The complex issue of tax on multinationals

In the quest for an alleged tax justice, a recent EU Directive to implement the OECD’s global minimum tax for multinational enterprises may negatively impact smaller countries, hamper free capital movement and also undermine tax competition


Agreed at European level in October 2021, EU directive 2022/2523 has implemented the second pillar of the OECD agreement to ensure a worldwide minimum tax for multinational enterprise groups and large domestic groups in the EU. By imposing this minimum tax on multinational companies, the signatory countries of the OECD (Organisation for Economic Co-operation and Development) multilateral convention hope to raise €130bn–€170bn in tax revenue worldwide for the companies concerned (those with a turnover of at least €750m).

The issue that this regulation is intended to address is that the legal entities of which multinationals are composed have a separate legal personality and are taxed in their respective countries under different tax regimes. As a result of the ability of multinationals to influence transfer prices and thus locate profits in the country of their choice, the mobility of capital, the development of the digital economy and transfer prices, profits were often realised by structures established in what the OECD considers to be tax havens or at least places with tax regimes that are perceived to be “too lenient”.

The central idea of this system, which is very complicated to set up, is rather simple and because of its significant yet ignored side effects, simplistic: no matter in which country a multinational declares its profits, they must be taxed at the same minimum rate. When the company pays less than 15 percent tax in a foreign country where it has a subsidiary, the country where its head office is located will recover the difference between the effective rate paid and the 15 percent rate, so that the total tax paid reaches the said 15 percent threshold (IRR income inclusion rule – in this case, it is the parent company that is taxed).

Alternatively, countries may provide for a so-called qualified domestic minimum top-up tax (QDMTT): in this case, any additional tax paid will be borne by the subsidiary in the country in which it is established. The central idea of this system therefore appears to be to increase tax revenues while discouraging local companies from setting up abroad, because they will not be able to benefit from local tax incentives.

A flawed system
It should be noted that the system put in place is flawed from the start due to the exclusion of certain important sectors from this regulation: extractive industries and companies offering regulated financial services, international maritime transport companies and, with certain exceptions, public entities, international organisations, non-profit organisations, pension funds and investment funds are excluded.

Tax is not just a tool for financing or a method for distributing wealth

In addition to these exclusions, a number of adjustments have been made, such as the possibility for companies to declare a reduced tax base or the exclusion, for the first five years and under certain conditions, of certain Chinese companies. While the aim of these regulations is clear, the means used to achieve them are not really adequate.

This system benefits the largest countries, since they will either increase the number of taxpayers subject to corporate tax, or they will benefit from the dissuasive effect of the system put in place, since companies established in their country will be reluctant to relocate certain activities abroad.

On the other hand, the situation will become more problematic for some other countries, especially developing countries, for which corporate tax is very important and which often grant tax exemptions to companies setting up in their territory.

According to the figures put forward by certain international organisations, 60 percent of the revenue from this minimum tax would benefit the G7 countries, while developing countries would only receive three percent of the revenue. The imbalance is such that some have proposed the introduction of positive discrimination for the smallest countries, subject to certain conditions. Alongside developing countries, it is the traditional tax havens and, above all, the smallest European states, such as Belgium, Luxembourg or Ireland, that will lose part of their tax appeal, which, because of their small size and the limited importance of their markets, is their main attraction.

The first negative effect of this minimum taxation is that it is likely to increase inequalities between rich and poor countries; in reality this amounts to making the former richer and the latter poorer in the name of theoretical tax justice. It should be noted, however, that some emerging countries, such as Argentina, have wished for an even higher tax rate, an attitude that is not understandable in the long term.

It is not impossible that we will observe the opposite phenomenon: in other words, a levelling down of taxation on company profits in certain countries that currently apply a higher effective rate. Indeed, while this regulation will highlight the allegedly inadequate nature of the level of taxation in certain countries, it could also inspire others to lower their level of taxation to the threshold deemed acceptable by the OECD, thus becoming more attractive than they have been in the past. We should not lose sight of the fact that the new 15 percent rate is, in some cases, much lower than the rate of corporation tax, especially in Europe.

Compatibility with EU treaties?
Another problem with this minimum tax is linked to the Treaty of Rome, which institutes, among other things, the free movement of capital. The question arises as to whether this regulation might not hinder the free movement of capital between European companies, since under the new rules this capital will be subject to an ‘additional’ tax that is not provided for under the tax law of the country of destination of the funds, and compliance with these measures will entail costs for the companies concerned. We can be sure that this issue will sooner or later be referred to the Court of Justice of the European Union.

An attack on tax competition
Regardless of what has been said, the essential point here – and there should be no mistake about it – is that the new regulations constitute an attack on tax competition. Of course, the OECD rejects this accusation, arguing that the agreement has no other purpose than to set multilaterally agreed limits on tax competition. This is clearly an understatement.

The first negative effect of this minimum taxation is that it is likely to increase inequalities between rich and poor countries

In fact, developing countries and smaller countries did not really have the power to oppose this agreement: if they agreed to these limits, they did so under pressure, since, in practice, these countries will suddenly lose their attractiveness to potential investors. Furthermore, if they want companies already established in their country to remain there, they will have to take measures to increase their effective tax rate (by acting on the rate or the method of calculating the tax base), to ensure that the 15 percent threshold is reached, in the hope that some of the companies already present will not leave to avoid complications. This is likely to affect local businesses too.

Under the pretext of tax justice, which mainly serves the richest countries, we are witnessing a form of inter-state coercion, when even in Europe, certain companies benefit, in practice, from regimes that are out of line with ordinary law in terms of effective taxation (for example, the deduction of research and development costs). In any case, this time things have gone one step further, with the decision to tax income that the State that was competent to do so had chosen not to tax.

This once again raises a fundamental problem in international taxation: the issue of assessing the adequacy of another country’s tax system. However, this discussion should not take place since it is the needs of each country that determine the importance of tax to be levied and the needs of one country are not those of another.

It therefore seems incongruous to force, in fact or through a treaty, a country to levy a higher tax than it really needs to. It will be left with no choice though, if it does not want the ‘surplus’ to be taxed to reach the 15 percent threshold. At this point the company will be taxed by the country in which the parent company is established, and it will have lost everything.

Furthermore, considering that one cannot assess the severity or “adequacy” of a country’s tax system simply by looking at tax rates and the method of calculating the tax base does not really make sense. Tax is not just a tool for financing or a method for distributing wealth. It also serves as an economic incentive or as a means of encouraging or discouraging certain behaviours deemed to be, depending on the circumstances, favourable or harmful to society.

In conclusion, the fact that an effective tax is low can be attributed to a whole series of reasons other than the desire to engage in unfair tax competition. However, the minimum tax on multinationals seems to be based on a genuine assumption of tax dumping, without taking into account the specific situation of each country.

Under these conditions, it is even feared that in the future such a regulation could be provided for smaller companies; at the very least, since the principle seems to be accepted, it is hard to imagine what would prevent the leading member states from proceeding in this way. This is a well-known modus operandi that has been employed many times, always under the cover of a higher value, such as tax justice or an always vague general interest.