Recently Released OECD Global Minimum Tax Guidance Clarifies Impact to Community Development Tax Credits, But More Guidance Is Needed Before 2023 Implementation

Published by Brad Elphick, Peter Lawrence on Monday, April 17, 2023 - 12:00am

The Organization of Economic Cooperation Development (OECD) released guidance Feb. 2 on the Global Minimum Tax (GMT), which provides some clarity on the treatment of community development tax incentives for purposes of calculating large multinational entities’ effective tax rate. The recently released guidance provides greater clarity on how investments in the low-income housing tax credit (LIHTC), the new markets tax credit (NMTC), the historic tax credit (HTC), and the renewable energy investment tax credit (ITC) and production tax credit (PTC) could be accounted for without negatively impacting the calculation of large multinational corporations’ effective tax rate.

The guidance was a follow-up to the October 2021 agreement signed by more than 135 countries that detailed the GMT’s two pillar solution. The first pillar would allow governments to tax global firms based on where they obtain profits instead of where they are domiciled, and the second pillar of the proposal provides for a minimum level of taxation at 15%. Before the guidance was released, large multinational corporations and community development tax credit stakeholders were concerned about how the GMT would treat nonrefundable tax credits, including existing community development tax credits.

An Overview of the Global Minimum Tax

As globalization of the world economy deepened, many countries became increasingly concerned by large multinational companies placing a greater portion of their income generated worldwide into low-tax countries, which reduces tax revenue in many of the largest countries that companies do business in. This prompted the OECD/Group 20 (G20) to create the Inclusive Framework on Base Erosion and Profit Sharing (BEPS) in 2015. This framework led the OECD/G20 to create a Global Minimum Income Tax, which would ensure that global companies pay a minimum level of income taxes based on where income and profits are generated. Following the signing of the October 2021 agreement, the OECD issued a 70-page model rules document in December 2021. In March 2022, the OECD released a 228-page commentary on the model rules.

The GMT is intended to improve international taxation rules by requiring large multinational corporations to pay a “fair share” of tax where they operate and obtain profits. Large multinational corporations are defined as businesses with annual worldwide group revenue exceeding €750 million (about $780 million) in at least two of the four fiscal years immediately preceding the tested fiscal year. Pillar 1 would allow governments to tax global firms based on where goods and services are sold instead of where the company is based. Pillar 2 would create the 15% minimum tax, also known as the Global Anti-Base Erosion (GloBE) rules. There are three components to the GloBE rules:  the Income Inclusion Rule (IIR), Qualified Domestic Minimum Top-up Tax (QDMTT), and the Undertaxed Payment Rule (UTPR). The IRR imposes the top-up tax on low-taxed income, and the top-up tax can be reduced by the QDMTT. The UTPR denies deductions or requires equivalent adjustments in countries where the income is not taxed under an IRR. All three rules ensure that there is a minimum effective tax rate of 15%.

Pillar 2 is enforced by certain rules. If the global company is operating in a country without a minimum tax rate of 15%, other countries are permitted to charge a top up tax so that the global company is paying a 15% tax rate in each country where income is sourced. Due to this, it does not matter if the United States actually adopts the global minimum tax into the Internal Revenue Code, as other countries can still adopt it. If another country adopts Pillar 2 and a multinational corporation operated in both that country and the United States, the other country could charge the multinational corporation a top-up tax equivalent to the amount that would bring the effective tax rate in the United States to 15%. This creates a strong incentive for countries to adopt similar rules, so they don’t forego tax revenues.

It is estimated that the GMT would create $220 billion in additional tax revenue worldwide. Furthermore, the OECD argues the GMT will “level the playing field” for U.S. businesses by ending the “race to the bottom,” or reduction in corporate tax rates.  

Impact to Community Development Tax Incentives

When the model rules were released in Dec. 2021, the original concern was that the GMT could have devastating consequences for community development tax credits. Under the original interpretation of the rules, the GMT could have reduced the value of the LIHTC, NMTC, HTC, ITC and PTC by including the reduction in the entity’s effective tax rate caused by using the tax credit incentives. Global companies are some of the largest investors in community development tax incentives in the United States. There was a need for clarification, specifically if U.S. community development tax credits affected the calculation of the 15% minimum tax threshold, and the guidance provided some.

If guidance was not provided, an investment in nonrefundable tax credits by a large multinational corporation could reduce their effective tax burden to less than 15%, causing companies to pay more in taxes in other countries, effectively eliminating the benefits of the tax credits. This could cause companies to invest less in nonrefundable tax credits, including the community development tax incentives, and perhaps even to sell existing investments.

