Does Pillar Two Offer a Fair Deal for Developing Countries? : Leopoldo Parada

The impact of Pillar Two on developing countries has been a prominent topic in academic circles, policy forums, and media. In this episode, Dr. Leopoldo Parada shares his expert insights on some of the aspects of Pillar Two that are frequently highlighted as advantageous for developing countries.

Dr. Parada discusses whether the STTR and the QDMTT are beneficial for developing countries. He also offers his views on the future of tax incentives and recommends the best policy options for developing countries.

But that's not all - Dr. Parada also shares his inspiring career journey and provides invaluable career tips.

Transcript

Hi everyone, thank you for tuning in to the second episode of Cross border Tax Radio. I am your host Ankur and in this episode we have a special guest joining us to share their thoughts on whether the pillar two rules offer a fair deal for developing countries. I am extremely honoured to have Doctor Leopoldo Parada join us today to formally introduce him. Doctor Parada has completed an LLM and a PhD and he is a reader in tax law at King's College London, the Dickson Poon School of Law in the UK. Previously he was an associate professor in tax law and director of the center for Business Law and Practice at the University of Leeds School of Law. In the past, he's also held academic positions in Italy, Germany and the Netherlands. Doctor Parada also works as an independent tax policy advisor for different national governments and international organizations around the world. He has participated in different legislative tax reforms worldwide, including most recently the introduction of interest limitation rules in Indonesia and the OECD pillar two in Curacao and Suriname. His research focuses primarily on the international implications of beps, the application of tax treaties and the european and international tax implications of the digitalisation of the economy. Doctor Parada is the author of several books and academic articles and he is also a regular speaker at specialized conferences around the world, including specialized media outlets both within and outside the UK. Most notably, his academic work has been cited by the US Congressional Research Service and by the EU Advocate General in his opinion in the CJ EU case c 342 20 related to investment funds in Finland. He has also collaborated with the International Consortium of Investigative Journalists in important investigations related to tax avoidance, including the Pandora Papers in 2021. In 2020, Doctor Parada was recognized in the tax scope 35 leaders of the future in taxation list as one of the most promising tax policy experts worldwide. Welcome Doctor Prarada.

Thank you for having me, Ankur.

It's a privilege to have you with us. To our listeners, this episode will follow the same format as the previous one. There will be two sections. Firstly a technical discussion and then in section two we will hear from Doctor Parada about his inspiring career journey. Since the topic of our discussion today is whether the pillar two rules offer a fair deal for developing countries, we will first focus on the STTR and the QDMTT, which are often said to be good options for developing countries by international organizations. And finally, we'll hear Doctor Parada's views on the future of tax incentives. To lay down the broad context for question one, the rule order under pillar two is that the STTR takes priority, followed by the globe rules. The STTR multilateral instrument says that this rule is an integral part of getting a consensus for developing countries. Doctor Parada, could you please tell us a little bit about the STTR and whether it is likely to bring any significant tax benefits for developing countries?

