Pillar 2 and International Investment Agreements: ‘QDMTT Payable’ Seals an Internationally Wrongful Act

The debate on interactions between pillar 2 and various aspects of international law follows climate change: It is getting really hot.¹ So far, however, no scholar or tax practitioner has published an article demonstrating — or even sufficiently highlighting — that the pillar 2 rules may lead to internationally wrongful acts both by states applying those rules and by the OECD orchestrating this process from its origin through all subsequent developments. Although there may be more examples of these acts caused by pillar 2, this article focuses on the most pressing: violations of international investment agreements (IIAs) significantly undermining the global investment regime.² This regime consists of a body of IIAs concluded by states following the end of World War II to protect and promote investment. The investment promotion is to be achieved by the host states respecting the protection standards, which should lead to a stable legal environment that favors foreign investments.

By far, the IIA’s most important and powerful enforcement tool is the right of individual investors to initiate arbitration against host states, or what is known as the investor-state dispute settlement (ISDS) mechanism.³ The OECD in its latest administrative guidance on pillar 2 may be viewed as aiming to disarm ISDS against the primary rule under pillar 2 by disregarding the status of a qualified domestic minimum top-up tax (QDMTT) as a QDMTT payable whenever a multinational enterprise group legally challenges a QDMTT.⁴

This article illustrates that the OECD approach to pillar 2 may trigger the so-called shared responsibility⁵ of states under the articles codifying rules that are binding under customary law on the Responsibility of States for Internationally Wrongful Acts (ARSIWA)⁶ as well as the responsibility of the OECD under the Draft Articles on the Responsibility of International Organizations (DARIO).⁷ Although it would be difficult to hold the OECD formally accountable because of its immunity from every form of legal process,⁸ revealing its shared responsibility is pivotal for tax and investment policymakers and other major stakeholders for at least two reasons.

First, the OECD enjoys immunity from every form of legal process, granted to it by the states that may legally and economically suffer from pillar 2. Therefore, they may require the OECD to waive its immunity to the extent that it could be held accountable for any wrongdoing.⁹ Second, the interlocking system of pillar 2 rules — if not QDMTT, then the income inclusion rule or UTPR (formerly the undertaxed profits rule) — cannot justify a breach of IIAs by states because those rules effectively force states to breach. These rules are the source of shared responsibility of all states and jurisdictions of the inclusive framework¹⁰ on base erosion and profit shifting on the one hand, and the OECD together with inclusive framework states and jurisdictions on the other (shared responsibility of states and international organizations). They also constitute a nearly self-enforcing legal mechanism to set the floor for global taxation of MNE profits, which is the main factor of pillar 2’s success, albeit arguably insufficient to ensure the normative legitimacy of the OECD’s work on it.¹¹

This article begins by briefly presenting the origin and fundamental purposes of the functioning of the OECD, including its activities within the sphere of IIAs. It concludes that the OECD’s works on pillar 2 seem to contradict its foundational purposes and responsibilities within the area of international investments. The article then discusses a potential violation of IIAs by analyzing QDMTT, arguing that applying QDMTT in the face of contrary IIA obligations is an internationally wrongful act because it is a principle of international law that states may not negate these agreements in reliance on their municipal laws,¹² like domestic laws implementing pillar 2. Next, the article briefly explains why the interlocking rules of pillar 2 may trigger collective international states’ and the OECD’s liability for wrongful acts by putting pressure on host states to violate IIAs. The penultimate section continues by analyzing how the potential application of the IIR or UTPR as a result of a taxpayer successfully challenging a QDMTT and receiving an arbitral award might affect an investor’s decisions and an ISDS tribunal’s reasoning. Finally, the article concludes that global tax and global investment regimes may peacefully coexist if the states concerned replace pressure with good faith while implementing pillar 2 rules, and do so via a multilateral treaty that will not displace the protection of investments under IIAs but respect it. This approach may no longer be viable via the OECD but may need to be pursued by the new global tax body under the auspices of the U.N. forum.

Background

This section aims to answer the question whether the OECD overlooked its fundamental purposes while designing pillar 2 and guidance on the QDMTT payable. The Marshall Plan (officially known as the European Recovery Program) was a 1948 U.S. initiative to provide foreign aid to Western Europe in the amount of $13.3 billion (equivalent of $173 billion in 2023) in economic recovery programs after the end of World War II.¹³ In the same year, the Organization for European Economic Cooperation was formed to administer that aid. It was reconstituted in Paris on December 14, 1960, as the Organization for Economic Cooperation and Development (or OECD) “in order to strengthen the tradition of co-operation and apply it to new tasks and broader objectives.”¹⁴

The text of the Convention on the OECD came into force on September 30, 1961. The convention’s preamble enshrines that the governments of the OECD member states are determined “to pursue these purposes in a manner consistent with their obligations in other international organisations or institutions in which they participate or under agreements to which they are a party.”¹⁵ Article 1 then stipulates that the aims of the OECD:

shall be to promote policies designed:

(a) to achieve the highest sustainable economic growth and employment and a rising standard of living in Member countries, while maintaining financial stability, and thus to contribute to the development of the world economy;

(b) to contribute to sound economic expansion in Member as well as non-member countries in the process of economic development; and

(c) to contribute to the expansion of world trade on a multilateral, non-discriminatory basis in accordance with international obligations.

