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Columbia FDI Perspectives
Perspectives on topical foreign direct investment issues
Editor-in-Chief: Karl P. Sauvant ([log in to unmask])
Managing Editor: Riccardo Loschi ([log in to unmask])
The Columbia FDI Perspectives are a forum for public debate. The views expressed by the authors do not reflect the opinions of CCSI or our partners and supporters.
No. 333 June 13, 2022
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Host countries have traditionally offered MNEs such tax incentives as tax credits and tax holidays to attract FDI. Although the effectiveness of fiscal incentives is controversial, their widespread use has resulted in a “race to the bottom” in international taxation: countries offer increasingly lower tax rates when competing to attract FDI.
The OECD’s newest iteration of the Base Erosion and Profit Shifting (BEPS) reform attempts to significantly erode tax competition through a two-pillar agreement joined by 137 countries.[1] Pillar 1 shifts tax rights over certain major companies to final consumers’ jurisdictions; Pillar 2 is encapsulated in the Global Anti-Base Erosion (GloBE) rules. Since the timeline for Pillar 1 is uncertain and Pillar 2 is likely to implicate a much larger portion of the international economy, this Perspective offers policy recommendations for host countries’ responses to Pillar 2.
Pillar 2 imposes a minimum corporate income tax (CIT) rate of 15% on all companies with annual revenues of €750 million or more and allows home countries to impose a “top-up” tax whenever MNEs’ effective tax rates are below 15% in any given jurisdiction. Host countries can still opt for corporate tax rates below 15%, but home countries will then likely impose the top-up to raise the tax rate on affected MNEs to 15%. Hence, with limited exceptions, host countries will lose any purported investment-promoting benefit attributable to the low rate—they would merely relinquish revenues to MNEs’ home countries.
How should host countries respond?
- The primary policy recommendation for host countries is not to lower effective corporate tax rates for covered MNEs below 15% or, if they are below that threshold, to apply a domestic minimum top-up tax to raise effective rates for in-scope entities to 15%. This implicates statutory tax rates, tax holidays, tax credits, and most tax provisions contained in contracts with MNEs.
- Jurisdictions that have not yet joined the GloBE Rules should do so to establish a convincing argument to exit fiscal stabilization arrangements that maintain sub-15% rates.[2]
However, host countries retain policy options to offer fiscal incentives that do not trigger top-up taxes if they choose to use this instrument. They can do the following:
- The 15% top-up ceiling. The top-up mechanism allows home country governments to impose an additional layer of tax only until a 15% effective rate is achieved, so host countries are free to compete on lowering corporate taxes down to that threshold—if they believe this could be effective. Because the average statutory corporate tax rate around the world is currently 24%, many host countries appear to retain policy space to do that. However, the top-up is based on effective, not statutory rates, which are to be calculated using a complex formula. Host countries that lower statutory rates should in general ensure that their effective GloBE rates do not dip below 15%.
- The substance-based income exclusion. Pillar 2 allows MNEs to exclude from GloBE income a value equal to 5% of payroll and tangible assets in a jurisdiction. Host countries can continue to offer tax rates below 15% on this income without incurring a top-up.
- Qualified refundable tax credits. Pillar 2 includes these credits in GloBE income instead of treating them as a reduction in taxes paid, leading to a smaller reduction in an entity’s effective tax rate per dollar of credit. This renders such credits, which must be repaid within four years after corporations satisfy conditions for receiving them, proportionally more attractive to corporations from a tax standpoint than tax holidays or non-qualified credits.
- Accelerated depreciation. The GloBE Rules require most deferred tax liabilities to be recast at the 15% minimum rate, meaning that deductions greater than 15% of an asset’s value may trigger the top-up mechanism. Depreciation deductions will therefore carry a lower value in jurisdictions with tax rates above 15% than they did prior to the Agreement. Many countries already have accelerated depreciation policies in place and may choose to continue to allow them, but should be mindful of this change.
- Non-corporate tax incentives. Under Pillar 2’s definition of covered taxes, host countries remain free to offer incentives on such levies as customs and import duties and VAT. The effectiveness of a non-CIT incentive strategy depends on current rates of non-CIT levies, but can be costly for developing countries that heavily rely on those taxes.
- Unlimited loss carryforwards. Companies can use prior losses to offset current gains indefinitely. Host countries could relax loss carryforward regimes, keeping in mind that loss deductions are recast at 15% in the same manner as accelerated depreciation deductions.
While experts debate the efficacy of downwards tax competition to attract investment, virtually all host countries currently rely on such measures. Regardless of host countries’ views on fiscal incentives, however, they should raise corporate effective rates to 15% or impose domestic top-ups to avoid losing revenue to home jurisdictions.
* Luca Jobbágy ([log in to unmask]) is a JD candidate for 2023 at Columbia Law School and a graduate of the Dual BA Program between Sciences Po Paris and Columbia University. The author wishes to thank Lorraine Eden for comments on an earlier draft of this piece, Howard Mann for a helpful discussion on this subject-matter and Daniel Bunn, Mary C. Bennet and Grace Perez Navarro for their helpful peer reviews.
[2] This may require renegotiating contracts and other arrangements. But since the tax effect for MNEs should be neutral, at least in principle, this may be possible.
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The material in this Perspective may be reprinted if accompanied by the following acknowledgment: “Luca Jobbágy, ‘BEPS reform: The end of fiscal incentives to attract FDI?’ Columbia FDI Perspectives No. 333, June 13, 2022. Reprinted with permission from the Columbia Center on Sustainable Investment (http://ccsi.columbia.edu).” A copy should kindly be sent to the Columbia Center on Sustainable Investment at [log in to unmask].
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For further information, including information regarding submission to the Perspectives, please contact: Columbia Center on Sustainable Investment, Riccardo Loschi, [log in to unmask]; Luca Jobbagy, [log in to unmask].
Most recent Columbia FDI Perspectives
- No. 332, Katia Yannaca-Small, ‘Shaping responsible business conduct through a Multilateral Treaty on Due Diligence,’ Columbia FDI Perspectives, May 30, 2022
- No. 331, Crina Baltag, “Denying the benefits of the Energy Charter Treaty: Shifting the policy or just the burden of proof?,” Columbia FDI Perspectives, May 16, 2022
- No 330, Karl P. Sauvant and Rebecca Chacon Naranjo, “WTO processes would benefit from the input of civil society”, Columbia FDI Perspectives, May 8, 2022
All previous FDI Perspectives are available at https://ccsi.columbia.edu/content/columbia-fdi-perspectives.
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Karl P. Sauvant, Ph.D.
Resident Senior Fellow
Columbia Center on Sustainable Investment
Columbia Law School - Earth Institute
Ph: (212) 854-0689
Fax: (212) 854-7946
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