Designed to fail?

Dr Brian Keegan explains why the OECD’s Pillar 1 scheme (to have the largest multinational companies taxed in part in their market territories) is far more ambitious than Pillar 2’s 15% minimum effective corporation tax rate – and may achieve its goal without necessarily having to take effect.

Governments across the EU will be watching the progress of the new directives to give effect to a 15% minimum effective corporation tax rate within the trading bloc. Few of these governments will be watching developments unfold quite as closely as the British government. While no longer obliged to adopt EU directives, the British government have, nonetheless, signed up to the essence of the 15% proposal. Given that the UK headline corporation rate is well in excess of 15%, every EU change might bring opportunity for the British economy.

There were, however, always two parts (or pillars, in the jargon) to the OECD-backed grand plan for the taxation of the major multinational sector. The current focus of the 15% project (Pillar 2) has taken the spotlight off the far trickier topic of where the largest entities pay their taxes (Pillar 1).

Large multinationals have created problems for governments since the time of the Dutch East India company. In the 1600s, the Dutch East India company quite literally became a law unto itself. Having an accounting period of a decade rather than a year was only one of its idiosyncrasies. Ever since, governments have walked the fine line between maximising revenue from their multinationals while not losing control of them.

The Pillar 1 scheme (to have the largest companies taxed in part in their market territories) is far more ambitious than Pillar 2. It overturns the right to charge tax based on the residency rule – a fundamental principle of tax law. Pillar 1 was devised as a blocker for digital services taxes currently threatened, if not implemented, in many countries. A digital services tax is, in effect, an excise duty on services (and thus overturns another fundamental principle of taxation, namely that excise duties are charged on goods). Pillar 1 was sponsored by the US to sidestep a disproportionate burden on its largest digital services companies.

From an Irish perspective, the proposed relocation of taxing rights under Pillar 1 may pose a greater threat than the 15% minimum effective rate. The threat extends beyond exchequer receipts. Large multinationals employ an unusually high proportion of Irish workers compared to most other countries. Pillar 1 may make it more efficient for some multinationals to relocate jobs to their market destinations to manage their overall tax bills.

But before anyone starts checking their visas and work permits, I’d suggest that the prospects of Pillar 1 happening any time soon are poor. Pillar 1 implementation requires countries to change their double taxation agreements. Previous OECD-backed reforms have also required treaty changes to stop tax avoidance using mismatches in the tax treatment of so-called hybrid instruments and the like. Yet, the US, which is the principal architect of Pillar 1, has yet to sign up for this kind of treaty change for any purpose.

This US reluctance to modify its own treaty network can be ascribed, at least in part, to Washington gridlock. Now, implementing Pillar 1 presents the additional political challenge of whether the US will be happy to lose tax to high-population market destinations like Brazil and China.

It may well turn out that Pillar 1 is a proposal primarily designed to block a digital services tax without ever having to come into effect itself. If this is the case, the current focus on the Pillar 2 15% rate is well-placed. There will be opportunities, not just in the UK, but in Ireland as well.

Dr Brian Keegan is Director of Advocacy and Voice at Chartered Accountants Ireland.