Accordingly, the foundational act of the OECD is explicit about its obligation to realize purposes consistent with international obligations. Inconspicuously guiding more than 140 states to violate their international obligations under IIAs by implementing pillar 2 rules only through domestic laws that don’t meet IIA obligations would seem to be at odds with that existential legal act of the OECD. The way in which the OECD directs and controls the entire process of developments pivotal to the implementation and application of pillar 2 by not only its member states but also remaining inclusive framework states and jurisdictions appears inconsistent with its obligations under IIAs.

Further, since its establishment, the OECD has played an important role as “a forum where treaty negotiators and experts from OECD and non-OECD countries work together to enhance common understanding of core treaty provisions and emerging legal issues and to improve outcomes of international investment treaties for governments and investors.”¹⁶ As this author argues in the sections below, implementation of pillar 2 prevails over, and even contradicts, the OECD’s role as a forum “to improve outcomes of international investment treaties for governments and investors.”

The OECD guidance on QDMTT payable boils down to the conclusion that any direct or indirect challenge in a judicial or administrative proceeding to any amount of QDMTT by the MNE group “based on constitutional grounds or other superior law or based on a specific agreement with the government of the QDMTT jurisdiction limiting the MNE Group’s tax liability, such as a tax stabilization agreement, investment agreement, or similar agreement” shall not be treated as QDMTT payable under article 5.2.3 of the OECD pillar 2 model rules.¹⁷ It means that the top-up tax payable under the QDMTT will not reduce the top-up tax to zero and thus may be collected by another jurisdiction under the pillar 2 rules (that is, the IIR or UTPR). Also, a QDMTT safe harbor¹⁸ will not apply when the QDMTT is not payable. Instead, the MNE group will be subject to the credit mechanism in article 5.2, and any QDMTT that was not included in QDMTT payable “shall be included in QDMTT payable for the Fiscal Year to which it relates when such amount is paid and no longer contested by the MNE Group.”¹⁹

Undeniably, the OECD guidance on QDMTT payable discourages MNE groups from legally challenging QDMTT via sources external to pillar 2 rules by apparently making these challenges economically unviable — that is, the challenge will simply lead to inevitable taxation under the IIR and UTPR. Although the OECD did not refer to IIAs explicitly, the challenges of the QDMTT in practice may mainly arise out of relevant IIAs²⁰ because of their scope of investment protection and international investment treaty arbitration case law, as discussed by scholars and practitioners.²¹

The OECD explicitly acknowledges potential tensions between pillar 2 rules and IIAs in its October 2022 report “Tax Incentives and the Global Minimum Corporate Tax,”²² without including legal analysis or further follow-ups. This report devotes to this subject only two paragraphs (paras. 21-22) out of 120. The OECD merely concludes that more analysis of the “interaction of these regimes is needed, taking account of investment treaties, ISDS interpretations and the implementation of Pillar Two.”²³ Absent this analysis, however, the OECD decided to discourage investors from any claim against the host states under relevant IIAs without even explicitly identifying the issue.

The OECD’s most recent working paper, “Tax and Investment by Multinational Enterprises,” is also completely silent about the interplay between pillar 2 and IIAs,²⁴ although it appears a perfect fit to address that theme. This approach does not appear sufficient, especially since other international organizations and forums perceive the issues in question as serious ones that require an adequate solution.²⁵ For example, the scholar Yariv Brauner made a strong critical observation on pillar 2:

EU and United States politics matter while those of other countries do not. In this author’s view, the entire Two Pillars agreement is tainted and hence morally invalid and practically wasteful. The consequences will be borne in the long run not only by the weaker states but also by the rich states since the current plan is simply unsustainable without genuine global agreement, but perhaps that is simply the world in which we live.²⁶

Interestingly, a few months before the OECD guidance was published, Reuven S. Avi-Yonah published a draft of an article²⁷ in which he downplayed a problem stemming from potential tensions between IIAs and an application of pillar 2 rules, as discussed in a paper by Catherine Brown and Elizabeth Whitsitt. They recommended delaying implementation of pillar 2 until “governments have had a chance to consider the risks that implementation poses under their investment treaties,”²⁸ but Avi-Yonah sees this as “misguided.”²⁹ Essentially, his observation stems from two interrelated assumptions. First, the possibility of taxation via an IIR by a home state of an investor or via a UTPR by a third state³⁰ would cause an ISDS claim challenging the revocation of promised tax incentives via the QDMTT to fail. Second, it would practically defeat the purpose of invoking a right to ISDS under an IIA by an investor in the first place because of the lack of the likely prospect of any irreversible economic gain in challenging the QDMTT; that is, a successful ISDS claim that results in a payment of compensation by a host state “could be treated as a further tax reduction that triggers additional tax elsewhere”³¹ either via an IIR or a UTPR. This resembles the implicit approach of the OECD toward IIAs.³² They have a common denominator: OECD policy interests emerging through the pillar 2 agenda without a legal analysis of the interplay between pillar 2 and relevant provisions of IIAs, the meaning of which ought to be determined according to general rules and principles of interpretation in articles 31-33 of the Vienna Convention on the Law of Treaties.³³ In this author’s view, the OECD relied so much on tax experts’ design of the interlocking mechanism of pillar 2 rules that it overlooked its own origin and fundamental purposes while pushing forward pillar 2 and guidance on the QDMTT payable.³⁴

Introduction to QDMTT and IIAs

Fair and Equitable Treatment

The claims against QDMTTs are likely to fall under IIAs because of alleged violations of fair and equitable treatment (FET) by premature revocation of promised tax incentives.³⁵ These allegations may have the greatest chance to prevail when states applying QDMTTs (“host states” in investment treaty nomenclature) promised tax incentives in agreements with investors (constituencies of an MNE group), like tax stabilization agreements, investment agreements, or similar agreements, as listed by the OECD.

