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A Turning Point for International Tax Reform

Oct. 15, 2021, 7:00 AM

It has finally happened—on Oct. 8 the Organization for Economic Cooperation and Development (OECD) announced 136 countries have signed up to reform the international tax system. The headlines are a 15% minimum rate of tax on some multinational enterprises (MNEs) and perhaps around $125 billion of profits will be reallocated to the countries where the world’s largest companies do business, rather than where they are located. In return, no new digital services taxes (DSTs) can be imposed

While 136 countries are on board, several countries have not signed up to the program. The agreement will also need to be ratified by parliaments around the world. This latter point could be challenging where there are thin majorities. If, for example, the provisions cannot clear the U.S. Congress (and many of the companies affected are based in the U.S.) it is unclear what happens to the program.

What Does it Mean?

The OECD hopes that tax competition between countries has just become a lot harder. The agreement is designed to stop governments trying to attract business and development through a “race to the bottom” by offering lower corporate tax rates. Governments that did this, rarely did so out of the goodness of their hearts. They hoped that the companies operating in their territories would create jobs, import technology and help generate wealth.

Politicians will be unlikely to give up these goals, so we can expect competition to move to other areas—perhaps lower taxes on employment where there is new investment, greater incentives to locate well-remunerated jobs in a country, or reliefs for high-net-worth individuals working or investing in a country. Relaxed regulatory systems and helpful legal environments are just as important as tax rates when it comes to influencing corporate location decisions.

For many years it has been known that the headline rate of tax means very little. The effective rate is what really matters and those signing up to this headline-grabbing agreement are well aware of that.

The Detail

The OECD program is built on two fundamental pillars:

  • Pillar One: who gets the right to collect taxes;
  • Pillar Two: a global minimum tax.

Pillar One

The rules will only apply to MNEs with global turnover above 20 billion euros ($23 billion) and profitability of more than 10%. The limit can be revised downwards to 10 billion euros after seven years, following a review. It would not be a surprise if this happened, as revenue-hungry governments will probably conclude that the threshold for the new regime is too generous.

Now for the hard bit: Where an in-scope MNE derives at least 1 million euros in revenue in a given jurisdiction, an amount (Amount A) will be reallocated to the territories where it does business. For smaller countries with GDP lower than 40 billion euros, the threshold will be a modest 250,000 euros.

25% of the residual profit in excess of the 10% threshold will be reallocated. Some difficult sums lie ahead.

The trade-off is that existing DSTs will need to be removed and no new digital levies can be imposed in the future. Any newly enacted DSTs cannot be imposed on any company from Oct. 8, 2021, until the earlier of Dec. 31, 2023 or when a multilateral convention (MLC) abolishing DSTs comes into force. Clearly the backstop of December 2023 is designed to focus minds on agreeing to the MLC. Whether it has that effect remains to be seen.

To implement this, MLCs will need to be signed and/or domestic legislation modified.

There is more work to be done on Pillar One—including drafting texts and putting together an explanatory statement. It is hoped it will come into force some time in 2023 when enough territories have ratified it.

Pillar Two

After some haggling from jurisdictions that may have been initially reluctant to sign up, the global minimum tax has been set at 15%. There is only one direction of travel for such a tax—so don’t be surprised to see it raised in future years.

The basic position is that the global minimum tax rules will apply to MNEs that meet the 750-million-euro threshold as determined under the country-by-country reporting rules.

There is a carve-out for government entities, international organizations, non-profits, pension funds and investment funds that are ultimate parent entities of an MNE group.

Exemptions have been agreed to exclude an amount of income that is 5% of the carrying value of tangible assets and payroll. However, this will be phased in from a more generous level.

In a transition period of 10 years, the amount of income excluded will be 8% of the carrying value of tangible assets and 10% of payroll, declining annually by 0.2 percentage points for the first five years, and by 0.4 percentage points for tangible assets and by 0.8 percentage points for payroll for the last five years.

This is somewhat difficult to track, and we might expect to see companies looking to revalue their tangible assets as and when they can.

There is a de minimis exclusion for those jurisdictions where the MNE has revenues of less than 10 million euros and profits of less than 1 million euros.

Implementation is hoped to have a similar timeline to Pillar One.

Conclusion

Politicians will feel pretty pleased with themselves. They can announce that they have taken action against the tax bogeymen. To give credit where it is due, this is an attempt to modernize the antiquated global tax system. But will it have the desired effect? That depends.

It needs to be implemented first and that cannot be taken for granted. If it is successfully enacted, it will probably raise more tax revenue. But it is important to remember the potential knock-on impacts on policymaking. The program only affects the largest companies, so there is plenty of scope for governments to attract smaller, high-growth businesses of tomorrow—don’t be surprised if they do this.

There are ways to attract investment other than through low corporate tax rates and the signatories are of course well aware of this.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

Laurence Field is Corporate Tax Partner at national audit, tax, advisory and risk firm, Crowe.

The author may be contacted at: laurence.field@crowe.co.uk

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