Sure. All right. So this is a very, very interesting topic. The STTF rule is basically a treaty provision that basically aims to give those countries the possibility to tax at an additional level or generate an additional level of taxation on certain cross border payments that are made between connected companies. So the idea is that that will be triggered when the payments are not taxed at a sufficient level on the side of the recipient. So this is generally a nominal corporate income tax below the 9%. Now, the subject to tax rule is not applicable to also have payments. It's restricted to certain payments. Generally, we talk about interest, royalties and services, for example, are also included. Now, what is the particularity of the rule? The subject to tax rule applies as a top up tax by this idea of a top up tax. So it's basically the difference between these minimums created, which is the 9%, and what is indeed the nominal corporate income tax rate in the receiving country, with the particularity as well that any withholding tax that is applied at the source level will also reduce the ultimate top up tax. So let me put you a very, very basic example so in mind that we are in a treaty context with two countries, so source and residents. So royalties have been hailed from the source country to the western country, and we need to see whether the Sanit tax rule is going to apply. So let's assume that because of the treaty, there is a withholding tax potentially applicable with a rate of 5%. And let's assume that the corporate income tax and nominal rent at the level of the recipient company in the resting country will be 4%. So how this works, basically, I need to consider the 9% as this is the minimum given and I need to deduct basically the sum of these two others amounts. So this is the 4% which is the nominal corporate income tax rate in the resident country, plus the 5% that the source countries still have the right to tax. So in other words, in this example, there is no additional taxation that is generated in the source country. This highlights two important issues. One of them is the STTR is a very, very limited provision. It will apply a very few situation, because every time that you have a recipient country, a resident country, with a corporate income tax of a nominal rate of 9%, for example, above 9%, there is no way that STTR to baptize is generated. You will have a similar issue if at source a withholding tax amounts to 9% or above 9%, because that will be when you make the math to calculate the top up tax, it will give you, again zero. So the only situations in which we can think potentially on the application of the STTR is those very few cases in which the restless state, for example, is given a full exemption, or those situations where you have exemption in the western state, but also very low or limited taxation at source. So in answering your question, I would say, at least from that perspective, which is the generation of revenues that can potentially be created in the source country certainly is not the CTR doesn't appear as a very, very beneficial provision.

Thank you for your answer, Doctor Parada. It's very useful to know that the STTR has a very limited use for developing countries. Now, the STTR is followed by the globe rules. And prior to the introduction of the QTMTT in the globe rules, these rules consisted of the income inclusion rule and the UTPR. The IRR is the primary globe rule under which the right to collect the top up tax is with the country in which the ultimate parent entity is situated on the low tax income of a constituent entity in another country. Now, these globe rules were earlier criticized on the ground that they favored residence countries, since parent entities are generally not located in source countries or developing countries. And now the QDMTT is often put forward by international organizations as a beneficial policy choice for developing countries. And it is, it is also said to be a good option for these countries to collect top up tax. Could you please share your thoughts on whether the QDMTT has balanced the scale for developing countries?