Depending on the facts of the case, a QDMTT may violate one or more core elements of the FET standard. Because of the characteristics of a QDMTT and the context of its adoption, the most relevant aspects are the requirement of stability, predictability, and consistency of the legal framework and the protection of investor confidence or legitimate expectations.³⁶ Generally, this may be a valid claim if “a State makes clear commitments to induce an investor to invest, and the investor relies on those commitments.”³⁷ In addition to agreements between states and investors, these claims may be valid in situations in which a clear and specific commitment follows from the domestic laws of states adopting QDMTTs to induce investments. If this commitment succeeded in attracting the foreign investment and, once made, resulted in losses to the investor because of later changes in law, it may constitute a violation of an investor’s legitimate expectations.³⁸

Arbitral tribunals and investment treaty scholars consider some of the core principles of the FET standard as one of the three sources of international law in accordance with article 38(1)(c) of the Statute of the International Court of Justice (ICJ),³⁹ that is, the general principles of law (GPLs) recognized by civilized nations. This pertains to the principles of good faith, proportionality, and nondiscrimination.⁴⁰ Another core element — the prohibition of denial of justice — is considered an international custom, as evidence of a general practice accepted as law, under article 38(1)(b) of the ICJ Statute.⁴¹ Prima facie, the OECD guidance on QDMTT payable triggers tensions with that part of the international customary law insofar as it tries to deny to investors (MNE groups) legitimate access to justice via sources of laws superior to pillar 2 rules with IIAs at the center of them.

Remarkably, according to the studies of the OECD Investment Committee, the FET standard is considered as a GPL by all of its member states.⁴² However, it may be more correct to assume that the FET standard is not itself a GPL, but “contains elements which are considered as GPL and, as such, will be relevant for the interpretation and concrete application of the FET standard.”⁴³ Actually, it would be enough if the OECD considers the FET standard as a part of international obligations of the inclusive framework states and jurisdictions under their IIAs instead of assuming that its legal value is close to nil vis-à-vis pillar 2 rules.

Umbrella Clauses

Irrespective of alleged violations of FET, the state’s promises may be brought under the protective scope of IIAs via so-called umbrella clauses because these clauses oblige the host states “to comply with obligations the state has entered into with respect to investments protected by the treaty in which the umbrella clause is found.”⁴⁴ Although ISDS case law varies in evaluation of the scope of umbrella clauses,⁴⁵ the prevailing view is that they extend to all obligations arising under any investment contract between the host state and an investor (parties of the IIA with an umbrella clause).⁴⁶ In the absence of an umbrella clause, a violation of contractual obligations by the host state would not be covered by the IIA, unless that violation is so severe that it violates any of the IIA’s standards of investment protection per se.⁴⁷ A United Nations Conference on Trade and Development study went further and pointed out that umbrella clauses usually have capacious language that is clearly intended to not only cover investment agreements between investors and host states, but also be broad enough to apply to “all kinds of obligations, explicit or implied, contractual or non-contractual, undertaken with respect to investment generally.”⁴⁸

In any case, an umbrella clause is important for investors aiming to challenge tax measures because it may open a separate door for claims based on an IIA, under which it is easier to prevail in ISDS proceedings than by relying on remaining standards of investment protection.⁴⁹ That is why investors often look for states’ promises to include specific provisions in investment agreements, like tax stability provisions, set-off clauses, adjustment clauses, advance tax rulings, or any other agreements relating to the tax treatment of their investments to be better protected against unforeseen tax measures.⁵⁰ That also is why the OECD in its guidance disregards “QDMTT payable” whenever a MNE group legally challenges any amount of QDMTT by the MNE group based on “superior law or based on a specific agreement with the government of the QDMTT jurisdiction limiting the MNE Group’s tax liability, such as a tax stabilization agreement, investment agreement, or similar agreement.”⁵¹

Important to the protective effect of umbrella clauses against tax measures is the observation from ISDS case law that only when the host state acts in its capacity as sovereign (as opposed to an act of private nature) will an umbrella clause equate a breach-of-contract claim to a breach-of-treaty claim.⁵² States always act in their capacity as a sovereign while applying tax measures; therefore, umbrella clauses may always protect investments against these measures, for example, pillar 2 rules.

Tax Carveouts

The FET is the most frequently invoked protection standard generally contained in IIAs⁵³ and is equally invoked in cases involving taxation measures.⁵⁴ The most frequent carveouts regarding taxation measures — partial tax carveouts — usually exclude tax-related disputes from the national treatment and most favored nation clauses under IIAs, while the FET standard is much less frequently excluded.⁵⁵ Consequently, the chances seem high that many relevant IIAs will effectively protect investments under the FET standard against QDMTTs insofar as they do not carve tax measures out of its protective scope.

