The United States is leading other developed wealthy nations to impose a global minimum corporate tax levy on multinational corporations.
After spending, and committing to spend, trillions of dollars to reboot their economies, the seven member states of the G7 are scrambling to secure funding. In a June meeting, they agreed that multinational corporations (MNCs) would pay a minimum 15% tax on their global revenues, regardless of national tax incentives they enjoy.
“Historic, game-changing, revolutionary: such has been the widespread reaction to the recent agreement by G7 finance ministers,” wrote José Antonio Ocampo, a former finance minister of Colombia, in The Asset in June. “The ministers also agreed on a new formula for apportioning a share of tax revenues from these companies among countries.”
That would bring an end to tax havens and companies shifting profits to low-tax jurisdictions, such as Ireland (12.5% corporate tax) while making money in high-tax destinations, such as the United States, where until 2017, the corporate tax rate was 35%. Now it’s 21%. “That global minimum tax would end the race to the bottom in corporate taxation and ensure fairness for the middle class and working people in the United States and around the world,” U.S. Treasury Secretary Janet Yellen said in June. “The global minimum tax would also help the global economy thrive by leveling the playing field for businesses.”
Enforcing a global minimum tax, however, will be a complex undertaking. Governments could change their laws and strategies to develop other incentives for attracting foreign direct investment (FDI). MNCs would revisit their business footprints. “It [will] reverse nearly four decades of falling global corporate tax rates,” wrote Aqib Aslam of the Regional Studies Division in the IMF’s African Department in a June blog.
Not all countries are happy with the minimum tax initiative, as many would see MNCs exit without any tax incentive to stay. Some experts note that if major developed economies agree to a global minimum tax rate, less influential nations might have no choice but to comply.
Almost all international tax laws originated in the 1920s, wrote Tang See Kit, a correspondent at Channel News Asia. They don’t address companies doing business in the digital space or tech firms. “They sell services remotely and attribute much of their profits to intellectual property held in low tax jurisdictions,” explained Kit.
Ocampo said advanced nations have relied “heavily” on corporate tax revenue, “thus have been hit harder by multinationals’ tax avoidance. That results in global revenue losses of at least $240 billion each year.”
On the other hand, emerging economies attempting to attract FDI and promote investment have used tax exemptions to attract investors. Free economic and industrial zones are two options that permanently exempt MNCs from paying corporate taxes.
A prime example is Jebel Ali in Dubai, where companies pay no taxes. Meanwhile, Egypt has the Suez Canal Free Zone, which promises reduced corporate taxes as an incentive to invest in the area around the waterway. “Egypt’s tax law [which sets rates at 22.5%] has removed most tax exemptions, except for companies with free zone status,” says Amr Elalfy, head of research at Prime Holding. There are similar zones under different names across the MENA region, all aiming to reduce investment costs by lowering or eliminating corporate taxes.
Then there are special agreements, such as the one the Irish government is accused of signing with Apple. The European Commission “determined that Ireland gave Apple a ‘sweetheart deal’ that let the iPhone maker pay significantly lower taxes than other businesses,” wrote Kim Lyons, an editor at The Verge. EU antitrust chief Margrethe Vestager noted, “this is illegal under EU state aid rules” when the story broke in 2016. The investigation is ongoing.
Some countries offer temporary tax breaks. “Countries compete vigorously to lure businesses and investors within their borders by offering numerous profit- and cost-based tax incentives, driving their tax rates down,” wrote Aslam of the IMF.
By 2019, the OECD, an organization club of mostly rich countries, floated the idea of reforming international tax laws to prevent such practices. It culminated in the G7’s announcement in June of the Global Minimum Tax (GMT) framework, instigated by the U.S. government. “This unprecedented progress reflects the [U.S. President Joe] Biden Administration’s commitment to building a global tax system that is equitable and equipped to meet the needs of the 21st-century global economy,” the White House said in a statement.
