Minimum 15% corporate levy due to take effect in 2023
A deal on establishing a global minimum tax rate for large multinational companies will open a new chapter in meeting challenges resulting from globalization and digitalization of the world economy, according to analysts.
At the end of October, leaders of the 20 biggest economies endorsed at the G20 Rome Summit an Organization for Economic Cooperation and Development deal on setting a global minimum corporate tax of 15 percent.
A Reuters report, quoting the draft conclusions for the deal, said the aim is for the new taxation rules to take effect globally in 2023.
Earlier, 136 countries and jurisdictions comprising 94 percent of global GDP reached agreement on an inclusive framework to make it harder for leading corporations to avoid paying tax by establishing special purpose entities in low-tax locations. The minimum corporate tax rate of 15 percent will apply to multinationals with annual revenue of more than 750 million euros (about $845 million).
Qiang Jianxin, head of the School of Economics and Finance at the University of International Relations in Beijing, said the current international tax system was established about 100 years ago with the aim of avoiding double taxation of enterprises by multiple tax jurisdictions and preventing international tax avoidance and evasion.
However, digitalization has brought new forms of business and new business models, which get round current international tax rules.
Qiang said that under these rules, a multinational pays taxes to the country in which its profits are earned. However, in the digital economy, some companies make profits online without setting up operational entities. As a result, profits can be reallocated across borders and companies can make profits in locations where they have no physical presence, such as a headquarters. This could cause a mismatch of earnings and taxes, and trigger an imbalance in the allocation of tax benefits among economies.
Moreover, to deepen economic globalization, economies have taken various measures to attract investment from international companies, triggering a race to the bottom on international tax rates and a quick decline in global corporate income tax rates, he said.
A race to the bottom refers to a competitive situation where a company, state or nation attempts to undercut the competition's prices by sacrificing quality standards or worker safety (often defying regulation), or reducing labor costs. Such a race can also occur among regions.
According to the OECD, under the current tax system, governments lose $100 billion to $240 billion in tax revenue a year.
Zhang Wenchun, a researcher at the International Monetary Institute of Renmin University of China, said that in addition to the increasing financial pressures on many countries, a race to the bottom causes distortions in tax incentives for investment and loss of investment efficiency.
"In today's economy, multinationals can make huge profits from intangibles such as trademarks and other intellectual property, which is much easier than relocating a plant. Companies can distribute the earnings they generate to subsidiaries in countries with very low tax rates. Some nations use minimum tax rates to attract companies so that they can generate substantial revenue even at tax rates that are just above zero," Zhang said.
To reform the tax system, the OECD released the blueprint for a "two-pillar solution" in October last year.
Pillar one would redistribute some of the taxation rights of multinationals from their home countries to markets where they operate and make profits, regardless of whether such companies have a physical presence there. Pillar two aims to find the lowest level of corporate tax competition and prevent a race to the bottom by introducing a global minimum corporate tax rate. Countries can use this to protect their tax base.
United States Treasury Secretary Janet Yellen said on a social media platform that the "historic agreement" on new international tax rules will "end the damaging race to the bottom on corporate taxation" and "remake the global economy into a more prosperous place for American business and workers".
The OECD estimates that pillar one is expected to affect about 100 of the world's largest and most profitable multinationals and will redistribute more than $125 billion in annual profits to countries where such companies operate. Pillar two, with a global minimum tax rate of 15 percent, is expected to raise $150 billion a year in corporate income tax revenues worldwide.
The US, in particular, hopes the new international regulations will bring in $350 billion in additional tax revenue over the next 10 years.
The aim is to put forward legislation for the two-pillar plan next year, before it takes effect in 2023. However, developed countries are expected to benefit far more from this new global tax system than developing nations.
In October, a report from the EU Tax Observatory, an independent research laboratory, said high-income countries stand to gain the most from the 15 percent global minimum tax, as multinationals are headquartered in such nations.
The European Union would see its corporate income tax revenue rise by more than 80 billion euros a year with a minimum tax rate of 15 percent without carve-outs. This would equate to 25 percent of the trading bloc's current corporate tax revenue. The US would gain about 57 billion euros a year, the report said.
