The commitment by 130 countries to introduce a 15% minimum corporation tax has stirred up objections from some countries that could make it more difficult to implement. Notably Estonia and Hungary contend that the agreement, brokered by the Organisation for Economic Co-operation and Development (OECD), contravenes EU law, potentially causing a problem for the 23 member states which are parties to the agreement.

Estonia and Hungary have two of the most generous corporation tax regimes in the EU. Hungary offers a headline corporation tax rate of 9%, while Estonia’s is 20% but drops to zero for certain kinds of companies. Of the other EU nations that compete aggressively on corporation tax, Ireland and Cyprus have also stayed out of the OECD agreement, though the Netherlands and Luxembourg have both signed up.

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

How multinationals avoid tax

At present, the 130 countries have agreed to a statement of intent, with an implementation plan to be finalised by October and to come into force in 2023. It follows a similar commitment made by the G7 nations 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$100 billion (£73 billion) and US$240 billion a year.

This is possible because each country decides on its own tax regime, which it can use to try and attract multinationals to set up a base with them for tax purposes. This competition, which is of course not confined to the EU, has been characterised by US Treasury Secretary Janet Yellen as resulting in a “race to the bottom”.

Multinationals are known for setting up subsidiaries in low-tax jurisdictions and filtering international earnings through them even though they do little business in the jurisdiction in question. The US tech giants, for example, have become particularly well known for such schemes, not least in relation to earnings from digital services and intellectual property royalties.

The OECD agreement rests on two pillars. Pillar one enables a fairer allocation of profits by multinationals by requiring that more of their activities are taxed where profits are earned – regardless of whether they have a physical presence there. Pillar two sets the minimum corporation tax level of 15%, and this is what is causing the controversy.

The Cadbury Schweppes case

The argument from Estonia and Hungary appears to rest on the 2006 case of Cadbury Schweppes plc and Cadbury Schweppes Overseas Ltd v Commissioners of the Inland Revenue. 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 taxes are generally not charged on the profits of a foreign subsidiary, this case concerned UK rules that provided an exception.

The Cadbury lawyers argued, among other things, that the UK legislation was a restriction on the EU freedom of establishment, which enables companies and individuals to set up undertakings anywhere in the bloc. The European Court of Justice accepted this argument, holding that it was incompatible with European Commission law for a member state to tax a resident company on profits made by a subsidiary in another member state, to prevent that subsidiary from taking advantage of more generous tax rates.

Estonia’s deputy secretary general for tax affairs, Helen Papahill, is reported to have said that this case “shows quite clearly that these kinds of rules should not exist” in the EU. The argument appears to be that the OECD agreement would entail countries where large companies are based imposing the minimum tax rate on subsidiaries incorporated in other member states with lower tax rates. Put simply, you can’t tax a company’s subsidiary that is based in another country.

However, the judges in the Cadbury Schweppes case only considered the impact of one member state’s tax laws on profits earned by a subsidiary in another member state, and it should not be taken as establishing a broader principle that the EU’s freedom of establishment laws prevent international tax rules from being agreed.

It is likely that the OECD agreement would be regarded as a justified limitation on freedom of establishment, potentially on the grounds that it creates a common solution to the problem that multinationals are not currently paying fair rates of tax. Arguably it would not even hinder a company’s freedom of establishment if every state followed the same minimum tax rate, particularly when smaller countries potentially have other advantages that could attract multinationals to incorporate in them, such as skilled workforces.

Nonetheless, this legal question is not the only obstacle to the OECD agreement being implemented. As a tax measure,, it is likely that it will need unanimous approval among EU member states – besides Hungary and Estonia. It is also still unclear whether Ireland and Cyprus will sign up.

The agreement may also face a tough time gaining approval from the US legislature, without which it would be greatly weakened. Tensions between the US and EU over European proposals to introduce an extra tax on digital companies are not helping. For all these reasons, the plan to tighten up corporation tax worldwide could still be facing a bumpy future in the months to come.