ISDS tax-related case law implies that the existence of umbrella clauses in relevant IIAs appears to disarm a tax carveout.⁵⁶ Umbrella clauses recapture tax measures under the treaty’s protection despite their exclusion by tax carveouts in the remaining scope. For example, article 2(6) of the Poland-U.S. bilateral investment treaty (BIT)⁵⁷ includes a broad umbrella clause: “Each Party shall observe any obligation it may have entered into with regard to investments.” The tax carveout in article 6(2)(c) does not apply to “the observance and enforcement of terms of an investment agreement.” Accordingly, this umbrella clause brings the host state’s commitments contracted for with an investor under the Poland-U.S. BIT’s protection, including a tax stabilization agreement and preferential tax rates or tax holidays under the state’s obligation toward investors to do so.⁵⁸

IIR and UTPR May Lead to Wrongful Acts

Violation of IIAs Without a Valid Justification

The above analysis argues that QDMTTs may violate IIAs and that the OECD is attempting to neutralize the protective effect of IIAs by pushing investors (MNE groups) toward taxation under the IIR or UTPR and by depriving investors of QDMTT safe harbors whenever they decide to rely on IIAs to protect their investments against QDMTTs. This strategy may lead to unexpected outcomes for the OECD, its member states, and all the inclusive framework members.

From an international law perspective, it seems odd that merely domestic rules implementing pillar 2 cannot have power to displace the established international law order (international investment regime). Indeed, any displacement of international investment law will originate from the political pressure of the OECD expressed orally and through its writings (for example, the administrative guidance and commentaries on pillar 2), rather than a robust and impartial legal analysis of the interplay between pillar 2 and international law.

The IIR and UTPR activate a pressure mechanism on states to implement QDMTTs to ensure that MNE groups pay at least 15 percent of global minimum tax. In the author’s view, the pressuring effect of the IIR and UTPR on other states to implement a global minimum tax of 15 percent would most likely not constitute a justified public policy reason under international law. In fact, even the anti-BEPS policy of the OECD has already been rejected by the Cairn tribunal as an argument against violation of the BIT by state fiscal measures:

As for the “Cairn paid no capital gains tax anywhere in the world” line of argument, this, in the Tribunal’s view, really goes to matters of tax policy, not law, which are matters for legislators, not the Tribunal. The Tribunal must decide on the basis of the law, irrespective of what its members’ views may be as to the overall fairness of the transaction from a policy perspective.⁵⁹ [Emphasis added.]

For an even stronger reason, if BEPS prevention as a policy goal was rejected as an interpretative factor favoring compatibility of states’ tax measures with an IIA, the broad, vague, and problematic goals of pillar 2 should be rejected even more.⁶⁰

The next subsections will address additional technical reasons for considering QDMTT-UTPR and QDMTT-IIR interactions questionable under international law.

QDMTT-UTPR Interaction

The QDMTT-UTPR interaction explicitly encourages other countries to engage in non-customary extraterritorial taxation. If there is any residual amount of top-up tax that remains unallocated after the IIRs apply, the UTPR allocation mechanism causes a top-up tax liability in the countries that introduced the UTPR.⁶¹ For example, it may apply to an ultimate parent entity (UPE) if it constitutes a low-taxed constituent entity.⁶² This threatens the existing tax policy in many states because the UTPR formula for income allocation can capture deliberately untaxed income generated in their territories.⁶³

The fixed formula under the UTPR, based on the share of total employees and tangible assets,⁶⁴ allows taxation of profits of a foreign entity without any link between the entity and economic activity in the state imposing the tax. The profits subject to tax under the UTPR are neither directly nor indirectly owned by the resident taxpayer (that is, local constituent entity). Many scholars consider this taxation to be extraterritorial,⁶⁵ asserting bad faith and negligence in the UTPR’s design because its extraterritoriality “departs from one of the fundamental elements of tax jurisdiction — the nexus requirement — in an unprecedented way, and there is precious little evidence that the departure occurred as the result of a process of careful and conscious deliberation.”⁶⁶ Other tax experts perceive the true nature of the UTPR as “an invalid expropriation or illegal confiscation.”⁶⁷ One article described it as “unprecedented, unprincipled, and simply there as a measure of coercion against jurisdictions that might choose to not adopt pillar 2, through the device of an appropriation of their tax base.”⁶⁸

Interestingly, even authors defending UTPR compatibility with international law⁶⁹ either cast serious doubts about its nature as a tax,⁷⁰ which implies that the UTPR is not a tax measure or is a bad-faith tax measure under IIAs (that is, not subject to tax carveouts),⁷¹ or do not base their reasoning on an in-depth and broad analysis of international law.⁷² These defenders also do not discuss the compatibility of the UTPR with IIAs.⁷³

The QDMTT-UTPR interaction also raises concerns considering GPLs, that is, preventing expropriation⁷⁴ and ensuring nondiscrimination.⁷⁵

An indirect expropriation might be caused if applying the UTPR leads to a tax assessment exceeding the capacity of the local MNE to pay the top-up tax, thereby threatening the entity’s insolvency. In these instances, the UTPR renders investment worthless and unviable and thus subject to the expropriation clause under relevant IIAs (in this case, between the UTPR state and the state of any investor in the investment chain).⁷⁶ Although any expropriatory effects of the UTPR must be carefully examined on case-by-case basis, ISDS scholars dealing with tax-related cases pointed out that the UTPR’s effect may be akin to a direct taking of investment without formal transfer of title, or to an outright seizure.⁷⁷ They also emphasize that the UTPR “is not justified by a legitimate public purpose or is applied in a discriminatory manner.”⁷⁸

