Opinion: What the 'global minimum tax' means for development financing

The global minimum tax, or GMT, is one of the most significant changes to international taxation in a century, having now been backed by over 130 countries. Nevertheless, there is still some lack of clarity on what this change may mean for private sector projects financed by multilateral development banks, or MDBs. Under the GMT, in-scope multinational enterprises, or MNEs, will be subject to a minimum 15% tax rate from 2023. The GMT is expected to generate an additional $150 billion in global tax revenue each year and increase and protect the tax revenues of low- and middle-income countries. For those MDBs that are scrutinizing the ownership structures and tax affairs of groups they invest in, the GMT will likely become a factor in due diligence processes. The GMT may not directly apply to groups they are investing in in emerging markets due to quantitative limitations, but it could still impact MDB financing indirectly through larger investment partners and due diligence processes that assess economic substance, treaty shopping, and effective tax rates. The GMT could encourage emerging markets to rethink their corporate tax systems and focus on non-tax factors to attract investment, which could provide greater assurance to MDBs when evaluating investment opportunities. An overview Under the Organisation for Economic Co-operation and Development’s blueprint, the GMT consists of the Global Anti-Base Erosion Rules, or GloBE, which has two interlocking components: the Income Inclusion Rule, or IIR, and the Undertaxed Payments Rule, or UTPR. IIR: The IIR allows the country in which the parent entity of an MNE is resident to impose a top-up tax on income of subsidiaries taxed at an effective rate of less than 15%. The GloBE also has a substance-based income exclusion, also known as substance exclusion, reducing the income subject to top-up tax by a percentage of payroll costs and tangible assets: UTPR: The UTPR is a backstop to the IIR and targets base-eroding intragroup payments between brother-sister entities. Some commentators have described this as a “sideways” rule as it applies between brother-sister entities in a group, rather than between parents and subsidiaries (like the IIR). The UTPR applies when the IIR does not and allocates a certain proportion of “top-up tax” to a group entity that makes a payment to another group entity in a low-tax country: STTR: The Subject-to-Tax Rule, or STTR, applies top-up tax when certain outbound payments to connected entities benefitting from a double tax treaty are subject to a tax rate of less than 9%: QDMTT: A Qualified Domestic Minimum Top-up Tax, or QDMTT, is a domestic minimum tax that a subsidiary country can implement on its own that effectively excludes domestic profits from the GloBE. What does the GMT mean for development finance? For those MDBs that carry out due diligence into the ownership structures and tax affairs of the groups they are investing in — investee group — and the partners and sponsors investing alongside them — the investment partners. With the GMT emerging as a powerful tool to prevent the erosion of a country’s tax base, there is a question as to how it could factor into these due diligence processes. In making this assessment, it's worth beginning by noting the GloBE’s quantitative limitations: It only applies to MNEs with consolidated revenues exceeding €750 million (though countries can opt for a lower threshold) and it doesn’t apply to countries where the relevant group's revenues are less than €10 million and profits are less than €1 million (the country revenue threshold). To the extent that a country adopts these thresholds, emerging market investee groups are unlikely to be directly subject to the GloBE. However, for a number of reasons, the GMT rules may still be relevant to MDB financing. Firstly, larger investment partners may fall under the purview of GloBE rules, which could result in low-taxed Special Purpose Vehicles, or SPVs, used by investment partners to hold their investments in investee groups being subject to top-up tax. This top-up tax would apply when the profits of the SPV exceed the country revenue threshold and the SPV lacks adequate economic substance to exclude its taxable income from the GMT under the substance exclusion. If MDBs assess the rationale for using such SPVs, two positive outcomes may arise: 1. It could reduce the likelihood of abusive tax planning as the application of top-up tax may partly offset any tax benefit provided by the SPV. 2. The substance exclusion could encourage groups to increase economic substance in SPVs. Secondly, the quantitative limitations mentioned above do not restrict a country applying the IIR or QDMTTs, which are expected to be widely adopted, to enterprises headquartered there that are large in the context of the local economy, such as small multinationals headquartered in their country. From a due diligence perspective, the application of such a domestic top-up tax could provide a degree of assurance that there is a minimum effective tax rate for the investee group. Thirdly, the STTR is not subject to the GloBE's quantitative limitations and aims to protect lower-income countries from base-eroding payments. MDBs may wish to consider the STTR, if applicable, when assessing whether outbound payments benefiting from a double tax treaty are potentially abusive. Finally, by putting a floor on tax competition, the GMT should encourage countries to focus on non-tax factors as a means to attract investment. For emerging markets, while the GMT may not always apply, the existence of the rules may force a broader rethink of their corporate tax systems, particularly their use of tax incentives. More robust tax systems that better support domestic resource mobilization may provide greater assurance to MDBs when evaluating investment opportunities in these countries. What’s next? The GMT rules will likely have direct or indirect impacts on investee groups and investment partners. As we approach the intended commencement date of the GMT in 2024, MDBs may wish to consider how analyzing these impacts may fit within the suite of tools they use to assess the tax affairs of their investee groups.