Sometimes it’s the little things that make all the difference. Those hard-to-see crumbs of evidence revealing the forest beyond the trees. That canary in the coal mine. That’s what I see when I look at one particular part of the historic global minimum tax of 15% agreed by 140 jurisdictions in 2021, namely a little thing known as the ‘undertaxed profits rule’ or ‘UTPR’.

The UTPR is a novel mechanism that will allow countries to tax corporate profits that are neither earned in their jurisdiction nor earned by their resident companies – an unprecedented, supercharged extraterritorial taxing power. Cast as a minor cog in the larger minimum tax machinery, a “backstop” relegated to mop-up duties, in reality the UTPR is so much more than that. 

The UTPR is the canary in the coal mine of global tax change. It shows us how international taxation is changing in fundamental ways, driven by shifts in the world economy, and signaling a remarkable departure from long-standing global taxing norms, with important implications for global tax governance, distributional outcomes, for fiscal sovereignty, and beyond. 

It was Jason Sharman – to my mind the sharpest analyst of global tax politics in the 1990s and 2000s – who first used the canary analogy to assess change in global tax politics. In an article from 2010, Sharman observed that, although the world’s great powers had spent 15 years trying to crack down on tax havens, the offshore world hadn’t exactly declined. And tax havens weren’t about to disappear. Instead, tracing small signs of change in the global economy, Sharman argued that tax havens would continue to find profitable markets for their services. It’s a succinct analysis that largely rings true today, even if what we consider tax havens now is very different from a decade ago.

Looking beyond the headlines, we can follow Sharman’s lead to tease out significance among the fine prints of the global minimum tax, a revolutionary commitment by the international community to impose a minimum tax level of 15% on corporate profits across the globe, brokered by the OECD and the G-20. Unimaginable just a few years ago, the global minimum tax has made all the headlines, heralded as an exemplar of diplomatic success built on American leadership, even as the global community continues to grapple with the technical details that will make up the nitty-gritty bits and bolts of legal implementation.

Untangling the UTPR

The UTPR is just a small part of this global agreement, a huge package of rules and standards running hundreds of pages. But it has perhaps the biggest impact.

Now, the tax aficionados will be keenly familiar with the UTPR, a key source of amazement and controversy among the global tax expert community, but for the generalist reader, it is worth explaining in context. The whole problem starts because, well, there’s no global tax authority, and so the international community needs to design some effective ways in which a 15% global minimum tax on corporate profits can be enforced. The two most straightforward ways to do that are:

(1) to have each country tax the profits earned in their jurisdiction at at least 15%

(2) to have each country tax the profits earned around the world by companies headquartered in their jurisdiction at at least 15% 

I’m simplifying here, but these two kinds of rules (technically speaking, the ‘qualified domestic minimum top-up tax’ and the ‘income inclusion rule’) form the backbone of the global minimum tax. Although they are novel in their specific design, these two rules build on core, century-old principles in international taxation, in particular the “source principle” (a country’s sovereign right to levy corporate income taxes on incoming arising from their jurisdiction) and the “residence principle” (a country’s right to tax income from companies resident in their jurisdiction, regardless of where the income was earned). These principles relate to more generally applicable norms in international society, where sovereignty and jurisdiction define and delimit the regulatory power and reach of governments.

The UTPR, however, is a big ‘fuck you’ to these principles. It allows countries to tax profits that are neither earned in their jurisdiction nor earned by their resident companies. On the contrary, it allows countries to tax income earned outside their jurisdiction (anywhere in the world!) by foreign companies (wherever they are based!). Practically, the UTPR works by giving any country where a multinational company has some presence (e.g. a subsidiary or permanent establishment) the right to apply a top-up tax if the company has an effective tax rate below 15% in any country around the world. Imagine giving China the right to tax some of Apple’s European profits through Apple’s Chinese subsidiary because the company pays a low effective tax rate in Ireland. That’s the gist of it! Here’s a practical example of how the rule would work. I’m simplifying again, and there are several restrictions on the UTPR, but conceptually, those are the broad strokes. When we put it like that, it sounds like some insane super-charged extraterritorial taxing power, doesn’t it?

A pragmatic balancing act

While crazy-sounding, there is some logic to the UTPR. Importantly, no one is really meant to actually apply the UTPR. It’s more of an insurance policy, a big baseball bat held over governments’ heads to incentivize them to adopt the two main rules, the domestic minimum tax and the residence-based income inclusion. In fact, the UTPR only serves as a backstop in the global minimum tax machinery – a fact the OECD are very keen to highlight – and thus it can only be used if the two main rules are not effectively applied to secure a minimum 15% level of taxation. (In reality, however, the UTPR is likely to actually be applied in some cases because some countries won’t – or can’t, e.g. because of domestic politics – implement the two main rules fully in compliance with the OECD model rules, most prominently the US.)

Moreover, the UTPR is a fundamentally pragmatic solution to three in part contradictory and in part overlapping political problems: US hegemony, the rise of emerging powers, and a breakdown of global tax consensus. 

First, there is no question that the UTPR is an American invention. Originally, when the global minimum tax was being scoped, the UTPR (then known as the undertaxed payments rule) was designed based on a Trump-era US policy known as ‘BEAT’, the base erosion and anti-abuse tax, a theoretically smart (if horribly impractical for companies) policy that limits the ability of foreign companies to shift profits out of the US market by imposing an additional tax on outgoing payments from US subsidiaries, e.g. interests or royalties, if they are taxed below a certain threshold.

Following US domestic policy templates has historically been a recipe for success in global tax reform, as Lukas Hakelberg shows in his excellent book, ‘The Hypocritical Hegemon’. Thus,  basing the UTPR on the US BEAT’s design was a pragmatic choice by global policy-makers. And it may partly explain why the Biden administration and the US Treasury has stuck by the UTPR idea, even as it has morphed away from its original BEAT inspirations and become much more encompassing and radical, something which has made Congress, and especially House Republicans, pretty damn mad.