Beyond the expropriatory capabilities, the UTPR also is capable of discriminatory tax consequences for investors. Of course, any conclusive answer on the discriminatory effect of the UTPR requires the examination of relevant facts and the manner in which the UTPR is implemented in domestic tax law to determine the exact object of comparison.⁷⁹ Clearly, the UTPR would be activated in one of its forms⁸⁰ when it is determined that no IIR (or QDMTT) will be applied to collect the full amount of a jurisdictional top-up tax in states where the MNE has low-taxed constituent entities.⁸¹ In this author’s view, this reveals a discriminatory effect (at least in disguise)⁸² insofar as a domestic taxpayer (subsidiary) in a state imposing an effective tax rate of at least 15 percent is subject to the UTPR’s tax when its parent entity (a foreign investor) is resident in a state where it is subject to less than a 15 percent ETR, compared with a purely domestic scenario, that is, when a subsidiary (domestic taxpayer) and its parent in the same state are subject to at least a 15 percent ETR.⁸³ A group of ISDS experts in tax-related cases⁸⁴ have concluded the potential discriminatory effect of a UTPR in similar circumstances to those already identified by case law violates the nondiscrimination clause in tax treaties.⁸⁵

Also, the UTPR is designed to punish not only states that do not adopt a global minimum tax of 15 percent under pillar 2 through a QDMTT or IIR, but also individual companies that do business in those states. Those companies are typically local subsidiaries through which foreign investors invest and conduct businesses. The purpose and effect of the UTPR do not seem to be recognized as a justified public policy reason under international law, and thus would not justify the UTPR’s discriminatory effect on investments.⁸⁶ This also implies that the UTPR’s pressuring effect concerns only (or mainly) foreign investors compared with domestic ones, essentially protecting the latter from the negative tax consequences of the pillar 2 interlocking mechanism. The ISDS case law in tax-related cases⁸⁷ strongly suggests that this protective tax treatment is discriminatory under national treatment clauses in relevant IIAs. It is also discriminatory under the nondiscrimination clause in the laws of the WTO.⁸⁸

The expropriatory and discriminatory capabilities of the UTPR may also translate into a lack of proportionality in the balance between a state’s regulatory power to impose taxes and the investors’ expectations that their investments will be protected under IIAs. That is to say, the UTPR may lead to a disproportionate tax burden for the local entity of the MNE group, precluding it from continuing its activities.⁸⁹ This particularly matters for examining and interpreting the breach of the FET standard.⁹⁰ The UTPR does not apply mainly to prevent abusive tax avoidance and may lead to discriminatory results. Hence, in this author’s view, its disproportionality is not justifiable.

QDMTT-IIR Interaction

Scholars publishing about IIAs and pillar 2 focus on the most obvious tensions between those regimes, which stem from the potential application of the UTPR. A deeper analysis of the QDMTT and of the role of the IIR in creating these tensions is needed.

This incomplete approach stems mainly from the assumption that the IIR applies only in the UPE’s state to impose tax on its tax residents.⁹¹ Indeed, in these circumstances, imposing a top-up tax via an IIR would not be subject to an ISDS claim because investors cannot bring treaty claims against their home state. However, this observation does not mean that IIAs cannot protect investments against IIRs whenever this pillar 2 rule may apply. The observation is correct only when the IIR applies under the primary rule, that is, it is applied by the UPE country. By contrast, a valid ISDS claim is not excluded in other situations, that is, whenever the UPE is not required to apply the IIR because the UPE’s country did not adopt the IIR or pillar 2 rules in general, or it simply does not apply the IIR for other reasons, like geopolitical bilateral relations with the state where an entity subject to the IIR is located. Then, the top-up tax is imposed via the IIR on the next intermediate parent entity in the ownership chain subject to it.⁹²

The misperception follows mainly from the statements by U.S. scholars regarding controlled foreign corporation-type taxation of foreign profits. For example, Avi-Yonah said a situation similar to that under the IIR already arose under CFC-type rules, like U.S. subpart F,⁹³ the global intangible low-taxed income rules,⁹⁴ or CFC rules in many countries around the world.⁹⁵ He elaborated that he is not aware of any case in which an MNE “sued its home country under a BIT for applying a CFC rule to it.”⁹⁶ This appears misplaced because the absence of claims under BITs about CFC rules stems from the lack of legal basis to make them under BITs. Investors cannot arbitrate under IIAs against their home states, and these states apply CFC rules to tax these very same investors (resident taxpayers controlling CFCs). As indicated above, however, the IIR may lead to an imposition of taxes not only in the UPE’s state (the state of the resident taxpayers controlling the CFCs) but also in the states of intermediary parent entities if the former state does not apply an IIR. This is not an unlikely scenario; the UPE from the United States is an example.⁹⁷

Another U.S. scholar suggests that “BIT claims are less likely to succeed against the income inclusion rule, given long-standing acceptance of controlled foreign corporation rules.”⁹⁸ This argument does not seem persuasive from an international law perspective, insofar as long-standing acceptance of CFC rules appears to be mostly by the United States and the OECD while the rules’ acceptance has been heavily challenged internationally (often successfully) by taxpayers (investors) under tax treaties, EU law, and European Economic Area law in front of domestic courts,⁹⁹ the Court of Justice of the European Union,¹⁰⁰ and the Court of the European Free Trade Association,¹⁰¹ respectively.