How the GMT works
The GMT framework would replace the EU’s Digital Services Tax, which mainly taxes American tech companies making money in Europe, according to a June 11 joint U.S.-U.K. statement. The GMT also would replace the OECD’s Base Erosion and Profit Shifting regulations and America’s Global Intangible Low-Taxed Income laws.
The new global framework comprises two pillars. The first requires MNCs to pay the domestic corporate tax rate where they operate, not just where they’re headquartered. That mainly affects tech companies and those selling to a global market via a virtual marketplace. “Pillar one is relatively small but politically salient,” Alex Cobham, an economist and chief executive at the Tax Justice Network, wrote in The Financial Times in June. It comes amid “public anger over the failure to tax multinationals focused on large tech companies that can outcompete more highly taxed local businesses,” he said.
Eligible multinationals would make more than 10% profit margins, and 20% of their revenue comes from overseas operations. Estimates predict “this will bring in additional revenue of $5 billion to $12 billion a year,” wrote Cobham in The Financial Times.
The second pillar of the GMT is the corporate tax rate floor for eligible multinationals. G7 countries in June agreed to set it at 15%, which the OECD said would increase their members’ combined tax revenue by $275 billion. That was the middle ground between the lowest tax rate in the EU, Ireland’s 12.5%, and the U.S.-proposed 21%.
The approved GMT framework ensures that all G7 countries benefit, regardless of whether other nations support the new system. “The consequence of a low effective tax rate for MNCs in a particular jurisdiction is the triggering of a ‘top-up tax’ in the jurisdiction of its ultimate parent entity,” Dean Rolfe, KPMG’s partner and head of international tax for Asia and the Pacific, told Channel News Asia in June.
It’s in the best interest of the wealthiest countries to enforce the GMT, even if other nations don’t participate. “As most of the largest multinationals are headquartered in OECD countries, the majority of the benefits would go to them,” wrote Cobham of the Tax Justice Network.
The U.K.’s Tax Justice Network estimated that G7 countries would gain a total of $168 billion in increased corporate income. The United States would see its corporate tax income rise by 21%, while the U.K., Germany, and France would see their revenue increase 15% to 30%.
Those revenues would increase further if only G7 countries applied the GMT to all their MNCs, as they would receive most of those additional revenues via the “top-up tax” mechanism. “The G7 members, with 10% of the world’s population, stand to receive more than 60% of the additional revenues,” said Cobham.
The GMT would mostly impact tech and online companies. The new framework gives governments a universal legal platform to tax tech companies on overseas profits. So far, attempts at taxing tech giants, including Amazon, Apple, Facebook, and Google in the EU, have been individual efforts that caused political strains. “Big tech companies have predominantly been taxed in their home country, which is often the United States,” an analysis by The Washington Post noted in 2019. “These new … taxes would mean European governments could take some of the U.S. slice of the pie.”
The GMT wouldn’t work for countries that have long relied on tax incentives to attract foreign direct investment. “Overall, countries with a moderate tax rate system stand to benefit at the cost of ‘tax havens’ with low or nil tax rates,” wrote Sudhir Kapadia, EY India National Leader for Tax, in Money Control in June.
Christina Wilkie, CNBC’s content editor and political reporter, warned in June that implementing the GMT would “effectively end the practice of global corporations seeking out low-tax jurisdictions like Ireland and the British Virgin Islands.”
That would profoundly affect MNC decisions from their global footprints. “The global minimum tax poses a serious threat to the business model of many jurisdictions,” wrote Cobham of the Tax Justice Network.
According to Trading Economics, a statistics portal, 10 nations, including several east European countries, Kuwait, Oman, Tunisia, and Switzerland, tax companies at 15%. Meanwhile, 17 levied lower corporate rates, with seven tax havens having no corporate tax.
Kit of Channel News Asia stressed the GMT would also hurt countries that offer tax breaks and incentives, making their effective tax rate much less than the headline figure. Singapore, for example, has an effective tax rate of 8.5%, according to Guide Me Singapore, while its headline rate is 17%. Cobham said Ireland’s “average effective tax rate for U.S. multinationals is just 2%” despite its headline rate being 12.5%.
