INTERVIEW: Leopoldo Parada

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Leopoldo Parada is an international law tax expert and reader in tax law at King's College London. He was previously an associate professor at the University of Leeds School of Law, where served as director of the Centre for Business Law and Practice. His recent paper, Global Minimum Taxation: A Strategic Approach for Developing Countries, examined the Organization for Economic Cooperation and Development's Pillar Two 15% global minimum tax and its impact on the developing world. We spoke on Oct. 3.

I wanted to talk to you about your paper on the developing world and Pillar Two. You talk about how you think that this is not going to be a favorable policy for developing countries. Why do you think it’s not going to be in their interests?

Well, there are many reasons, starting from the fact that when you look at Pillar Two and how Pillar Two works with these interconnected rules– UTPR, IIR and now also the QDMTT–it's very easy to say, 'Come on, join, get some revenues. You can become the default revenue collector. If someone is under-taxing somewhere, you have the opportunity to get a little part of that.' At the same time, you tell countries that they can’t get a tax benefit that is reducing tax competition. Even though we may disagree that tax competition is something that’s per se bad.

But the project itself has three presumptions. Those presumptions are, first that all corporate tax incentives are inefficient for attracting foreign direct investment. Secondly, there is the presumption that every single country, particularly developing countries, can make the switch from corporate income tax competition to other forms of competition. 'Don’t compete with your income tax system. Compete with your [value-added tax], compete with your personal income taxes, or compete with non-tax incentives,' as if all countries could do that very easily.

And there is a third presumption in this project, which to me is the most dangerous one, that if you join this project, you gain revenues. If you don’t join the project, you lose revenues. If you remember this famous phrase that they repeated many times at the OECD and in many international forums, 'You will leave money on the table.'

But if you go into the details, you realize that all of these three premises, at the end, they prove false. The whole project is constructed on these premises, and they are unconvincing. And ultimately, the reality of developing countries is very different.

The point about tax competition, I think is really interesting, because I'm not sure you ever had total agreement with all the participating countries that tax competition is bad, like you said. And you also had some disagreements about what kind of tax competition they were trying to stop. Some developing countries would say, taxes are one of the few things that they can compete on. Others would say, well, it’s sort of a net loss–you bid this much, we bid more, and then eventually everyone’s at the bottom. Why is the second view incorrect, in your view?

Because it presumes that any sort of corporate income tax competition is special. Let's go one step before. Why do countries compete? Why do they have to compete? Because there is some capital floating around, and investors are deciding, 'Where should I go with my money? Should I invest in this little island, or should I go to this big country? What can they offer me?' And then they start looking at several factors. They look at how the infrastructure is there, whether they can get some cheap labor, or whether they can use, perhaps, the very good telecommunications in that country, and many other aspects. And one of those aspects is the tax aspect. For many developing countries, especially small developing countries, particularly small island developing countries, they have very little to offer because they have less natural resources, infrastructure is sometimes not the best, and political stability is also sometimes quite problematic.

So they look at the tax system as a way to attract investors, which in my view is something very legitimate. You can do that as part of the competition game. The OECD understood this back in 1998, when we had this distinction between harmful and non-harmful tax competition. The whole idea was to say, some of these countries, they have to compete with something. To the extent that they attract substantial activities to the countries, and it’s not only about paper companies, it’s something that shouldn’t be counteracted at all. It’s part of the fair game, the tax competition game. The same was repeated in Action Five of the BEPS Reports. There was this whole discussion about [intellectual property] boxes, and the whole discussion turned to the same direction as the 1998 report. They said IP boxes can be harmful or non-harmful. It depends. If you are going to develop the IP, and all the income will stay in the country where the IP is developed, that shouldn’t be a harmful IP box.

Pillar Two completely changes the scenario, because it says if you have something like an IP box, it will reduce your effective tax rate. Therefore we need to counteract, you cannot use that as a way to attract investors. And that distorts the whole idea of tax competition, because it doesn’t recognize that many countries have an extremely attractive corporate income tax system, which is attracting foreign direct investment, real money.

You do see some of that logic, from the 2015 Action Five report that you mentioned, in the substance-based carveout of Pillar Two. But it’s not the same, and it may not be enough for countries to develop incentives around. Do you want to give your thoughts on that?

There is an idea of saying, let’s try to let these countries compete, to the extent that there is some substance. That is the substance-based income exclusion. But what does it mean for the country? We’re telling the country, forget about whatever you were trying to attract. Someone could argue that if you fall within the scope of this carve-out, you shouldn’t be worried about it. But that won’t be the Holy Grail for everybody. At the end of the day, the message is exactly the same. The message is to tell countries, this is how you should behave, because otherwise it’s unacceptable.

