The Global Tax Surprise
With a project as broad and wide-ranging as the Organization for Economic Cooperation and Development’s planned overhaul of the global tax system, many taxpayers who don’t view themselves as involved in significant international tax planning are unexpectedly finding out that they’ll be affected.
And they’re also finding out late in the process when their options for response are limited.
15% Global Minimum Tax
The project culminated in a 140-country agreement announced in the summer of 2021, including plans for the minimum tax. But it began in 2017 in response to public outrage over alleged tax avoidance in the tech sphere, especially with online companies that can avoid a physical presence in the markets where they do business. It grew to include a 15% global minimum tax that was meant to target income in low-tax jurisdictions derived from valuable intangible assets, like patents or copyrights, that are often used in tax avoidance structures due to their mobility. But design choices in how the minimum tax would work–as well as a new focus on “ending the race to the bottom” in tax competition between nations–ultimately led to a policy which can capture entities and transactions far removed from those specific cases.
One way that large companies can end up under the global minimum tax is through the use of tax credits, like those for research and experimentation or for green energy development.
The primary way that the 15% global minimum tax is enforced is through the jurisdiction where a given taxpayer’s parent entity is based. That tax authority imposes additional taxes on the company if it holds offshore income lower than the 15% rate. (Based on the OECD’s calculation of effective tax rates, which is based on financial accounting data and includes various adjustments, including for economic substance.) However, if a country doesn’t apply such a minimum tax–like with the U.S., after Congress declined to enact implementing legislation last year–then a secondary rule, the under-taxed profits rule, comes into play. This is imposed by subsidiary jurisdictions on a global corporation if it holds low-taxed income in any jurisdiction. Even its home jurisdiction.
Surprise, Surprise
This can lead to a scenario few envisioned when the project began–that a U.S. company would see foreign tax authorities impose additional taxes based on its domestic income. One way that a company might end up in the crosshairs is by claiming large U.S. tax credits that substantially lower its U.S. tax rate. (One qualification is that the tax only applies to corporate groups with annual global revenues of 750 million euros or more.)
The OECD has released additional guidance this year with language attempting to mitigate some of these risks. A release in February included a new concept, “qualified flow-through tax benefits,” which can apply to some of the financing arrangements used to claim low-income housing credits. And a July release outlined special treatment for credits which can be transferred to another party after they are claimed, such as many of the green energy incentives enacted by the 2022 Inflation Reduction Act.
An important point to note is that these new categories do not create a blanket exemption for these credits. They can only be applied when many conditions are met, and even then they only partially reduce tax liabilities under the global minimum tax.
Other credits are, as of now, unprotected. These include the R&D credit, maybe the most widely used corporate credit in the U.S. However, the OECD calculation of taxable income includes a 5% exemption for depreciable tangible property and an additional 5% exemption for payroll–which could significantly reduce the risk for the research-intensive companies that claim the credit.
Ultimately, the OECD project demonstrates how international taxes are no longer the siloed, niche topic they once were. Both general tax officers and corporate decision-makers are finding they need to wrap their heads around the details and the overarching concepts to fulfill their duties. They cannot afford to underestimate the significant complexity in these plans.
For more background on the OECD’s tax project and a better understanding its effects of on business tax credits, check out Alex’s new course, “The 15% Global Min Tax and US Tax Credits.”