Second, the UTPR is also pragmatic in that it meets calls by developing countries and emerging markets for stronger tools to combat profit shifting out of their jurisdictions, another  indication of the rising influence of these countries in global tax politics. Political expediency is no longer just about accommodating US tax interests. And although the UTPR is not first in the global rule order – something heavily criticized by developing countries – at the very least it legitimizes and institutionalizes a type of bottom-up tax collection and enforcement that developing countries have been advocating for in recent years. (And there are other examples of that kind of influence in the global minimum tax, too.)

Third, the UTPR was pragmatically devised out of necessity, as a way to incentivize countries to implement the global minimum tax in a climate of fracturing global consensus. Given huge disagreements at the OECD, and the prospect of unfriendly domestic politics (see: States, the United), global policy-makers realized early that the global minimum tax could never be implemented with a multilateral treaty; it would have to rely primarily on domestic legislation by each signatory. This has the advantage of allowing jurisdictions flexibility in implementation, but also risks fostering a global patchwork of uncoordinated rules – something the international community has worked hard to avoid in recent years. The UTPR offers a critical middle-ground by incentivizing all countries to adopt the two main mechanisms of the global minimum tax – a domestic 15% rate and an income inclusion rule – lest taxes that they could have had be snapped up by another (UTPR-applying) country.

One of the key factors that enabled revolutionary change to global tax governance in the past decade was unprecedented, sovereignty-infringing multilateralism, enforced by a strengthened G20 and built on an enlarged OECD-brokered consensus. That enabling environment has gone away with global power shifts, institutional changes (marked in particular by the advent of the OECD Inclusive Framework) and politicized distributional conflict. As my co-author Martin Hearson writes in a piercing recent essay:

There is no prospect of a consensus about reform to international tax standards, whether at the OECD, UN or elsewhere, that is deep, universal and strong. That is, any reform must compromise on one of these three aspects: it must be a shallow, modest reform; it must omit some countries; or it must be soft and non-binding.

The UTPR is a compromise on the last aspect in particular: it is non-binding. But it’s design gives it real teeth.

We can interpret each of these signs of pragmatism in relation to the UTPR as informative of larger trends in global tax politics. The global balance of power is changing, and policy-makers can no longer rely on binding, consensus-based multilateralism to get radical reforms through (see also e.g. the “other” part of the global tax deal, Pillar One). Fiscal sovereignty is back in a whole new way.  In the immediate future, global policy-makers will have to either lower their ambitions massively, or rely on innovative designs like the UTPR to promote compliance with new regulations.

A brave new world of taxing power

However, as a ‘canary’, the single most interesting aspect of the UTPR, to me, is that it shows us a radical new way that countries are expanding their taxing powers over multinational companies. 

The foundational problem for states trying to tax – and more generally regulate – mobile capital has always been that it might simply escape governments’ grasp by shifting income or investment or residence to more ‘favourable’ locations. That has been changing: better administrative capacity, strengthened international cooperation, and new regulatory tools has, in some cases, made it harder for companies to subvert national regulation. In taxation, too: Although corporations’ profit shifting remains big business, new research shows that it is becoming harder and more costly.

One important way that governments increasingly exercise regulatory power over corporations – and the UTPR is a prime example here – is through what researchers have called ‘networked liabilities’, or the ‘footprints’ that multinational corporate groups leave in jurisdictions: subsidiaries, permanent establishments, supply chains, market presence, etc. Even when a company is not formally resident in a country, if they have some reliance on or investment in that country’s market or infrastructure, the government has an entry point for enforcement. As Lori Crasnic, Nikhil Kalyanpur and Abe Newman, who coined the term, write, it’s a way for governments to “transnationalize its jurisdiction, reaching out from its borders through cross-national production systems to regulate the behavior of business based in other jurisdictions”.

This is exactly what the UTPR does: exploiting networked liabilities to enforce new taxing rights, in a way that has never been done before. It’s not that we don’t have variations of ‘networked liabilities taxation’ already. In fact, it is a rising trend that’s worth considering on its own. You can conceptualize recent expansions to source-based taxation, which enforces taxation through local permanent establishments of foreign-residence companies, as exploiting networked liabilities. Similarly, most destination- or market-based corporate taxes (which are becoming more and more popular), like digital service taxes or carbon border taxes, exploit the local market presence (either local revenue or imported goods/services) of foreign companies to impose taxation.

But all of these rules have key restrictions, allowing taxation only of income that is specifically associated with the local market, e.g. revenue generated from local users or buyers. What’s novel about the UTPR is that it exploits networked liabilities to tax income that is completely divorced from the local market presence. Again, the example: Think of China taxing Apple’s European profits through its Chinese subsidiary. That’s a whole new ball game. You can see why the UTPR might serve as a pretty scary prospect, motivating countries – especially those home to large multinationals – to implement the domestic minimum tax and the income inclusion rule.

Uncharted waters

Considering this analysis, I don’t think the true significance of the UTPR can or should be understated. As a canary in the coalmine for global tax change, it represents a strategic reshaping of global tax norms, underpinned by an unyielding realpolitik, which dramatically expands governments’ regulatory authority in the corporate tax domain. Potentially, it opens the door for a new era of global tax regulation where the exploitation of ‘networked liabilities’ takes center stage. 

Whether we view it as an audacious leap forward, a pragmatic response to complex challenges, or a worrisome flex of extraterritorial power, one thing is clear: conceptually, the UTPR is among the most innovative policies we have seen in international taxation in recent years. This little rule, with its big impact, will be one to watch.