Global Minimum Tax Rate: A Strategy in the Tax Collection Battle

The date June 5, 2021 may be claimed to mark a momentous event, as the Group of Seven (G-7) nations reached a landmark agreement backing the creation of a global minimum corporate tax (GMT) rate of at least 15% on multinational companies, regardless of where they are based or where their sales are made. Later, in July 2021, the G-20 also backed this plan.

This G-7 accord feeds into a much broader existing effort of the Organization for Economic Cooperation and Development (OECD) and major economies. For the past few years, major global economies have been taking strong initiatives to discourage multinational companies from shifting profits (and consequently tax revenues) to low-tax countries.

Transformation of the international tax system, outpaced by globalization and digitalization, has also been a top priority for the OECD. The OECD has been coordinating tax negotiations among 140 countries for years on rules for taxing cross-border digital services and curbing tax base erosion, including a GMT on companies.

To strengthen the above position and to introduce uniformity in tax rates worldwide, a “Minimum Global Corporate Tax Rate” is proposed as one of the arrows in the tax collection quiver by the large economies of the globe. A GMT is a tax regime established by international agreement whereby countries adhering to the agreement would impose a specific minimum tax rate on the income of companies subject to the respective jurisdiction’s tax laws.

A GMT would apply a standard tax rate to a defined corporate income base worldwide. Each country would be entitled to the revenue generated by the tax and incorporate the rate and rules into its own tax system. Governments could still set their corporate tax rates, but if companies were to pay lower rates in a particular country, their home governments could “top up” their taxes to the minimum rate, eliminating the advantage of shifting profits.

Shown below is a simple depiction of a GMT:

The OECD estimates tax leakage, due to differences between countries’ tax systems, of $100 billion to $240 billion each year, 4%–10% of global corporate income taxes. Given the magnitude of tax revenue in question, complex and competitive tax laws, presence of tax haven structures—a global uniform tax rate on overseas profits is the only viable path.

Since the initiation of its base erosion and profit shifting (BEPS) project in 2013, the OECD has proposed a “two-pillar” approach, adopted by the Inclusive Framework members, to establish new profit allocation and nexus rules (Pillar 1) and introduce GMT (Pillar 2). Pillar 2 includes two main rules, the income inclusion rule and under-taxed payment rule, along with a third rule (subject to tax rule) for tax treaties.

Paired together, these two rules create a minimum tax both on companies that are investing abroad and on foreign companies that are investing domestically. They are both tied to the minimum effective rate of at least 15%, and they would apply for each jurisdiction where a company operates. The outline also proposes to exempt companies “in the initial phase of their international activity” from GMT. The outline specifically states that digital services taxes (such as the Indian Equalization Levy) and similar policies will be removed.

Stance of Key Stakeholders/Economies

The agreement would involve a careful mix of political trade-offs as it would result in both winners and losers for different countries on separate issues.

U.S.

U.S. President Joe Biden has stated that with a GMT in place, multinational companies will no longer be able to pit countries against one another in a bid to push tax rates down, and will no longer be able to avoid paying their fair share by hiding profits generated in the U.S., or any other country, in lower-tax jurisdictions. The Biden administration has welcomed the G-7 proposal. His administration has pushed for a GMT rate in order to end what Treasury Secretary Janet Yellen frequently describes as a “30-year race to the bottom” in corporate taxation as countries compete to lure multinationals.

According to a Treasury Department report on Biden’s Made in America Tax Plan, seven of the top 10 locations for U.S. multinational profit in 2018 were tax havens. “Bermuda, a country of merely 64,000 people, shows 10% of all reported U.S. multinational foreign profit,” it noted.

India

India is likely to benefit from the global minimum 15% corporate tax rate, as the domestic rates applicable to corporations in India are higher than the above threshold. The first proposal will not impact India directly. India is expected to continue to attract investment: It is not one of the low-tax jurisdictions at which this proposal is aimed.

However, the second proposal of granting taxing rights to the market jurisdiction could lead to India getting a right to tax tech giants like Facebook, Google, etc.

India will likely work towards a consensus as long as it gives “meaningful and sustainable revenues to market jurisdiction.”

Europe

To date, several EU member states have expressed strong opposition to any GMT that impinges on their sovereignty to establish corporate tax rates, especially if the agreed rate is set at a level such as 15% or above.