Of course, in principle, when you think about the application of this interconnected rule, IAR, UTPR, and when the whole map of Binna two was created, there was no QDMPT. So in other words, all the taxing rights were assigned to the level of the ultimate parent entity. We all know that story. You know that most of the ultimate parent entities will be located in countries that they are consider developed rather than developing countries, right? So there was indeed an imbalance, as you point out, that the QDMDT trying to solve. Now, the QDM DT, and this is perhaps, you know, apparently was also a very smart move from the OECD from a political perspective, because when this happened, actually was exactly at the moment where the OECD was struggling to convince developing countries to endorse the pillar two project. So there were two things that they work to a certain extent, to attract developing countries into these, this project. One of them was the STDR. And things that we haven't talked about here yet, but the STDR, we didn't know much about the STDR until July 2023. Right. So we chose, again, you know, at least from my perspective, you know, that the STTR was indeed a political concession, you know, trying to use as a political bargain to bring countries in. The QDMTT did something similar, because the QDMTT was offered to developing countries as an idea for them to say, don't give up those extra revenues that are generated. Keep those revenues with you. You will, you will have a clear benefit here. You will have a gain, you know, which, which is materialized in more tax revenues in Yuandeh because of the mechanic of the rules, right. IAR applies to the extent, you know, that one of the subsidiaries of the group is under tax or below the 15%. The UTPR applies to extent that there is no ar applied, you know, at the level of the UB or the level of the intermediate entity. So the idea of the QDMD is to revert that priority on who exercised first attacks in rights. From that perspective, you could say, yes, the QDMTT generated a sort of a positive switch, right? Without the QDMTT, the whole narrative of pillar two was a narrative of punishment, but it was a narrative where I. And basically, we can put it in these words, if a country doesn't want to impose taxation, corporate income taxation, at a minimum effective rate of 50%, then someone else will go and tax the remaining part to complete the 15%. That was a narrative until the QDMDT. The QDMDT changed that narrative and transformed that narrative into a narrative of benefit. So it was a message for developing countries to say, here you have a tool that you can use in order to keep those revenues within the country. Now, that narrative is very smart, because convince many developing countries that they are always in need for more tax revenues to endorse the project. But after all, if you think in a very pragmatic perspective, having or not having a QDMT is better to have it, because it might at some point generate some revenues. Where is a caveat of all of this discussion is that a QTMTT will generate some revenues in some cases. In other cases, it won't be like that. For a very simple reason. You cannot evaluate the QD and T as a sort of an isolated policy without considering all the dynamic factors that can affect the decisions of the investors. So two of the factors that, that nobody has really addressed in this discussion. What happened with the elasticities of investment? Are all the investors reacting in the same way if they are located in country x or country y? What's happened with the other competitive advantages that a country may have, a country that is actually implementing the QDMTT? Is it the same to talk about a country that has very bad infrastructure, that perhaps may have not the most stable political environment, or the economic situation is not the best in the country? So it's the same for that country, that other country that has perhaps all the very strong and competitive advantages vis a vis, you know, the naval. The answer is no, right? So if we put this in a very simple example, let's think about two countries, a and b, right? Both countries and neighbor countries. Country a decided, you know, a long time ago to have a tax incentive, you know, a tax holiday, zero corporate income tax rate. And that country, however, has not the most stable political environment. The economy is quite unstable at the moment. They have problems with infrastructure and other issues like that. In other words, when you look at the other competitive advantages of country a, there are a series of issues that make the country less attractive, but they have a very attractive corporate income tax, you know, 0%. So an investor, let's say the only investor you know, in the region deciding to go to Canterbury. Cantrevia, on the other hand, has higher corporate good tax, let's say 30%, 35%. But they have all the advantages. Telecommunications, like go to infrastructure, is way better than n. Three a lab, of course, is cheaper than country a, certainly is way more stable from a political and economic perspective. Right? Now, imagine that both countries A and B decide to implement beta two. Both decide to have a QDMTT. The narrative is that if you have the QDM DT, you will get revenues. So if we follow that reasoning, we should think, okay, so can three a, we keep will get revenues because it will avoid that top attack, goes somewhere else, right? But in practice, this will depend of the reaction that the investor has in country a. So now this investor has both countries a and B taxing at a 50% minimum tax rate. And the difference comes that country a now appears as less attractive when you look at the competitive, the other competitive advantage that that country has, piece country bhdem. In other words, nobody can guarantee that the investor in country a won't move to country b. So the logic of the OECD at all countries will benefit, doesn't matter. You know, the other more dynamic factors, economic factors like elasticities of investment or competitive advantages, is actually a false statement. Because it's not considering the reality, you know, of the economy, which is that investors consider different factors when they move from one country to another. Of course, this example is very extreme. I'm not saying that this is something that necessarily is going to happen in other countries. I'm just simply saying that, as we might have seen, that some countries will benefit with the QDMTT because they will do, some others they would not, and some other actually might lose with this. So trying to sell, you know, this idea of the QDMTT as a sort of a holy grail that will solve, you know, all the problems, you know, and thank God we have now the QTMT. It's actually a little bit misleading and developing countries should be careful to consider it. And unless they have clarity about the wrong situation with all the factors, not only is not only looking at this from an static perspective like the OECD is proposing, but also from a dynamic perspective, what happened with the investors within the country, within the different sectors of the country, how they are behaving? Do we have data to determine how the elasticities of those investors at the moment? Do we have clarity about what are the other competitive advantages of the country vis a vis enabled countries? Because that will make a difference on the impact of the QDMTT, which is, in very simple terms, an impact on revenue. This is how the Oeds sold the project. This is how we calculate and benefits in the country. So if there is no investor, you simply don't have ravages because you don't have when to exercise, you know, your tax.

Thank you very much for your answer, Doctor Parada. Now, developing countries also frequently, frequently use tax incentives to attract foreign direct investment. What do you think the future holds for these tax incentives after pillar two? And what would you recommend as the best policy option for developing countries?