Although the IIR shares a similar mechanism of income allocation with CFC rules, they vary from each other significantly in fundamental ways. CFC rules target taxpayers’ tax avoidance behavior, which, to a various degree and by different criteria of application, examine the taxpayer’s nontax business purpose to prevent cross-border tax avoidance.¹⁰² By contrast, IIRs, interlinked with the UTPR and QDMTT, target tax competition among states and aim to ensure that MNEs pay a minimum level of 15 percent tax, irrespective of tax avoidance purposes of MNEs and qualification of their constituent entities as CFCs.¹⁰³ Consequently, the pivotal arguments of jurisprudence favoring compatibility of CFC rules with tax treaties — to prevent tax avoidance¹⁰⁴ — do not apply to IIRs (and by analogy to UTPRs). Thus, any argument from the lack of ISDS tax-related claims against CFC-type rules does not mean that claims related to similar (but significantly different) rules, like IIRs, are unlikely to arise.

Last but not least, an authoritative and influential scholarship work on tax treaties — Klaus Vogel Commentary — breaks down the OECD’s logic on the compatibility of CFC rules with tax treaties (that is, taxation of its own residents)¹⁰⁵ by aptly observing that the wording of the first sentence of article 7(1) of the OECD model tax convention (and its equivalents under tax treaties):

not only provides protection against taxing claims of the source State, but also against tax claims of a meta-residence State, that is, a State in which not the taxpayer company itself but its shareholder is resident. In the absence of factual circumstances which might constitute a PE of the taxpayer in the State where the CFC is located, it is the CFC State which has exclusive taxing rights, under the 1st sentence of Article 7(1) OECD and UN MC [model convention], for the undistributed profits derived by the CFC as such. It is only where the DTC [double tax convention] at issue contains particular CFC provisos or where a general anti-abuse proviso applies (explicit or implied) that the State of which the taxpayer is a resident may apply its domestic CFC regime.¹⁰⁶

This means, in the view of Klaus Vogel Commentary, that CFC rules are not generally compatible with tax treaties, and one of the main reasons for this is the extraterritorial taxation contrary to article 7(1) of the OECD model tax convention (and its equivalents under tax treaties). This compatibility requires explicit wording through a so-called safeguarding clause or a principal purposes test-like clause, as well as the actual application of CFC rules only within the bandwidth of those clauses.¹⁰⁷ This supports the view that the issue with extraterritorial taxation is not only relevant for UTPRs but also, albeit less egregiously, for IIRs.

Shared Liability for Internationally Wrongful Acts

Can the OECD share responsibility with states that violate IIAs? The preceding subsections imply that pressuring other states to violate IIAs via the interlocking rules of the QDMTT, IIR, and UTPR may be seen as a state’s practice that is unacceptable under international law, that is IIAs and GPLs. It is therefore not inconceivable that the interlinking mechanism of pillar 2 rules and the OECD “solution” in the form of its guidance on QDMTT payable may trigger shared responsibility under ARSIWA and DARIO, which codify binding rules under customary law on the responsibility of both states and international organizations, like the OECD, for internationally wrongful acts. Violating IIAs and pressuring other states to do so constitute such acts.¹⁰⁸

ARSIWA is widely recognized as one of the leading sources codifying international law, including the concept of shared responsibility.¹⁰⁹ In light of articles 16 and 47(1) of the ARSIWA, states that adopt and apply pillar 2 rules to collectively pressure each other to revoke tax incentives, breach relevant IIAs, and potentially breach international environmental law,¹¹⁰ in this author’s view, could be subject to shared responsibility for internationally wrongful acts. In a similar vein, albeit less authoritatively,¹¹¹ articles 14 and 48 of DARIO impose shared responsibility for committing internationally wrongful acts on international organizations and states where an international organization and one or more of its member states jointly commit the same wrongful act. As observed by André Nollkaemper and others, it is “common in international practice that several states and/or international organizations contribute together to the indivisible injury of a third party.”¹¹² The responsibility shared among an international organization and its members, notwithstanding their separate identities under international law,¹¹³ seems reasonable because the relationship between an organization and its members is typically characterized by a high degree of interconnectedness.¹¹⁴

This interconnectedness clearly emerges from the relations between the OECD and its member states generally as well as specifically regarding pillar 2 rules. In fact, the OECD directs and controls the entire process of developments pivotal to the implementation of pillar 2 by not only its member states, but also all states and jurisdictions of the inclusive framework.¹¹⁵ In some instances, the OECD appears to pressure both members of the inclusive framework and other international organizations (for example, the U.N., particularly the African Group)¹¹⁶ to follow its lead for pillar 2. DARIO contains rules addressing direction and control exercised over the commission of an internationally wrongful act by an international organization¹¹⁷ as well as its coercion of a state or another international organization to do so.¹¹⁸ Although the OECD did not coerce other states to implement and apply pillar 2 rules, its pressure and guidance to violate IIAs seem questionable under DARIO. At least, inclusive framework members may have legitimate claims to require that the OECD bear responsibility for the damage arising from their wrongful acts (violation of IIAs) by applying pillar 2 rules. More research is needed by international law scholars to determine whether the OECD actually meets the prong of shared responsibility.¹¹⁹

