This article reflects the position and information available as at 15 December 2022.
For years, countries have competed for international business by offering lower corporate tax rates.
Ireland built part of its economic model around a low corporate tax rate. Cyprus and Malta developed competitive international business environments. Luxembourg became a major financial centre. Other jurisdictions used tax incentives, exemptions and special regimes to attract investment.
That competition is now being challenged.
The OECD’s Pillar Two agreement introduces a global minimum effective corporate tax rate of 15% for large multinational groups. On 12 December 2022, EU member states reached agreement on implementing the measure across the European Union. The rules apply to multinational and large domestic groups with annual consolidated revenue of at least €750 million.
The obvious question is whether this is the beginning of the end of international corporate tax competition.
I don’t think it is.
It is the beginning of a different form of competition.
The 15% Number
The first point that is often misunderstood is what the 15% actually means.
It is not simply a new global corporate tax rate.
The Pillar Two rules are designed around an effective tax rate, calculated on a jurisdiction-by-jurisdiction basis. Where the effective rate falls below 15%, a top-up tax can arise.
This is very different from saying that every company in every country will suddenly pay 15% corporate tax.
The rules are targeted principally at large multinational groups and large domestic groups meeting the €750 million threshold.
For the vast majority of small and medium-sized businesses, this is therefore not a direct 15% minimum tax regime.
That distinction matters.
The End of the Race to the Bottom?
The political argument behind Pillar Two is straightforward.
If one country offers a very low corporate tax rate, multinational groups may have an incentive to locate profits there rather than where the underlying economic activity takes place.
Governments have responded by attempting to establish a floor.
If a large multinational group has an effective tax rate below 15% in a particular jurisdiction, the international rules are designed to create an additional tax charge to bring the effective taxation up to the minimum level.
The European Commission and Council have presented this as a way of limiting the race to the bottom in corporate taxation.
But a minimum rate does not eliminate competition.
It simply changes what governments compete on.
Tax Competition Will Not Disappear
A company does not choose a country solely because of its corporate tax rate.
It also looks at the availability of skilled labour.
It considers infrastructure.
It considers political and legal stability.
It considers access to markets.
It considers regulation.
It considers banking.
It considers the cost of employing people.
It considers intellectual property protection.
It considers government support.
It considers the quality of professional services.
And, increasingly, it considers whether the tax system is predictable.
If the minimum corporate tax rate becomes 15%, these factors become more important, not less.
The competition moves from “What is your tax rate?” to “What do I get for the tax I pay?”
The New Tax Competition
This is where I think the consequences become more interesting.
Countries will increasingly compete through measures that may not simply involve reducing the headline corporate tax rate.
They can compete through infrastructure.
They can compete through refundable tax credits.
They can compete through investment incentives.
They can compete through R&D support.
They can compete through skilled immigration.
They can compete through regulatory efficiency.
They can compete through access to capital.
And they can compete through creating an environment in which a business can actually operate efficiently.
This is potentially a healthier form of competition.
A country that wants to attract a multinational cannot simply offer a low tax rate.
It has to offer an ecosystem.
What Does This Mean for Smaller Investors?
For investors, the €750 million threshold is important.
The global minimum tax is principally aimed at the largest corporate groups. A privately owned company, investment vehicle or portfolio company below the relevant thresholds will not simply become subject to a 15% global minimum tax because Pillar Two exists.
The analysis becomes more complicated where businesses form part of a larger consolidated multinational group.
This is particularly relevant to private equity.
A private equity investor may own a number of businesses through different structures and jurisdictions. Whether those businesses fall within Pillar Two depends on the applicable ownership and consolidation rules and the size and characteristics of the relevant group.
The lesson is therefore not that every investment structure suddenly needs to be rebuilt.
The lesson is that group structure and tax analysis are becoming increasingly important.
Private Equity Will Need to Pay Attention
Private equity has traditionally been very focused on tax efficiency.
That is understandable.
The difference between a 10% and 20% effective tax rate over the life of an investment can materially affect investor returns.
But the global minimum tax introduces another consideration.
Tax efficiency cannot simply be measured by the lowest available statutory rate.
Investors will increasingly need to consider how the entire structure works.
Where is the operating company?
Where is the intellectual property?
Where are the employees?
Where is the management?
Where is the income generated?
Where is tax actually paid?
And what happens when the investment is sold?
This is not necessarily bad for private equity.
In fact, it may favour investors who already build structures around genuine economic substance rather than simply attempting to locate profits in the lowest-tax jurisdiction.
Cyprus and Malta Still Have a Role
For smaller economies such as Cyprus and Malta, the arrival of Pillar Two should not automatically be interpreted as the end of their international investment models.
The real question is what happens beyond the corporate tax rate.
If a jurisdiction provides an effective legal system, professional services, financial infrastructure, access to European markets, an educated workforce and a competitive environment for international businesses, it can remain attractive even if the tax advantage becomes less significant for the very largest multinational groups.
The same principle applies elsewhere in Europe.
A country cannot rely indefinitely on tax alone.
But neither does it necessarily need to.
The Large Multinational Will Have Fewer Options
The biggest impact may be felt by the largest multinational groups.
Historically, a sufficiently large international group could structure its operations across multiple jurisdictions and potentially reduce its overall tax burden through differences between national tax systems.
Pillar Two is designed specifically to make that strategy more difficult.
The OECD estimates that the minimum tax could generate significant additional global corporate tax revenue, while placing a floor under international corporate tax competition.
For the largest groups, tax planning therefore becomes less about finding a jurisdiction with a very low headline rate.
It becomes more about understanding the interaction between jurisdictions.
That is a fundamental change.
The Real Question Is Effective Tax
For investors, the headline corporate tax rate has never told the entire story.
A jurisdiction with a 10% corporate tax rate but high operating costs, expensive labour and inefficient regulation may be less attractive than a jurisdiction with a higher tax rate and a much better business environment.
The same applies to international investment structures.
The relevant question is not:
“Where is tax lowest?”
It is:
“Where is the overall economic return highest after tax?”
That is a much more sophisticated calculation.
The Global Minimum Tax Does Not Create Global Tax Harmonisation
There is another important distinction.
A 15% global minimum tax does not mean that corporate taxation has been harmonised around the world.
Countries will continue to have different tax systems.
They will continue to have different tax rates.
They will continue to have different deductions and incentives.
They will continue to have different regulatory environments.
And they will continue to compete for investment.
The difference is that the largest multinational groups will operate within a new international floor.
That is a significant change, but it is not the same thing as global tax uniformity.
What Happens Next?
The next few years will be about implementation.
The EU has agreed the framework and member states will have to translate the rules into national legislation. The Council indicated that implementation into national law was to take place by the end of 2023.
That means businesses have a period in which to understand the consequences.
Some jurisdictions will lose part of the advantage created by low corporate tax rates.
Others will discover that their broader economic proposition is strong enough to compensate.
Some tax incentives will become less valuable.
Others will remain highly relevant.
And investors will increasingly look beyond the tax rate itself.
The Beginning of a New Competition
The 15% global minimum tax is therefore unlikely to end tax competition.
It may actually make the competition more sophisticated.
Countries will have fewer opportunities to compete simply by offering very low effective corporate tax rates to the world’s largest multinational groups.
They will have to compete on substance.
Businesses will have to think more carefully about where they actually operate.
Investors will have to analyse the complete economic and tax environment rather than simply looking at headline rates.
And jurisdictions that want to attract international capital will have to offer something more than tax.
The global minimum tax is therefore not the end of the international tax competition.
It is the beginning of its next phase.
The battlefield is moving from tax rates to economic substance.