Can the OECD Play the Trump Card?

On January 20, 1981, Ronald Reagan was sworn in as the 40th president of the United States. On the same day, the Iranian government released 53 hostages who had been held since November 1979, when a group of armed college students stormed the U.S. embassy in Tehran amid the Iranian Revolution.

The timing of this naturally spawned countless conspiracy theories. (Reagan’s administration would eventually be embroiled in a scandal involving hostages and Iran, but it was unrelated.)

In reality, the convergence of dates was neither a conspiracy or coincidence, but probably a result of natural tendencies in diplomacy. Then-President Jimmy Carter was committed to ending the hostage crisis–which had likely tanked his presidency–before he left office. The impending inauguration of the hard-liner Reagan put pressure on Iran to make a deal with Carter while it still could–a “good cop, bad cop” dynamic that Carter took advantage of. But as negotiations almost always go to the eleventh hour, this process took all of the lame duck period of Carter’s term. (The Iranians may have also wanted to deny Carter the honor of announcing the release himself. )

Returning to the present day, there is also plenty of presidential upheaval. The once-unlikely prospect of Donald Trump returning to the White House has become more and more probable (if not inevitable), following a disastrous debate performance from 81-year-old President Joe Biden last month and an assassination attempt on Trump this Saturday.

The likelihood of Republicans returning to partial or full control of Washington could imperil the Organization for Economic Cooperation and Development’s Two-Pillar Solution, especially the Pillar Two 15% global minimum tax. Even though the project began under Trump himself in his prior term in office, it has become a top target for Republican critics since Biden signed the agreement and touted it as a major accomplishment for his administration.

To Biden's most vociferous critics, the agreement represents everything that's wrong with his administration–feckless failure to protect America's interests, acquiescence to bureaucratic European organizations that think they know best, and U.S. Treasury Department officials who put lofty left-wing principles above common sense.

If Trump returns to office, he’ll likely be even more belligerent on the global stage than in the past, and will look to all of the economic tools at his disposal to assert American economic dominance. The Trump administration would almost certainly retaliate against countries that use the undertaxed profits rule, part of the global minimum tax that enforces the agreement by taxing global multinationals based in jurisdictions that don’t fully implement the agreement. (The U.S. would be one of those jurisdictions.)

Many U.S. companies fear that countries could target them with the UTPR if they use generous tax credits such as the credit for research & development. Countries can apply the UTPR on a multinational present in their jurisdiction, if that multinational pays less than a 15% effective rate of taxation in any other country, including its home country.

Republicans have already proposed legislation allowing the U.S. Treasury Department to retaliate against taxpayers from countries that impose the UTPR on U.S. businesses. But that may not even be necessary–there is already legislation on the books that allows the U.S. to double tax rates on those from countries deemed to be discriminatory. And there’s also the Section 301 tariff process, which gives the president vast authority to impose tariffs on products from countries the executive branch has deemed are engaging in anti-U.S. behavior. (And Trump loves tariffs almost as much as he loves golden-painted furniture.)

Trump 2.0 and the prospect of a trade war could shatter Pillar Two, even as it’s already been implemented in countries around the world. But perhaps it could also save it–just like Reagan’s election helped save the hostages?

(I want to make clear I'm not trying to compare the OECD to the Ayatollah–just noting the similar situations!)

If the U.S. and the OECD could figure out an arrangement that would put U.S. companies out of the UTPR’s reach, that would give Trump little to fight over. That may sound unlikely, but remember that this was the original plan–when the prior Trump administration pushed for the OECD to adopt a minimum tax similar to the Tax Cuts and Jobs Act’s tax on global intangible low-tax income, the hope was that the other countries might “grandfather” GILTI into compliance. That would effectively turn off the UTPR for companies based in the U.S., at least most of the time. Treasury was preparing analysis to show that GILTI as it currently exists is as harsh on taxpayers as the Pillar Two plan, so countries need not worry that an exemption would allow companies to work around the system.

When the Biden administration came in, his Treasury Department pushed for the OECD to use a higher rate, which ended up being 15%. The divergence between the OECD rate and GILTI’s 10.5% tax rate, as well as the general politics of how the deal was finished, made a U.S. exemption less likely, and now it’s seen as a nonstarter. The administration hoped to move GILTI closer to the Pillar Two model through a tax bill, but that was dropped from what ultimately became the Inflation Reduction Act.

So grandfathering is out, at least for now. But the OECD did agree to a transitional safe harbor which effectively shields the U.S. from the UTPR for an extra year. The safe harbor applies for countries with overall corporate rates of 20% or higher–which the U.S. rate of 21% just barely slips by. That gave negotiations over a fix for the stickiest points, like the R&D credit, some breathing room. But few saw it as a permanent solution.

Still, there are some hopes that a safe harbor could prove to be a permanent solution. If the OECD can agree on favorable treatment for expenditure-based tax credits like the U.S. R&D credit, then the UTPR would probably not apply to U.S. companies that often. Add in other factors like the substance-based carveout, an exemption for tangible property and payroll, and it could be reduced in the U.S. further. If the amounts at stake are minimal anyways, finding some blunt shield could be more agreeable.