Even though investors do not have any direct mechanism to hold states and the OECD collectively accountable for violating international law by applying pillar 2 rules and pressuring other states to do so,¹²⁰ ARSIWA and DARIO may be of strong interpretative and determinative value for arbitral tribunals. The former value may be useful to decide if there was a lack of good faith in acts of pressure by the OECD and states to implement pillar 2 rules in breach of international law. The latter value could be instructive during the ISDS proceedings regarding the determination of liability for an internationally wrongful act and the way to compensate for its damages to investors. For example, the Cairn tribunal “marks a continuation in the international investment law jurisprudence to make use of the ILC Articles as an authoritative source of international law,” while it ordered India, “as a measure of restitution, to withdraw its tax demand that has been found internationally unlawful and also awarded compensation to the foreign investor.”¹²¹

Moreover, it remains to be seen whether the OECD avoids all possible legal repercussions under international law because of its immunities, or if it will be required by its member states to waive that immunity to the extent needed to bear the shared responsibility for committing internationally wrongful acts. A question also arises about the right of arbitral tribunals to use provisional measures¹²² to stop states from applying IIRs and UTPRs, neutralizing the pressure put on host states involved in ISDS proceedings to continue to violate IIAs by revoking tax incentives through QDMTTs (this practice might also be targeted by provisional measures). Of course, an arbitral tribunal would only be able to order provisional measures for the investor that is a party to the proceeding, which means that it may benefit only the investors who initiated the ISDS claims against states applying a QDMTT, IIR, or UTPR.

Investor Strategy

Investors must have a strategic perspective considering potential taxation under an IIR or UTPR after challenging a QDMTT. The OECD’s guidance on QDMTT payable sends a glaring signal to investors: Do not challenge QDMTTs via IIAs because even if you prevail (arbitral awards in favor of investors), you will gain nothing because of the obligation to pay global minimum tax anyway under the IIR or UTPR. In fact, this reasoning was developed and published by various stakeholders months before the mentioned guidance, and was arguably supported by political considerations rather than a robust legal analysis of the subject matter.¹²³ Allison Christians and others went so far as to recommend that the OECD, as one of practical means to ensure compatibility of pillar 2 rules with IIAs, put relevant pressure both on investors as well as on courts and tribunals.¹²⁴ Their pieces of advice also cumulatively aim to ensure an alleged compliance of pillar 2 rules with IIAs by carving out QDMTTs from the protecting scope of IIAs via a multilateral treaty, excluding an investment protection from stabilization clauses for those rules. If followed by the inclusive framework members, the advice will significantly reduce protection of foreign investments globally. However, the major point on taxation under the IIR and UTPR after challenging QDMTT via IIAs is neither certain nor conclusive for an investor’s decisions and the ISDS tribunal’s reasoning.

From a strategic perspective, states often take the risk of an investment treaty claim seriously because of the reputational damage of appearing to be an unsafe place to invest as well as the costs (time and money) to defend the claim, especially if the investor’s claims are strong.¹²⁵ States cannot therefore overlook that ISDSs contributed to developing a rule-oriented regime for cross-border investments,¹²⁶ which significantly decreases the risk of investments and thus their costs at their territories. This implies that states will most likely consider an amicable tactic for investors signaling the willingness to initiate ISDS proceedings against the negative effect of pillar 2 rules on their investments.

States’ tactics will certainly include negotiations with investors regarding a feasible solution.¹²⁷ If negotiations fail to bring a solution, investors will have to decide whether it is worth pursuing an investment treaty arbitration. An affirmative decision will likely be influenced by a sufficiently material negative financial effect of pillar 2 rules on the investments. That is, a large effect will presumably cause investors to seriously consider filing an arbitration. Even then, it might be enough for investors to find an acceptable solution with states just by sending them a notice of intent (a trigger letter),¹²⁸ without actually initiating an ISDS claim.

This shows that there are ways for investors to effectively leverage their rights under IIAs without ever bringing an investment treaty arbitration. Moreover, investors will likely use their rights to arbitrate whenever the effect of pillar 2 rules on their financial situations is significant, unless their position is weak.

From a technical perspective, it is by no means clear and certain that investors will pay tax regardless of where the host country’s constituent entity is located or whether it is collected in a host, home, or third country. It is speculative to argue that a successful ISDS claim (for example, obtaining compensation in the amount of a revoked tax incentive plus interest from the host country) will reduce the ETR of the host country even if it has a QDMTT; that is, an assumption that compensations under arbitral awards paid by host states circumvent QDMTTs and neutralize the effect of successful ISDS claims.

First, despite that the OECD’s guidance on QDMTT payable implies taxation under the IIR or UTPR if investors challenge the QDMTT, it is appropriate to consider timing and the procedural aspects of ISDS and their likely effect on an application of pillar 2 rules. An ISDS generally takes three to five years to conclude, although it is possible to take longer than that,¹²⁹ especially if the state has strong grounds to challenge the tribunal’s jurisdiction, in which case it may proceed in phases that will lengthen the arbitration.¹³⁰

Assuming that the investor wins the arbitration by effectively challenging an uncompensated revocation of tax incentives by applying the QDMTT starting in 2025, the relief requested would be compensation for the taxes paid until the end of the arbitration — let’s say in 2030 — plus interest. At that point, it is uncertain whether other states would apply the IIR or UTPR for the years in which the issue was arbitrated, and even if they do so, whether the amount to be paid would equal the amount under the arbitral award.¹³¹ As a result, the investor would, at a minimum, benefit from the years in which the QDMTT was in effect because it would be compensated for that time without triggering top-up tax via the IIR or UTPR. It is by no means certain that states will follow the OECD guidance on QDMTT payable and apply an IIR or UTPR immediately after each ISDS claim against the QDMTT becomes public. Moreover, for UPEs located in states without pillar 2 but with a statutory rate above 20 percent, the UTPR is deferred for an additional three years (till the end of 2026) in accordance with the “Transitional UTPR Safe Harbour.”¹³² So a successful challenge of the QDMTT initiated under IIAs in 2025 gives a two-year benefit instead of one year. Depending on the developments of pillar 2, this period may be extended by the OECD and thus the mentioned benefit. This applies to the largest MNE groups in the world — notably from the United States.