A carve-out is the partial divestiture of a business unit in which a parent company sells a minority interest of a subsidiary to outside investors.
Developing countries would see smaller revenue gains, such as 6 billion euros for China, 4 billion euros for South Africa and 1.5 billion euros for Brazil, the report said.
Zhang said: "Many developing countries still consider 15 percent is too low. The agreement does not do enough to meet the needs of these nations, and an independent tax body should be set up by the UN to devise new rules that meet the interests of all parties at different stages of development."
The exclusion of specific sectors such as extractive industries and regulated finance from the new tax rules may also create fresh problems concerning international tax competition and tax evasion, he added.
Implementation of the new global system would still require specific countries to adjust their tax systems based on the rules set out by the OECD deal, Zhang said.
"If the US and European countries, where most multinationals are headquartered, pass the legislation for such a minimum tax rate, it would have a big influence on the global economy, even if some tax havens do not do so," he said.
Zhang said the new corporate rules are the start of a fresh international tax order, although they are not perfect and do not solve all problems. Implementation of the minimum tax agreement will also require new legislation in each country.
"The new rules will eliminate unilateral actions such as a digital services tax, and help reduce trade tensions," Zhang said. "But they will also bring changes－in particular, the global minimum tax will affect international capital flows by increasing the tax costs of many cross-border investments."
Zhang added that transforming the new rules into domestic tax laws will also face challenges. For example, in the EU, accusations and criticism from opposition parties in many countries will probably cause difficulties for these nations to pass tax legislation to accompany the new global system. As a result, it remains to be seen whether an international tax system can be established.
Jonathan Geldart, director-general of the Institute of Directors, said setting the lowest corporate tax rate at 15 percent will remove some of the most extreme examples of tax competition.
"This will make it harder for countries to reduce corporate tax to very low levels just to encourage organizations－typically in the technology and e-commerce sectors－to move their legal entities to such locations purely for tax advantages," he said. "On the other hand, for the companies affected, there will be less incentive to decide location just because of lower taxes."
Geldart said there has been a considerable amount of negative publicity about some extremely successful global companies declaring their profits in a jurisdiction away from their customers in order to take advantage of lower tax rates.
"We believe companies need to look at how all their stakeholders might view what they do, in order to ensure they don't suffer reputational damage from what many consumers have seen as sharp practice," he said.
Geldart said the countries that will benefit the most are those－including the United Kingdom－that have historically had corporate tax rates above the new minimum of 15 percent, regardless of how developed they are.
"What this does do is reduce the ability of any country to just have low corporate tax rates as a way of attracting organizations to move their headquarters," he said. "In reality, international firms will look at a wide range of things when deciding where to locate, including the overall ease of doing business and the availability of customers. But at least it will no longer just be about tax."
He said the incentive for governments to agree to this OECD process is to try to keep highly mobile companies from moving to jurisdictions with very low tax rates.
"To reduce the effect on digital businesses, some commitments have been made as part of the same agreement to move away from specific technology and digital taxes that some countries had adopted in response to public concern," Geldart added.
Ronnie Lins, director of the China-Brazil Center for Research and Business, said the two-pillar plan should theoretically affect research and development-intensive sectors more severely.
However, the "global tax universe" allows for the possibility of carrying out many tax maneuvers. The new international regulations may not work for some companies in certain sectors, and the characteristics of a local tax system and the interest of governments in attracting multinationals should not change that much, he said.
"Take the pharmaceutical and high-tech sectors for example. We find that intellectual property, algorithms, patents－among others－are intangible and R&D-intensive goods. Although they are most affected by the new taxation, they have increased flexibility to implement more favorable tax guidelines for their activities," Lins said.
He added that in theory the sectors that could be most affected are those related to the digital economy. However, the extent to which they are affected will depend on where the companies are located. In addition, the characteristics of the tax system in a particular country will be fundamental for evaluating the outcome of the new international tax system.
Lins said the final implementation of the new tax regime should consider standardizing taxes between countries, and this can only happen in the very distant future.
The new regulations will help many countries. For example, China will be able to carry out deeper tax reforms, better contain tax evasion and create improved conditions to enhance its development, he added.