reform is a very long game. A very long and very, very complicated game. On that note, I'd like to say thanks very much for a fantastically well-informed and interesting take on all of this.

You know, of all the fields of human knowledge that I've dipped my toe into, this is the hardest to understand. It's like hundreds and hundreds of pages of technicalities, so it’s been really helpful having you set out all the subtleties so clearly for us. Thanks very much!

Zorka Milin:

It's been great. It's been such fun. Thanks for having me.

 

 

 

This is the end of the transcript.

 

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