This blog was first published in Swedish on September 1, 2021. It is published "as is" with no amendments made because of subsequent events.
Initially, it must be acknowledged that I have shown little interest in developing country issues. I am and remain a product of the OECD and have therefore mostly watched with indifference when current tax international rules have resulted in developing countries being plundered of their tax revenues
The following should therefore be seen as an attempt to seek redemption.
1. The OECD Role and Standards in the International Tax Area
The role of the OECD is to safeguard the interests of its member countries, primarily those of the United States (because it pays most of its budget) and secondarily the interests of other member states, all in relation to their economic size.
The OECD's work is primarily about "damage control", i.e., to persuade developing countries to adopt the OECD's views and prevent them from thinking for themselves.
A small country like Sweden has therefore limited influence over OECD's key issues. Against this background, it is hardly surprising that the interests of developing countries are considered only nominally by the OECD, if at all.
Over several decades, the OECD has established both conference centers and working groups focused on developing countries. But its work has primarily been focused on "damage control", i.e., to persuade these countries to adopt and implement the OECD's views and prevent them from thinking for themselves.
The closest the OECD has come to actually assisting developing countries on their own terms is via the "Platform for collaboration on Tax". However, the OECD participates in this grouping together with the World Bank, the UN and the IMF.
2. Developing countries are ripped off under current international tax rules
Let us not turn a blind eye to reality. Developing countries are thoroughly ripped off by today's international tax rules. These were developed in the 1920s when the colonial power Britain wanted to ensure that British MNEs were primarily taxed at home. That is why the emphasis in treaties is on residence taxation.
Voices were raised during the BEPS project that the global tax cake should be redistributed to increase source taxation rights, which would have given developing countries expanded rights to tax foreign investment and outgoing payment streams. However, neither the United States nor other capital-exporting countries were willing to discuss in those terms.
Notwithstanding, following the completion of the BEPS project in the autumn of 2015, the question how the global tax pie should be divided has become an increasingly hot topic.
3. Today's allocation of the global tax pie is increasingly put into question
Several NGOs and authors of books and articles believe that developing countries should terminate their tax treaties. The reduced withholding tax rates on dividends, interest and royalties not only lead to lower tax revenues, but also to MNEs utilizing such intra-group payments to minimize the local tax base. To completely circumvent applicable withholding taxes on cross-border payments, MNEs often classify them as technical fees, overhead expenses, insurance premiums, etc.
Developing economies should be skeptical about the benefits of tax treaties
Likewise, MNEs easily circumvent treaty provisions on permanent establishment. BEPS's cautious recommendations to prevent abuse of the PE provisions are, as the term suggests, only recommendations. Most of the capital-exporting OECD countries, including Sweden, have chosen not to include these anti-abuse rules in their tax treaties.
The authors of a recent IMF report published in February noted that treaties are usually a "loss-making business" for developing countries and that "developing economies should be skeptical as to whether benefits of tax treaties outweigh their costs". (1)
A closer examination of pillars 1 and 2 suggests that developing countries have good reasons to be skeptical about these proposals as well.
4. Pillar 1
Note at the outset that Pillar 1 is not a new tax, but the proposal aims to redistribute a certain share of the world's largest MNE tax bases from residence to market countries. The objective is to ensure that MNEs pay more corporate tax in countries in which they derive large profits from sales without establishing a (taxable) physical presence.
Since the majority of MNEs' sales profits come from large consumer markets, the redistribution will primarily amount to an internal OECD exercise.
Large countries outside the OECD, such as China, India and Brazil, are also expected to benefit from Pillar 1, but not necessarily as much as one would expect. In terms of population, India is a large country, but its consumers do not have nearly the same purchasing power as American or German consumers.
Traditional developing countries in Africa and Asia will at best benefit only marginally, despite that the proposal contains lower threshold amounts for the poorest countries. These countries are mainly low-wage production states with weak consumer markets, which means that most developing countries are likely to fall outside the scope of the rules.