Right. That's a very, very good question, because of course, pillar two changes the whole environment on tax incentives. Countries, of course need to adapt to what's going to happen now for a very simple reason. If you used to have a tax holiday, and that will be within the scope of pillar two, of course it will reduce your effective tax rate. That can trigger top of tax somewhere else. So countries, and particularly in developing countries, they should bear that in mind at the moment. Now, this shouldn't be limited exclusively to the fact of how we are compliant with pillar two and how we adapt our tax incentive to pillar two. There is a risk on that. And I'm telling you this because I've heard so many times, and particularly petitioners repeating the idea of the OECD, that since refundable tax credit apparently outside the scope of billet two, because of course they will amount to something equivalent to a subsidy or grant, it seems to be a feasible alternative for developing tenders. I would say be careful with that. Refundable tax credit in practice means that you need to have money to get back to those taxpayers. So if we are talking about a developing country with not the biggest wallets in the neighborhood, I could say it's a really bad idea to go for a qualified refundable tax credit. So from a policy perspective, we need to be very careful with these sort of things. So what is my approach generally when I have to talk with different developing countries on these matters? The first thing is, of course, forget about the idea that pilot two is a project that will generate revenues. Pilot two was not created with that purpose. Pillar two was created with the purpose of limiting tax competition. So try to internalize that idea within the country, because there is nothing about the altruistic idea of generating more revenues around the world, because this is not the original aim of the project. And the second thing is, well, perhaps take this opportunity to look further on your tax incentives. As you mentioned, developing countries, they use tax incentive to attract direct investment. They need that, some of them, I've seen that in the reality, some of those tax incentives are extremely effective to attract investment. Investment is not about public companies, is about employment. It's about money being injected into the economy. It's about a series of other benefits that they will come necessarily associated with that foreign investment coming to the country. If we generate two extra thousand positions of employment those people will consume, generally the welfare is increased. But also I could say it's important that developing countries take the opportunity to also look at what they have and say, well, okay, so not all the tax incentives we have, they work in the same way. We might have some of the tax incentives that are not extraordinarily efficient. So we need to rebuild some of them, we need to transform some of them as well. And of course, we need to make pillar two less impactful within the, within our economy. So that means also to look at the potential non tax incentives that can be offered in the future. Subsidies are outside the scope of pillar two. Just be careful. I would say in the general message for developing countries that nothing is connected to the potential collection that you have with the QDMTT, because there is this prohibition on collateral benefits. So if you are going to collect with the QDMT x amount and then you are going to give that in the form of a grant to a company, you will be limited by the glove rules. Finally, I would say from a policy perspective, and my recommendation for calculus could be try to make it simple, try to reduce the burden that is already created by bidden tool new tax administration. So don't make it more complicated than it is. And this is again coming back to this message. When I hear the repetition of things that are there on paper, like the refundable tax credit, you know, and when we think about the small countries, that they have a very limited tax administration, that they have problems with collection and enforcement, be careful, because a qualified refundable tax credit should be completely out of the side from that policy decision. It's nothing is not really a good decision for those countries to pursue that. That's a very different story if when we are talking about a powerful tax administration that they have cash to give back, because that's correct vulnerability. And if those countries can do that, we generally will be developed countries. And then go ahead, don't buy, you know, everything that is put, you know, out there in terms of the benefit or in terms of simply saying, well, just transform, you know, all your incentives related, you know, to credit, you know, and make it refundable, because that can be a very, something very, can impact negatively the wallet at the end of the country.

Thank you very much for all your answers, Doctor Parada. Your answers will be extremely useful for developing countries for assessing the impact of pillar two. We'll now move on to section two, where we get to know a little bit about our experts career journey. Doctor Prarada, you've accomplished so much in your career and your journey is extremely inspiring to all of us. Have you always been interested in a career in tax law or was there anything specific that sort of guided you in this direction?

