Pillar Two Proves to Be a Hard Pill to Swallow for Latin America

When the OECD’s Pillar Two was announced, and members of the Inclusive Framework endorsed it, Latin American countries were at the forefront, with a vast majority of political leaders supporting it. This is unsurprising, as South America alone has the highest average statutory corporate income tax rate globally at 28.32%.

So how harmful could it be to adhere to a modest minimum 15% effective tax rate applicable to multinational enterprises with a global revenue over 750 million euros ($819.6 million)?

Now that the clock is ticking, the impact of Pillar Two is no longer just an exciting political speech on international tax and the fight against tax havens, but a reality that, like a wave, could drown some Latin American nations if not surfed properly.

While Pillar Two intended in its inception to stop the race to the bottom—having countries compete for business by offering increasingly more attractive tax incentives—its configuration under the Global Anti-Base Erosion, or GLoBE, rules has been described as “a shortcut taken by capital exporting nations,” that is “eliminating the few competition tools that capital importing nations have, and who have to sustain over 90% of the world population.”

Maybe it is due to the above that Latin America is taking its time enacting anything Pillar Two-related.

Argentina, which early on thought a 15% effective tax rate was not going far enough—going to the lengths of proposing a minimum of 21% and a maximum of 25%—now remains silent on the topic, after the exit of its Minister of Economy, Martín Guzmán.

Chile’s government, which undertook a now-failed attempt to overhaul the tax system in 2022-2023—a perfect opportunity for Pillar Two-related announcements—didn’t even include it in the footnotes.

Ecuador’s president, Guillermo Lasso, was keen in May to use his temporary executive powers with a tax package right after dissolving parliament. Even in a context where no Congressional approval is required, Pillar Two was absent from his administrative agenda.

Impact Varies Across Region

Significantly, the impact of Pillar Two isn’t the same across Latin America. While countries rich in natural resources, like Argentina, Brazil, or Mexico could impose such a measure without necessarily causing harm to their economies, other jurisdictions depend heavily on attracting foreign investment.

The latter is the case with countries such as Uruguay and Costa Rica that rely on highly stable political and economic systems, while giving certain benefits like free-trade zones, that made them both recognized hubs for MNEs operating in Latin America. But how will Uruguay deal with the tax-stability contracts signed between the state and foreign investors?

Another singular case is El Salvador, a nation that used to be ravaged by violence and in desperate need of stabilizing its political and economic system. Its approach has been to enact rules that would make trading in cryptocurrencies through El Salvador highly appealing; the same has been done with highly attractive incentives to tech companies that decide to create new investments in what is perceived to be a high-risk country. What is the path such a country could follow now?

But the challenges of Pillar Two aren’t just something that small countries have to address. As pointed out by author Lucas de Lima Carvalho, Brazil might have strong constitutional issues in adapting such measures as the undertaxed profits rule, the UTPR. Will the implementation of Pillar Two lead to issues such as proposing amendments to the Brazilian constitution?

Having said this, and as has been stressed by Peter Barnes and Stephen Shay, there is no time to wait, as the failure to act ultimately will be felt by taxpayers.

The reality of Pillar Two is that the unwillingness of a nation to implement a GloBE coherent 15% ETR will feed the pensioners and lower the pressure on taxpayers in other countries eager to see an income inclusion rule, IIR, or the UTPR in place, such as the members of the EU.

In that regard, some nations like Colombia are somewhat ahead by establishing a 15% ETR even if different in terms of calculation and scope to the one designed under Pillar Two. However, since this permanent minimum effective corporate income tax wasn’t created in line with GloBE, will it trigger double taxation? Others, like Mexico, are interested in enacting Pillar Two legislation and might do so before the end of 2023.

Contrary to its southern neighbor, the political landscape of the US makes it seem that any advancement on Pillar Two is unlikely in the short term, even if President Joe Biden views it favorably. If anything, the fact that one of the major parties in the US has proposed a bill to effectively impose 5% to 20% additional tax on the US-source income earned by residents of countries that have enacted “unfair taxes” (for example, the UTPR), is a clear warning sign to any Latin American country willing to go above and beyond when completing their OECD homework.

What is the Solution?

A starting point is understanding that securing a 15% ETR in a way that is aligned with GloBE is the best way to ensure that Latin America won’t forgo any tax base in favor of other countries.

Secondly, one might argue that it is unnecessary to raise the general ETR of a country to 15%, and instead just impose such a minimum threshold for companies that belong to multinational groups with revenue above 750 million euros. In other words: aim at your real target.

Last but not least, it is critical to understand how the negative effect—a lower return on investment— that the implementation of Pillar Two might have in one jurisdiction could be compensated by the implementation of qualified refundable tax credits, and what limits the OECD may impose on these. And, particularly for companies operating in the EU, whether such incentives made at the expense of developing economies could be captured under the EU’s Foreign Subsidies Regulation.

For LATAM countries, Pillar Two isn’t about fighting tax havens or winning or stopping any race, but rather is about designing a tax system that guarantees they can still cook their own lunch by making their economies grow, and not having it being eaten by someone else on the planet.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Ignacio Gepp is a Partner with Puente Sur in Chile.

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