The February 2023 guidance provides a technical implementation framework for countries choosing to adopt the GMT regulations. Investments in LIHTC, NMTC, HTC, ITC and PTCs that are not consolidated and are accounted for using the equity method of accounting will not affect the calculation of the 15% effective tax rate negatively. This guidance provides some clarity on critical issues for tax practitioners, and more broadly U.S. government officials. A press release from the U.S. Department of the Treasury included a statement that Pillar 2 of the GMT was created so that the “top up tax would be compatible with common tax treaty provisions.”

Clarity Provided, But More Is Needed

The March 2022 guidance from the OECD allows for the equity method of accounting for tax credits, however there are those in the industry that still want additional guidance. The March 2022 guidance excludes certain types of gain or loss, which includes excluded equity gain or loss. The equity method exclusion did not specifically include tax expense, benefits, or credits. Additionally, the equity method could be used to determine the effective tax rate, but would not look at the country’s book income on a consolidated basis. The Feb. 2023 guidance states that community development and renewable energy tax credits were included amongst the exclusions, as long as those investments were not consolidated . However additional clarification is needed to ensure that the various versions of the equity method of accounting, including the proportional amortization, deferral and hypothetical liquidate at book value (HLBV) methods, fair value option, are considered equity methods of accounting that meet the intent of the guidance provided.  Some investors have concerns that other countries won’t interpret the guidance the same way that the United States does when it comes to the various subsets of the equity method.

What Comes Next?

The OECD will continue to release guidance on an ongoing basis to ensure proper implementation of the framework. The recently released guidance provided the clarity and the needed security for community development tax incentives, but additional guidance is needed. Furthermore, Novogradac renewable energy partners have looked at the transferability rules in Pillar 2 and noted that there may be potential for transferable credits and “direct pay” credits to receive favorable treatment by meeting the definition of a qualified refundable credit but will need guidance in this area.

In a June 2022 memo, Novogradac recommended that future OECD guidance confirm two remaining components. First, if the use of the equity method includes all variations of the method, such as the proportional amortization and HLBV methods. Second, guidance would need to confirm the joint venture rules, which state that the effective tax rate is not changed by the joint venture rules as long as the joint venture has income, and the owners are subject to tax at a nominal rate of at least 15% or the joint venture has a loss and the owners are entitled to use that loss.

Tax experts in the United States would also like additional clarification on other countries’ interpretations and implementations of the guidance and the Pillar 2/GMT regulations. The deadline to implement Pillar 2 is supposed to be Jan. 1, 2025, but given the current status, it is unlikely that it will happen by this date. Currently, the European Union’s member states have until Dec. 31, 2023, to implement the GMT into national legislation, with the rules applicable for fiscal years starting after Dec. 31, 2023. In the United Kingdom, the rules are currently in draft legislation proceeding through Parliament. The rule will be implemented in the UK in accounting periods starting after Dec. 31,2023. In Japan, a tax reform package, containing only the IIR provision of the GloBE rules, was submitted to the national legislature. The IRR is expected to take effect starting on or after April 1, 2024. These rules are expected to take effect on Jan. 1, 2024, but can be adopted earlier. Australia is awaiting additional guidance from the OECD but is expected to implement the rules in 2024. It will be crucial that these countries adopt the February 2023 OECD guidance.

Additionally, it is unknown if implementation and administration will be carried out in 2023. An analysis released prior to the OECD April 2022 report predicted that implementation of the GMT will be difficult due to different global economies’ priorities.  The United States also may have internal pushback on GMT implementation. According to a Bloomberg Tax Report, Republican lawmakers expressing opposition on the GMT and BEPS framework, and House Ways and Means Committee Chari Jason Smith, R-Missouri, is quoted as saying that House Republicans are concerned with the work product of the OECD, and want to ensure that the GMT does not adversely affect the United States. House Republicans are considering reducing or eliminating U.S. funding for the OECD, which provides 19.1% of the total.

Novogradac will continue to monitor news on the GMT, and various Novogradac working groups will be monitoring key developments. To access ongoing discussion and analysis about the GMT, consider joining Novogradac working groups, which include the GAAP Accounting for Tax Credit Working Group, Renewable Energy Working Group, the LIHTC Working Group, the Opportunity Zones Working Group and the New Markets Tax Credit Working Group.