In the EU, the deal will need a bloc-wide law to be passed, most likely during France’s presidency of the bloc in the first half of 2022, and that will require unanimous backing from all 27 members. Welcoming the deal as the most important international tax agreement in a century, French Finance Minister Bruno Le Maire said he would try to win over those holding out. “I ask them to do everything to join this historical agreement which is largely supported by most countries,” he has said, adding that all large digital corporations would be covered by the agreement.

China

China, which has a nominal corporate tax rate of 25% and grants a 15% rate to some hi-tech companies, has reiterated its commitment to a GMT scheme, holding that a GMT of 15% would help create a fair and sustainable international tax system.

Rich nations are concerned that the Chinese government may seek exemptions for certain sectors as the negotiations go into the next phase, but Chinese analysts say the initiative has few potential risks for the country because it is already a magnet for global investors. Some policy advisers believe China’s involvement with the U.S.-led global tax proposal could be used as a bargaining chip to reduce U.S. tariffs on Chinese imports.

The global minimum tax has more potential risks for Hong Kong—the seventh-largest tax haven in the world and the largest in Asia, according to the Tax Justice Network—through which some 70% of foreign investment from the Chinese mainland is now channeled. Hong Kong Financial Secretary Paul Chan said the proposed changes to the global tax regime might affect some of the tax concessions the government offers to various industries.

Ireland

Irish Finance Minister Paschal Donohoe, whose country has attracted many big U.S. tech firms with its 12.5% corporate tax rate, said he was “not in a position to join the consensus,” but would still try to find an outcome he could support. He has, for example, warned that the country could lose between €2 billion ($2.37 billion) to €2.4 billion a year, equivalent to a fifth of the state’s annual corporate tax revenue, under the proposal.

Estonia

Estonia’s corporate income tax rate is 20%, but since the tax is levied not at the stage of earning profit but at the time of distribution to shareholders, there can be very low or practically no corporate tax for a few years. The proposed GMT may tax profits earned by corporations for business in Estonia, even though the local laws of Estonia do not tax those (until distributed).

Estonian President Kersti Kaljulaid commented that no companies in Estonia will actually fall under this proposed regulation. She pointed out that Estonia is “extremely transparent” and not a tax haven and the tax system is “totally compatible” with the EU. She indicated they would watch how this technical debate evolves, and when regulations are final and technicalities become known, the government would be open to negotiate and find a way to prove to the world that its tax system actually will work with the new system globally, as well.

Tax Havens

The profits shifted to tax havens or lower tax rate jurisdictions will be subject to a minimum tax rate under the proposed change, thereby providing no reason for multinational companies to shift profits to such jurisdictions. The G-7 proposal has the potential to change the dynamics of tax havens, as profits shifted to such jurisdictions may face incremental taxation. This may yield around $150 billion in additional global tax revenues annually.

The lower the rate, the greater the threat to the most obvious havens such as Jersey, the Cayman Islands, and the British Virgin Islands. Since those territories have zero corporate tax rates, they will be impacted most, and a lower proposal is more likely to earn support. The 15% tax would also affect countries not typically considered tax havens, like Thailand, the U.K., Vietnam, Hong Kong, Singapore, Ireland and Macao. The corporate tax rate for these countries varies between 12% and 21%, but the effective tax rate is much lower, after taking into consideration various incentives, and hence a 15% level would likely still cause problems.

Switzerland, headquarters of Nestle, Novartis, and Roche, plans to offer companies subsidies to offset the 15% tax. Ireland, as mentioned above, has a 12.5% corporate tax rate and is among the countries whose approval is necessary for the G-7 tax plan to take effect. Ireland appears to intend to retain its tax rate to offset the disadvantages of a small country in attracting foreign investment. The point is this minimum tax essentially undermines all investment incentives of using tax havens.

Challenges to Efficacy

While the agreement creates a broad framework and has been received with much enthusiasm, there are still many open questions/challenges which need to be considered.

Tax Competition

The agreement represents a significant blow to tax competition, and it is not surprising that a country like Estonia (a champion of excellent tax policy) was unwilling to sign up to that. The eight countries that did not sign off on the plan were the low-tax EU members Ireland, Estonia and Hungary, in addition to Barbados, St. Vincent and the Grenadines, Sri Lanka, Nigeria and Kenya.

