The Implications of Pillar Two for Corporate Tax Reform

Recent proposals for corporate tax reform in Canada call for changing the existing tax on shareholder income to a tax on rents or above-normal profits. A feasible option would be an allowance for corporate equity (ACE) system based on the territorial principle. Canada has agreed to the approach to international corporate tax reform developed by the Organisation for Economic Co-operation and Development, including the pillar two minimum tax proposal. We explore the compatibility of adopting pillar two with the ACE system. Several elements of pillar two would complement moving to an ACE system. Large multinational corporations would be liable for a top-up tax if their effective tax rates in any given jurisdiction fell below 15 percent. The effective tax rates and the top-up tax would both use the territorial approach and consolidated accounting. The top-up tax would be similar to a tax on excess profits. Pillar two might also mitigate tax competition and reduce the constraints that countries face in increasing their tax rates on excess profits. For these reasons, pillar two would facilitate moving to an ACE system. At the same time, the minimum tax would deter adoption of an ACE if the deduction for the cost of equity finance reduced the pillar two effective tax rate. On balance, pillar two would be compatible with proposed corporate tax reforms.