Targeting U.S. companies which happen to have low effective rates for a year or so was always kind of a diversion for the OECD project anyways. Those that are claiming tax credits for R&D or green energy aren’t engaging in base erosion as it’s commonly seen. And if the U.S. is contributing to the “race to the bottom” here, it’s certainly not winning. Is the distinction between the U.S. nonrefundable credits and the subsidies countries around the world are instituting worth going to (economic) war over?

It’s not even clear that foreign countries are all that eager to use the UTPR against the U.S. Some will no doubt jump at the chance to grab revenue from U.S. conglomerates, but many will fear the possible repercussions.

This seems like the kind of situation where a deal would make a lot of sense for everybody, and a hard deadline could push things forward.

The downside is that it all may not matter to Trump anyways. Unless an agreement could prevent the UTPR from applying to the U.S. in all possible cases–that’s a heavy lift–there could be enough to justify a retaliation. Trump appointees are likely to be people who are ideologically opposed to the very concept of the Pillar Two–they might view any exemption as simply an affront. Why should the U.S. need an exemption to a fundamentally illegitimate tax?

The situation remains as unpredictable now as it was before. But in a gut way, I feel like the change in Trump’s political fortunes could shift the politics at the OECD as well. Sometimes, the devil you know is better than the devil you had hoped to forget.

DISCLAIMER: These views are the author's own, and do not reflect those of his current employer or any of its clients. Alex Parker is not an attorney or accountant, and none of this should be construed as tax advice.

A message from RoyaltyStat:

RoyaltyStat® is the market leader in databases of royalty rates and service fees from third-party transactions to facilitate transfer pricing compliance and the valuation of intangibles. Our focus on high-quality data, unique transfer pricing analytics, and knowledge-based customer support makes us the choice of transfer pricing practitioners worldwide, including the top accounting and law firms, Fortune 500 multinational entities and more than 15 tax administrations. Find out more at royaltystat.com.

Sign up for the Emperor Subscription

Thanks for reading! Don’t forget, you can sign up here for a paid Emperor Subscription, to get extra bonus content, including interviews with newsmakers in the tax field, every week.

On Friday, I talk to University of Missouri law professor and tax expert David Gamage about the implications of the recent Supreme Court decision in Moore v. United States.

The transactions are handled by Stripe, a safe and secure payment processing platform. Electronic receipt and invoice available. (If anyone has any difficulties subscribing, please let me know.)

The Emperor Subscription will also give you access to past interviews, including with former OECD tax official Pascal Saint-Amans, Tax Foundation CEO Daniel Bunn, M.I.T. professor Michelle Hanlon, transfer pricing expert Ednaldo Silva, ITEP senior fellow Matthew Gardner, National Foreign Trade Council Vice President for International Tax Policy Anne Gordon, and carbon pricing expert Shuting Pomerleau. As well as other content.

You can sign up here for $8/month or an $80 annual payment. Please consider subscribing!

LITTLE CAESARS: NEWS BITES FROM THE PAST WEEK

• The OECD last week released its annual report on corporate tax statistics, a 100-page treasure trove of data about global trends in taxation. It includes information about changes in the amount of tax incentives (including patent boxes), aggregate revenue, and tax treaties. One interesting area is an apparent decline in base erosion and profit shifting (BEPS), which would seem to indicate that pre-Pillars reforms are having some effect. This is largely based on data from the OECD’s 2015 BEPS project’s country-by-country reporting system, one of those reforms, which the report notes provides an incomplete picture. The report also notes that while there appears to be less active tax avoidance activity, there is still plenty of income that is mismatched with economic activity–most likely in zero-tax havens.
• The Internal Revenue Service also last week announced that it has raised more than $1 billion through efforts to collect past-due taxes from the wealthy, including large partnerships and corporations. A lot of this involved simple letter campaigns to notify taxpayers of what they owe, but those can go a surprisingly long way. The announcement didn’t mention international issues specifically, but these efforts undoubtedly include enforcement actions against offshore entities. For instance, the IRS previously announced it would crack down on foreign corporations with U.S. subsidiaries that are using transfer pricing to, the agency claims, inappropriately lower their U.S. taxable income.
• One of the interesting subplots of the Pillar Two saga is how jurisdictions seen as zero-tax havens are responding to the new rules. Many are instituting new corporate taxes as well as Pillar Two-specific regimes such as the qualified domestic minimum top-up tax. Bermuda, which has already implemented new taxes to comply with Pillar Two (along with refundable credits to remain attractive to businesses), announced last weekend it was creating a new tax agency to administer this new system. Whether or not Pillar Two ultimately changes the incentives, it certainly has changed behaviors in the jurisdictions that were previously at the center of complex and problematic tax structures.

PUBLIC DOMAIN SUPERHERO OF THE WEEK

Every week, a new character from the Golden Age of Superheroes who's fallen out of use.

Blue Streak, first appearing in Headline Comics #13 in 1945. A skilled trapeze artist, his brother was killed when he tried to stop gangsters from stealing the circus' ticket money. (Suspiciously similar to Robin's origin story, which was published in 1940.) Seeking vengeance, he adopts the alter ego and uses his acrobatic skills to bring the culprits to justice.

NOTE: This newsletter will be off next week for a personal vacation.

Contact the author at amparkerdc@gmail.com.