But the question is, for whom? For a very non-democratic institution that self-attributed the power to design policies for countries around the world. I tend to put this in a very strong way, because people tend to forget how the OECD was born. For many years the role of the OECD was as an organization trying to promote best practices around the world, and now it’s to design tax policies for countries? It’s a very different story.

I think one issue that hasn’t been discussed so much is the issue of refundable versus non-refundable tax credits. In theory, those are economically the same. But I wonder if a lot of developing countries are in a position where they can’t offer immediate refundable tax credits, just because of cash-flow issues and resource constraints. Do you think that is another dynamic here?

Absolutely. To talk about qualified, refundable tax credits for very small developing countries, especially small islands, is such a bad idea. Simply because they don’t have the wallet to do that. They tried to convince developing countries around the world that this is fantastic–'Now you can offer qualified, refundable tax credits and fill the gap.' It will create another problem for them, which is that you need to give cash back to all of those companies. Some developing countries, they have the wallet for that, and they might do that. Others that I work directly with, small islands, they simply cannot do that, and they shouldn’t do that at all.

But then you have other problems. They try to think, what else can we do to compensate for the fact that we need to tax these companies, these multinationals at a higher rate of corporate income tax? They start looking at reductions of personal income taxes, they start looking at exemptions of VAT. So in other words, what they are trying to do is something that can generate way more trouble from a tax revenue perspective than simply keeping a very low corporate income tax rate. Because corporate income taxes are not the main revenue generator in developing countries. They’re actually very insignificant in most of them.

So now we push them to compete with the real revenue generators they have, they will simply be poorer. They will stop receiving tax revenue simply because someone in Paris thought that every country around the world depends on corporate income taxation, and the reality is very different.

Is the remedy better than the illness, in this situation? Maybe not.

I guess the idea is that it will increase corporate tax revenue so it’ll be a higher percentage. But you’re saying that even if you don’t look at subsidies and other ways they might try and compete outside the tax code, countries may lose tax revenue because of other tax areas they look to, to make their jurisdiction attractive.

I think before they look at non-tax, the natural reaction is to look at your tax system as a whole. It might be that there’s extra revenue collection in corporate income taxes, but I need to compensate for the attractiveness in the perspective of the investors. I don’t want my investors to leave. And I can’t presume that all investors behave in the same way, because that’s not true. It depends on the country, it depends on the industry.

So what can I do once I have to charge an effective tax rate of 15% at the corporate income tax level? Maybe I want to offer those investors the possibility to pay a bit lower in personal income tax. Or maybe I create an exemption in VAT. And maybe they don’t do that, but if they do that, they will create an extra problem.

Some countries can provide subsidies. The OECD tends to believe that competition based on subsidies is better than competition based on tax incentives.

Let me tell you something about that. When you give a subsidy, you have way more discretion to decide who is going to benefit from the subsidy. If you think about many developing countries with problems of corruption, I would definitely prefer to have a very clear tax incentive in the law, rather than a subsidy that nobody knows how it will ultimately be granted. So this panacea of subsidy competition is also sort of false, at the end of the day.

Interesting. I guess I’ve heard people say that subsidies or spending is ultimately more accountable, that it’s more transparent. But you’re saying that’s not always true in practice.

That’s what I believe. I don’t think that this idea of subsidies being more transparent is true. You just need to visit some very small developing countries, and see the relationship between big multinationals, or investors, and the government. Are you opening a door for more corruption through subsidies, rather than an effective control of tax incentives? A tax incentive or a tax holiday, it needs to be in the law. Everybody knows that it’s there. You know that if you invest X or Y, you will get a single property tax, or a 10% rather than 25% corporate income tax. The law says that. It’s an objective thing. With a subsidy, you don’t necessarily need to do the same. I can start creating subsidies, to keep investors. They tend to be less transparent at the end of the day. So I might ultimately be creating a new form of competition that will be more difficult to regulate.

Do you think there is a way to fix Pillar Two? Is there a way to make some modifications, to fix these issues? Or do you think Pillar Two just needs to be totally thrown out and rethought?

I don’t see the need for Pillar Two, to be honest. I recognize all of the interesting elements of Pillar Two. I think this could be done in a very different way. If the OECD, or even the UN, wanted to regulate tax competition among countries, there are other ways to do it. For example, you could create objective criteria that countries need to follow in order to demonstrate that the incentives they provide in the corporate income tax area attract substantive investment. That’s something they can monitor. There are many other reporting things that countries must do, we could go in the same direction.

So there is no need for this level of complexity at all. There is only one clear winner in all of this, and those are the Big Four–KPMG, EY, Deloitte, PwC, they will fill up their pockets because of Pillar Two. So do we need to do all of this, to give money to the Big Four and to put pressure on very small developing countries with very tiny tax administrations, just because someone in Paris thought that things should be done in this way? I don’t think so. I think there are alternatives.

Contact the author at amparkerdc@gmail.com.