In fact, Pillar 1 risks seriously disadvantaging certain developing countries such as Kenya and Nigeria that have adopted digital services taxes. The United States has made it crystal clear that it approves Pillar 1 on the condition that all countries abolish, or refrain from introducing, digital services taxes. However, Pillar 1 will never be able to compensate the loss of income suffered by a developing country that is forced to abolish an introduced digital services tax.
5. Pillar 2
Pillar 2 is somewhat more favorable to developing countries. The proposal's objective is to introduce a global minimum tax on companies. However, this proposal is not about forcing all countries around the world to adopt a corporate tax rate of at least 15%.
The minimum tax proposal contains a main rule (income inclusion rule) and a back-up rule (undertaxed payment rule).
According to the income inclusion rule, the countries where MNEs are resident are expected to ensure that profits derived from foreign subsidiaries are always taxed at least 15%. Pillar 2 therefore operates in practice in the same way as CFC legislation.
The undertaxed payment rule becomes applicable when a country in which the MNE is resident does not introduce minimum tax rules. The source state then has the right to levy tax according to the same principles as the main rule. The undertaxed payment rule aims at preventing countries from gaining a competitive advantage by not adopting the minimum tax.
Note that pillar 2 prioritises residence taxation over source taxation. Nothing would stop the OECD from reversing the order of priority. It is accordingly the tax bases of OECD countries - not the developing countries - that the rules aim to protect.
The OECD believes that developing countries nevertheless benefit from Pillar 2 because the rules prevent a race to the bottom in the area of corporate tax.
However, some developing countries' main source of income come from the corporate tax and they impose rates of between 25-30%. These countries consider that a minimum tax rate of 15% is too low to put an end to either "the race to the bottom" or aggressive tax planning.
Other developing countries fear that a minimum tax of 15% may discourage foreign direct investment. They are therefore opposed to MNEs' resident countries neutralizing their tax breaks and have therefore requested substance-based carve-outs. The consequence of Pillar 2 would otherwise be that the MNEs' residence countries recuperate the tax revenue that developing countries choose to forego in treaties or through domestic legislation to stimulate foreign investment.
The undertaxed payment rule will rarely apply and is also an administrative challenge for developing countries' tax authorities. To encourage developing countries to rally behind Pillar 2, the OECD has spiced up the proposal with a 'subject-to-tax rule' that is supposed to be added to developing countries' tax treaties and target certain types of intra-group payments that are low or zero taxed in the other contracting state. The rule is attractive to developing countries because the source state here receives primary tax right over such low-taxed income. The rule can most aptly described as an "anti-treaty-shopping rule". (2)
However, it remains unclear what payments that will be covered under the 'subject-to-tax rule', what rate and thresholds that will apply, when the rule will become applicable and how the rule will be implemented.
Many OECD countries are dragging their feet because the rule de facto increases source taxation and also encourages the use of gross-based withholding taxes in tax treaties.
6. Concluding Remarks
Developing countries are better organized today than they were 10 years ago. The role of the BEPS Monitoring Group, which is an association of NGOs, is specifically to advance the developing countries' interests at the OECD.
In recent years, the UN Committee on Taxation has also become more vocal. It is becoming increasingly independent of the OECD and prioritizes more aggressively the interests of the poorer countries.
Sweden lacks both relevant research and active involvement in tax issues concerning developing countries
Moreover, developing countries have begun to exert increasing pressure on the G20/OECD through their own groupings. Both the African Tax Administration Forum and the G24 (whose members are mainly developing countries) publish regularly interesting and sometimes quite revealing comments on the G20/OECD's pillars 1 and 2 proposals.
Sweden lacks both relevant research and active involvement in tax issues concerning developing countries. Given the knowledge that we have acquired today on these issues, it is no longer morally acceptable for Sweden to first provide aid and then take it all back by concluding tax treaties that both reduce tax revenues and facilitate aggressive tax planning in developing countries.
(1) The issues are addressed in Chapter 8 of the IMF report.
(2) The subject-to-tax rule would not apply though if the agreed tax rate ends up being lower than the applicable withholding tax rates on interest and royalties in the treaties concerned, unless the rule also includes other types of payments.
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