Second, it is uncertain if a payment of damages by a host state would be characterized as a reduction of tax, triggering a top-up tax under the IIR or UTPR. Depending on the accounting treatment adopted by the MNE group when doing the consolidated accounts,¹³³ the future treatment of the top-up tax subject to an ISDS proceeding may vary among countries and different MNE groups. Depending on the future profitability and local ETR when the ISDS ends, the payment increasing or reducing the top-up tax for a prior year may be of no value. This would be the case if, for example, the jurisdictional ETR already exceeds 15 percent, or if the MNE group later falls out of scope of pillar 2. That is to say, payment of compensation in line with the arbitral award by the host state may or may not “be treated as a further tax reduction that triggers additional tax elsewhere.”¹³⁴ This all depends on very specific rules around computing covered and adjusted covered taxes and allocating taxes among countries, and on the applicable accounting rules.

Third, and connected with the second point, canceling the financial gain stemming from the arbitral award by the IIR or UTPR is uncertain. The amount of top-up tax paid in the host country under the QDMTT and compensated as a result of the arbitral award may be different from the top-up tax to be paid in the home country via the IIR or the third country via the UTPR. The final financial result will be driven by different factors, like the level of flexibility around financial accounting standards afforded by different countries.

All in all, arguments are far from being certain regarding paying tax anyway because of arbitral awards compensating revocation of tax incentives by a QDMTT triggering the IIR and UTPR. Even if compensations in ISDS cases related to pillar 2 may raise difficulties operating those rules and determining final benefits for investors, these difficulties are of little bearing to successful ISDS claims and motivation of investors to make them.¹³⁵

Conclusion

Pillar 2 appears to constitute a quantum leap in the international tax world. However, progress that violates fundamentals of law for states and international organizations seems to be a serious regress of normative legitimization of the OECD and the rule of law in the sphere of international tax and investment law. The pillar 2 rules in their anticipated form (domestic rules) may violate not only IIAs but also GPLs like principles of good faith, nondiscrimination, and non-expropriation. Crucially, the interlinking mechanism of the pillar 2 rules may trigger collective international liability of states and the OECD for wrongful acts by putting pressure on host states to violate international law (mainly IIAs). This is all questionable under the rule of law and one of its main constituencies — the obligation for states and international organizations to act on an international arena in good faith. It also appears to contradict the legal foundations of the OECD and its commitments “to improve outcomes of international investment treaties for governments and investors.”¹³⁶

Considering the analysis in this article, it seems unreasonable to conclude that delaying the implementation of pillar 2 until “governments have had a chance to consider the risks that implementation poses under their investment treaties”¹³⁷ is “misguided.”¹³⁸ Indeed, this delay appears justified and wise regarding proper considerations of not only the interplay between pillar 2 rules and IIAs, but also international law, including GPLs, international environmental law, international human rights and international customary law embodied in ARSIWA, DARIO, and the principle of denial of justice.

By contrast, downgrading problems related to the potential clash between pillar 2 and international investment regimes, as done by some scholars¹³⁹ and the OECD,¹⁴⁰ is misguided. It misses many considerable legal and policy issues, as identified and closely analyzed in this article. In fact, these issues are already surfacing and attracting the attention of many states. Signals from various jurisdictions, including the United Kingdom, Singapore, Hong Kong,¹⁴¹ Poland,¹⁴² the United States,¹⁴³ and some Latin American countries (for example, Argentina, Chile, and Ecuador),¹⁴⁴ and most recently the secretary-general of the U.N.¹⁴⁵ and the Association of Southeast Asian Nations (ASEAN)¹⁴⁶ either explicitly or implicitly indicate that there will be delays implementing pillar 2 for various reasons. Once member states of the inclusive framework are properly alarmed about the issues with the clash between pillar 2 and international law, they will likely have good reasons to delay implementation to assess the risks and tailor solutions. If risks are too high, they may never implement pillar 2 rules and may seek to develop and enforce more suitable tax and investment policy options.¹⁴⁷

This article’s overall conclusion is that proceeding with pillar 2 must take into account not only the wording of IIAs and other sources of international law, but also geoeconomic situations and resources of countries. It requires robust legal and geoeconomic reasoning without high pressure from the OECD. Perhaps the new global tax body under the umbrella of the U.N. could have a leading role in the process of ensuring pillar 2 compatibility with international law through a multilateral treaty.¹⁴⁸ However, this process shall not pave the way to the mentioned compatibility through a significant reduction in protection of foreign investments. It would be detrimental to the rule of law because a powerful legal tool to enforce fair and equitable tax treatment of foreign investments (ISDS) will become inoperable to all entities in-scope of pillar 2. The best tax and investment policy outcome would be to implement pillar 2 via a multilateral treaty with a preservation of protection of foreign investments under IIAs and a respect for international environmental law and international human rights law. The global tax and investment regimes can coexist together peacefully. This only requires a replacement of pressure with good faith.