A UNCTAD report highlights the interplay between efforts to tackle tax avoidance and protect investment, calling for accelerated reforms to align investment agreements with new global tax rules.

In a big step towards tax standardization, nearly 140 countries agreed in late 2021 on a 15% global minimum tax for large multinationals – a landmark deal to prevent "a race to the bottom” as governments compete to attract foreign companies.

UNCTAD research shows that in one-third of tax jurisdictions, profit-based fiscal incentives allow multinational affiliates to often pay less than this rate.

The global tax deal will target particularly low-taxed income investment hubs. Under the new rules, for example, a multinational benefitting from a low-tax agreement with the local government could face higher taxes in its parent company's jurisdiction.

“Such a change shows how global tax reforms interact with existing investment frameworks,” said Hamed El-Kady, an UNCTAD expert working on the issue.

An UNCTAD report published on 23 November explores the potential legal challenges under international investment agreements (IIAs) and the likelihood of investor-state disputes as countries align to the new global tax regime.

The report underlines the need to accelerate IIA reforms to ensure they support the global minimum tax deal and other internationally agreed policies on issues like climate change and health.

Potential conflicts, but ‘wave of claims’ unlikely

Tax-related claims account for about 15% of all publicly known investor-state dispute settlement (ISDS) cases that have been filed to date.

The report assesses four IIA standards likely to cause the most tension.

• Fair and equitable treatment: Common in older IIAs and often invoked in ISDS cases, this provision's broad nature could pose challenges for the implementation of the global minimum tax, especially regarding tax incentives in special economic zones or otherwise individually negotiated special tax regimes.
• Umbrella clause: This clause brings individual state obligations into the IIA framework, leading to legal complexities in ISDS cases. Though less common in new IIAs, it remains a potential dispute source in older agreements as it extends to tax freezing clauses in investor-State contracts.
• Non-discrimination rules: Including national and most-favoured-nation treatment, these rules may cause tension as entities within and outside the scope of the proposed rules to implement the global minimum tax may be treated differently.
• Expropriation provision: Protecting against dispossession, this provision considers “confiscatory” taxation to constitute an indirect expropriation. Overall, the agreed minimum of 15% is, however, unlikely to reach the threshold of a “substantial deprivation” as generally required by ISDS tribunals.

The report notes that certain international investment agreement standards could impact national tax collection methods and the effectiveness of the global minimum tax.

It says that the withdrawal of certain tax incentives, like those negotiated for special economic zones, may conflict with the fair and equitable treatment standard and the umbrella clause.

“Frictions may similarly arise from the different treatment of the constituent entities of enterprises that are covered by the minimum tax and those that are not,” it adds.

However, UNCTAD says “a wave of claims” is unlikely. Instead, multinationals might use potential litigation as a bargaining tool for other benefits, such as reduced customs duties or amended production-sharing agreements.

Urgent need to accelerate reforms

The report emphasizes the urgency of reforming IIAs to support the global minimum tax.

Highlighting the interplay between combating tax avoidance and promoting investment, it calls for a multilateral instrument to better define how the global minimum tax interacts with IIAs.

Meanwhile, to reduce risks of friction, it recommends that governments reassess and refine corporate income tax incentives to ensure fair treatment for both foreign and local enterprises.

“It's not just about ensuring fairness, it's about maintaining coherence between global tax and investment policies,” Mr. El-Kady said.