Are QRTCs the Fatal Flaw of Pillar Two?

Originally published: March 2024

It’s become common to criticize Pillar 2 (P2) for its treatment of Qualified Refundable Tax Credits (QRTCs). Many P2 critics claim that countries will a QDMTT and then take that revenue to hand out QRTCs, effectively shifting to another form of tax competition. The Tax Foundation calls this P2’s fatal flaw (https://lnkd.in/e3gVi9gH). Left-leaning tax activists have made similar claims (https://lnkd.in/ebWG2rtS).

Of course, P2 has put QRTCs in focus. In the US, the IRA and CHIPS tax credits were enacted when P2 adoption was still uncertain, but they add to the perception there is a new wave of tax credit competition. In some countries, QDMTT and new CIT regimes will generate additional budget that could be used for QRTCs. But the QRTCs can’t go to the same businesses proportional to their QDMTT contribution. Depending on the specifics, some QDMTT paying MNEs will get no QRTCs, some will a bit and some will receive more than they have paid. Stylised examples usually miss this dynamic. A leading P2 critic on Twitter / X also summarised his criticism that QRTC status should be denied for profit linked credits (eg patent boxes) and only available for expenses linked credits (https://lnkd.in/eWWzeudf). But that’s how QRTCs actually work. Curiously, he seemed to imply that the bar for QRTC is too high rather than too low.

Widely available QRTCs present a budgetary risk for countries, as QRTCs could exceed QDMTT revenue. How acceptable is it to pay MNEs more than they contribute (whether individually, or as a group of MNEs)? It feels likely that QRTCs that result in such outcomes will face a blowback, particularly if they target mobile activities (the main focus of P2). Also, although QDMTT unlocks the budgetary space for QRTCs, the regular ups and downs means that countries will likely reassess their handouts, meaning any rough equivalence between QDMTT revenue and QRTC handouts could disappear in a matter of years.

By then, it will become obvious that QRTC are a form of subsidy. P2 undermines the effectiveness of one form of tax competition, so it is logical to expect an increase of other forms of government-led competition for FDI. But articles like this greatly overstate how easy that is and because you’d expect alternatives to be less optimal (otherwise countries would already be doing it before P2), the impact of QRTCs should logically be at a smaller scale than tax competition on rates.

Time will tell just how important QRTCs will be in a post-P2 world. The jury is not out yet.

Obvious disclaimers: this is not advice. These views are my own and do not necessarily represent my employer.

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