That's a good question. Well, I would say my interest in taxation came a long time ago, more than 20 years ago, when I was still studying law. It wasn't last year, and I had to study tax law, and I found it really fascinating. One of the things that really attracts me from the very beginning to these matters of taxation is something that people in tax tend to forget and people outside tax, they simply don't know, which is that taxation is everywhere. It's everywhere in our life since, I would say, since we are born, until we, until we die. So that is fascinating because it means there is a very interesting social aspect of taxation that people tend to forget and what makes it very, very, very attractive, knowing about taxes is not knowing about the technicalities of a particular tax, is knowing about the implications of it. So I would say if back then I got interested in the topic. But my career with tax started very much, I would say, by fortune, because I was still in the process of looking for jobs. And I remember that I attended a wedding party and of a friend. And in that wedding party, that was many years ago, I was in Chile. And in that wedding party there was a professor who also was a partner of big four. And I didn't know him, he was not my professor of Jack's law. But we started talking and we were seated, one besides the other, on the table. And then he mentioned that there was a position, you know, open in that, in that big four, and when they would be interested, you know, and then I decided to apply and then they hired me. And then I started my career that way. Now that was only, you know, the deployment side. Of course, my interest in tax was. Was before, but as any other graduate student at that point, it was, oh, I was having a lot of uncertainty with the. I could work on these matters my whole life. Not so. The rest is history. Of course, I could do this in many countries, and I'm happy that I ultimately opted for it.

Thank you, Doctor Parada. I'm sure your career journey will provide guidance and motivation to all our listeners, especially our young listeners. All also generally have someone who inspires us, a person whose achievements or character motivates us to strive for more. My last question to you is that could you please share if there is anyone who has inspired you, either in the field of tax law or in any other field?

Well, many, many people. I couldn't name all of them here. Perhaps, you know, I will answer you with a more generic answer. I try to get inspiration from others all the time. That for me means I always try to be in an environment where I'm not the smartest person. And that that has worked very well. And I could say I could recommend especially, you know, young listeners that they tried that. When you are in maze, you know that you are indeed the smartest person. Probably you are in the wrong place because you are not learning anything new. Try to surround yourself by others who are also smarter than you. There is nothing wrong with that. There is nothing shameful on that. It's actually something very good. And you will see that in a very short time you will also improve yourself. And at the same time, I would say I could recommend others as something I do very often is don't thank yourself so seriously, the more you achieve and the older you get, you start realizing that those things that you can see, they're very important and that makes you very proud are indeed not that relevant. Don't take yourself so seriously. Enjoy simple things. Get a good hobby outside of what your area of expertise is. For me, that, for example, is photography. Something that breaks me completely out of the field of text law. I love painting as well, and these are things that brings me to a completely different world. Finally, I would say something I do all the time and I I recommend others as well to do. Don't only mingle with people of your field. There is nothing more boring than just talking with an only tax lawyer, or only lawyers, you know, manage yourself, you know, part of all the community. Learn the interest. Others as well. Mingle with musicians. Mingle with people you know that they have completely different interests. At the end of the day, that is a smaller representation of what the world is about. So the more you know about the realities of others, the rather your spectrum of understanding is created. So that would be my answer to that. Rather than giving you any specific names of people that they might inspire me. But they are. There are many of them as well, and maybe another opportunity. We can really talk about each one of them.

Thank you, Doctor Parada. Those are extremely useful tips. With that, we come to the end of our episode. Doctor Parada, I can't thank you enough for sharing your thoughts and your time with us. And one more thing that I want to finally say is that I'm a bit envious of the upcoming international tax law LLM batch at King's College London. Who will have the opportunity to learn from you? I will be graduating in September and I won't have that opportunity. But once again, thank you so much for your time.

Thank you very much, Ankur. And congratulations on your initiative for this podcast. I know that you started this only this year, so I wish you all the best as well with the rest of the episodes.

Thank you Doctor Parada. And to our listeners, we hope that you enjoyed this episode as much as I did. We promise to bring you more expert insights and interesting topics in future episodes. Until next time, this is Ankur signing off from cross border tax radio.