A GMT could significantly reduce, but not completely eliminate, tax-based competition among countries. If a common minimum tax rate provides multinationals with little or no tax advantage from moving investments and shifting profits to lower-tax jurisdictions, economic competition among countries would be influenced more by the comparative quality and strengths of their infrastructure and the skills of their workforces. The purpose of a GMT is to discourage tax-motivated profit shifting and base erosion by multinational companies.

The OECD framework is intended to discourage nations from tax competition through lower tax rates that result in corporate profit shifting and tax base erosion. International economic leaders consider U.S. agreement essential to the success of a global minimum corporate tax.

Balance of Tax Revenue and Foreign Direct Investment

Like other rules that tax foreign earnings, the income inclusion rule will increase the tax costs of cross-border investment and impact business decisions on where to invest round the world, including in domestic operations. The result could be less foreign direct investment (FDI) and slower global economic progress.

However, many policymakers are prioritizing tax revenues before investment and growth. A major chunk of world FDI channels through nations with low or no corporate tax rates, facilitating investments by companies in both developed and developing countries. Eliminating the tax benefits of structuring investments through these jurisdictions would directly impact business incentives to speculate across borders.

Understanding how a world minimum tax might negatively impact cross-border investment and the way to avoid that outcome is going to be critical if global FDI is to completely recover following the pandemic.

Global Support is the Key

The possibility of resistance from countries with a corporate tax rate below 15% cannot be ruled out, as their economic models will be shaken. This minimum tax essentially undermines investment incentives provided by the lower tax rates offered by countries like Ireland, Bermuda, Cayman Islands, British Virgin Islands.

The problem is not getting the G-7 to agree, it is getting the agreement of countries whose main competitive advantage is that they are tax havens. U.S. Treasury Secretary Yellen said she will try to persuade countries with low corporate tax rates that do not support the plan, such as Ireland and Hungary, to join the agreement—but that persuasion is backed up by the Biden administration’s proposal to raise taxes for companies based in countries that do not join.

Digital Services Tax

The G-7 communiqué included a significant reallocation of profits to market countries for the “largest and most profitable” companies, coupled with the removal of digital services tax (DST) for all companies when the new allocation rules take effect. It left open what will happen in the meantime to DST on large technology companies in various jurisdictions, though it mentions there should be “appropriate coordination between the application of the new international tax rules and the removal of all DST.”

Further, considering that any deal is based on the removal of all DSTs, it is at this point not feasible to make any accurate assessment of the impact on countries and corporations.

Double Taxation

It is necessary to address how national tax systems and the existing network of double tax treaties will have to be adapted to fit into this multilateral agreement. Avoidance of double taxation is important. Issues related to the complexities of enforcement and tax collection also need to be addressed. These clarifications are necessary to prevent a significant increase in international tax disputes.

Tax Base

Defining the tax base on which the minimum tax rate applies is very important. Tax laws in individual countries also vary in design and complexity, resulting in very different income tax bases and rules. However, to be recognized as fair and achieve acceptance, a GMT requires a standard definition of tax base/income. Drafters of a GMT will also have to determine if it will apply broadly or only to multinationals with revenues over a specific threshold; whether some industries or regions will be exempt; and how it will be implemented, amended, and enforced.

Looking Forward

The road to a global tax agreement seems long, involving many technical and policy complexities and challenges. Many countries need to amend their tax laws. U.S. participation is critical to the plan’s success (it depends on Congressional action and likely will be opposed by Republican legislators and business skeptics).

The G-7 agreement will signify a change for most countries, and it remains to be seen how the new landscape on cross-border taxation will look. There will be winners and losers. The largest economies may stand to benefit the most. It appears to weigh heavily on most developing and emerging economies, as well as some EU member states with preferential tax regimes. Clearly, tax havens will be losers!

While the implementation still looks far away, countries across the globe are certainly moving towards an interconnected international tax system with standardized tax rates for global businesses. GMT is the largest-ever change to the global tax landscape, and the culmination of years of effort, discussion, negotiation, proposals/re-proposals, etc. It is prime time for multinational corporations to review their business models and structures for global businesses assuming tax responsibility globally.

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

Anshu Khanna is a Partner with Nangia Andersen LLP, a member firm of Andersen Global.

The author may be contacted at: anshu.khanna@nangia-andersen.com