why the argument that it breaks EU law is likely to fail

The commitment of 130 countries to introduce a minimum corporate tax of 15% has raised objections from some countries which could make its implementation more difficult. Estonia and Hungary, in particular, argue that the agreement, brokered by the Organization for Economic Co-operation and Development (OECD), breaches EU law, potentially causing a problem for the 23 member states that are party to the agreement.

Estonia and Hungary have two of the most generous corporate tax regimes in the EU. Hungary offers an overall corporate tax rate of 9%, while Estonia’s is 20%, but drops to zero for certain types of companies. Of the other EU countries that compete aggressively on corporation tax, Ireland and Cyprus have also remained outside the OECD agreement, although the Netherlands and Luxembourg have both signed.

So what is the legal basis for Estonia and Hungary to claim that the plans violate EU law, and are they likely to be right?

How Multinationals Avoid Tax

At present, the 130 countries have agreed on a declaration of intent, with an implementation plan to be finalized by October and to come into effect in 2023. It follows a similar commitment made by the G7 countries at the UK summit a few weeks earlier, and aims to prevent multinational companies from avoiding paying taxes. The OECD estimates that this costs countries between US$100bn (£73bn) and US$240bn a year.

This is possible because each country decides on its own tax regime, which it can use to try to induce multinationals to establish a base with them for tax purposes. This competition, which of course is not limited to the EU, has been described by US Treasury Secretary Janet Yellen as a “race to the bottom”.

Multinationals are known to set up subsidiaries in low-tax jurisdictions and filter international income through them, even if they do little business in the jurisdiction in question. U.S. tech giants, for example, have become particularly notorious for such schemes, particularly with respect to digital service revenues and intellectual property royalties.

The OECD agreement is based on two pillars. The first pillar allows for a fairer distribution of profits by multinationals by requiring that more of their activities be taxed where the profits are made, whether or not they have a physical presence there. The second pillar fixes the minimum level of corporation tax at 15%, and this is what is controversial.

The Cadbury Schweppes Affair

Estonia and Hungary’s argument appears to be based on the 2006 case Cadbury Schweppes plc and Cadbury Schweppes Overseas Ltd v Tax Commissioners. Cadbury Schweppes, a confectionery and soft drinks company, was headquartered in the UK but had operated a group structure with subsidiaries established in Ireland for tax reasons. While UK corporation tax is not generally levied on the profits of an overseas subsidiary, this case involved UK rules which provided an exception.

Cadbury’s lawyers argued, among other things, that the UK law was a restriction on EU freedom of establishment, which allows companies and individuals to set up businesses anywhere in the bloc. The European Court of Justice accepted this argument, considering that it was incompatible with the law of the European Commission for a Member State to tax a resident company on the profits made by a subsidiary in another Member State, in order to prevent that subsidiary from benefit from more generous tax rates.

Estonia’s Deputy General Secretary for Tax Affairs, Helen Papahill, reportedly said the case “shows quite clearly that these kinds of rules should not exist” in the EU. The argument seems to be that the OECD agreement would imply that countries where large companies are based impose the minimum tax rate on subsidiaries incorporated in other member states with lower tax rates. Simply put, you cannot tax the subsidiary of a company based in another country.

However, the judges in the Cadbury Schweppes case only considered the impact of the tax laws of one Member State on the profits made by a subsidiary in another Member State, and this should not be taken as establishing a principle wider that EU freedom of establishment laws prevent international relations tax rules from being agreed.

It is likely that the OECD agreement would be seen as a justified restriction on the freedom of establishment, potentially on the grounds that it creates a common solution to the problem that multinationals currently do not pay fair tax rates. Arguably, it wouldn’t even hamper a company’s freedom of establishment if every state followed the same minimum tax rate, especially when smaller countries potentially have other advantages that could incentivize multinationals to s integrate into it, like a skilled workforce.

However, this legal issue is not the only obstacle to the implementation of the OECD agreement. As a tax measure, it is likely to require the unanimous approval of EU member states, with the exception of Hungary and Estonia. It is also unclear whether Ireland and Cyprus will commit.

The deal could also struggle to win the approval of the US legislature, without which it would be significantly weakened. The tensions between the United States and the EU over European proposals to introduce an additional tax on digital companies do not help. For all these reasons, the global corporate tax tightening project could still face a chaotic future in the months to come.