That could dent those countries’ investment prospects as part of the incentive for staying is their lower tax rate compared to advanced economies. “The tax rate in itself was very attractive for a number of years,” said Thomas Byrne, Ireland’s minister for Europe, in a television interview in June.
On the other hand, African nations and other developing economies might benefit from the GMT. It would narrow the gap between their current tax rates, ranging from 25% to 35%, and countries that increased their corporate tax rate to 15%, said the African Tax Administration Forum (ATAF) in a note.
ATAF requests that eligible MNCs’ annual global revenue threshold drop from the G7’s $10 billion to just under $300 million. It also asks that revenue generated from routine operations be combined with accumulated free cash flows from past years under the GMT framework. That effectively means that more MNCs would pay GMT.
Aslam of the IMF noted that African countries prefer higher GMT rates. “Governments are turning to [global] minimum taxes as a means of preserving their tax base,” he explained. “This is particularly true in developing countries with weaker tax administrations, which face major challenges in effectively taxing these large multinationals.”
Despite that, Elalfy doesn’t believe that GMT would make a difference to the status of MNCs in emerging markets. “Emerging markets often have tax rates that are higher than 15%. Plus, moving [headquarters] would involve higher costs which may not justify moving to another tax jurisdiction,” he explained.
Saving the government?
Kapadia of EY in India noted that the agreement over the GMT is happening quicker than ever before, and there is more political push to implement it. “The pandemic seems to have accelerated the pace of reaching a broader agreement on the issue,” he wrote in Money Control in June.
COVID-19 forced almost all wealthy nations to spend trillions of dollars on protecting their struggling businesses, curbing unemployment, and leading investments. “Government debt levels have surged, and deficits are expected to remain elevated in the near term as countries pump prime activity,” said Kapadia. He estimated that “fiscal holes [amount] to 14.9% of GDP for the U.S., 16.9% for the UK, and 7.2% for the EU,” he wrote.
Yellen, the U.S. treasury secretary, told the press in July that by “making big multinational corporations pay their fair share,” the government would have the “resources to fund priorities for domestic renewal – such as infrastructure, childcare, affordable housing, and education.”
However, the implementation of GMT is challenging. Ocampo, the former Colombia official, noted that it’s difficult to dissect an MNC’s balance sheet to identify profits generated in one jurisdiction, as their operations are highly integrated. “Profits are essentially the result of the firm’s global activities,” he said, suggesting collecting taxes based on a “formulaic [approach] according to employment, sales, and assets,” he explained.
Ian Borman, a finance partner in the London office of Winston & Strawn, stresses that tax havens may give MNCs fresh incentives to counter GMT. That may mean new unfair advantages. “Low tax jurisdictions will use any opportunity to replace low tax rates with other incentives by something else, potentially making a labyrinthine tax system even more complex,” he wrote to The Global Legal Post.
Governments that have long relied on tax incentives must also now expedite improvements in their business environment. CIMB Private Bank economist Song Seng Wun told Channel News Asia that Singapore would still attract investors under a GMT despite almost doubling its effective tax rate. “Singapore’s infrastructure, rule of law, stable political environment, as well as connectivity to regional and global economies, are among the intangibles companies also consider,” he explained. “Because we know that businesses are in Singapore for more than just tax reasons, as long as Singapore’s overall package remains attractive, [the new tax rules are] not a significant issue.”
G20 and OECD nations will start negotiating the implementation of the GMT with the G7 in July. Yellen, the U.S. treasury secretary, said when the G20 approves the new framework, smaller economies may have no option but to comply. “For those that do not, there will be an enforcement mechanism to pressure those countries to comply,” Yellen said as reported by MNE Tax, a specialized news portal. “It doesn’t require absolute agreement across the board. It has a way of bringing holdouts into it.”