Global Minimum Tax Endorsed

“This is a major victory for effective and balanced multilateralism. It is a far-reaching agreement which ensures our international tax system is fit for purpose in a digitalised and globalised world economy. We must now work swiftly and diligently to ensure the effective implementation of this major reform,” 
– said OECD Secretary-General
Mathias Cormann.

The Organisation for Economic Cooperation and Development (OECD) announced that participants in October this year had agreed in Paris to apply a uniform corporate tax rate of 15 percent to multinational companies, including tech giants such as Google, Amazon, Facebook, Microsoft, and Apple, in order to make it harder for them to avoid taxation by setting up operations in and shifting their profits to low-tax countries. 137 countries and jurisdictions, which account for 94 percent of global GDP, have agreed to the new rules as of 4 November.

What is the global minimum tax deal and what will it mean?

The OECD has been fighting for years against allowing large international companies, primarily digital companies in recent times, to funnel their profits through low-tax jurisdictions to pay less tax.

Ireland’s status as a tax haven is a good example of this since it has applied a lower-than-average corporate tax rate of 12.5 percent as a tool to attract new-age digital giants such as Facebook and Google. This remarkable feat has proved to be a huge success both for Ireland and for tech firms: the Celtic Tiger has had the most colossal growth boom in its economic history, bringing economic prosperity to the country, while global companies based there pay corporate tax on their worldwide profits in Ireland and thus escape paying tens of billions of dollars every year in tax, drawing anger from many EU countries.

Of course, companies engaged in productive activity (and thus making important contributions to job creation as well as paying taxes and contributions for their employees even if they do not pay income taxes) should not be lumped together with companies that deliberately shift their profits for the purposes of tax optimisation. All the more as standard tax rates do not normally apply to big corporations, since tax administrations may grant corporate tax rate reduction to major companies. The most famous example of this is Apple’s tax deal with Ireland allowing the company to pay a corporate tax rate of 0.005 percent on its global profits for many years. Therefore, the European Commission had ordered the Irish government to recover 13 billion euros in back taxes from Apple, but the tech giant did not have to pay back taxes to Ireland because the Court of Justice held that the practice was highly questionable but not contrary to EU law.

The Apple-Ireland tax case has had a huge impact on the corporate tax practices of multinational companies: almost 40 percent of large companies’ profits, or more than 700 billion dollars, were shifted to ‘tax havens’ in 2017. It is not by chance that the expression is enclosed in quotation marks, as tax havens do not only include Cayman Islands, Panama, and jurisdictions that correspond to its definition, i.e. countries that do not share financial information with foreign tax authorities, but also, especially nowadays, Ireland and Hungary. Moreover, experts indicate that this process has been tending to broaden: 76 countries cut corporate taxes between 2000 and 2018, not because they did not need tax revenues, but in order to entice companies with low or zero taxes.

The aim of negotiations coordinated by the OECD for years was to achieve fairer taxation of the digital economy. Negotiations had been progressing slowly, and worse, the Trump administration withdrew from international digital tax negotiations at the OECD last summer, claiming that there had been no progress in the negotiations, but, in fact, Donald Trump did not support European plans to impose digital service taxes on US tech giants.

US shift

The new US administration re-joined global efforts to declare war on tax havens. ‘A global minimum tax will end the damaging race to the bottom on corporate taxation,’ Secretary of the Treasury Janet L. Yellen said at her confirmation hearing at the Senate. However, it should be noted in this respect that other factors could also have played a role in the turnaround from the Trump administration. The US government saw massive tax revenue losses due to the economic recession caused by coronavirus pandemic, while planning to launch an economic and family recovery programme costing trillions of dollars. To help finance the long-term economic programme, the corporate tax rate was raised to 28 percent from 21 percent, previously cut by Trump to 21 percent from 35 percent in order to lure investment back to the US, but to no avail. It is worth remembering here that it was just the official tax rate, and the effective tax rate of US-headquartered multinational companies dropped under 8 percent.

Rules

The rules designed to combat international tax avoidance is planned to come into effect globally in 2023. According to the draft, G20 leaders called on the countries and jurisdictions that cooperate closely in the implementation of the OECD’s 15-point Action Plan on Base Erosion and Profit Shifting (BEPS) to develop the model rules and multilateral instruments swiftly in accordance with the Detailed Implementation Plan.

The EU directive on the 15 percent global minimum tax is expected to enter into force by 2023, while a European Commission official announced that the EU directive might be forthcoming before the end of the year. Experts estimate that the Member States will collect around 150 billion euros in new revenues annually.

There are two pillars of the reform:

• According to Pillar 1, multinational companies with more than 20 billion euros in revenues and a pre-tax profit margin above 10 percent would pay taxes not only in countries where their headquarters are but also in countries where they have customers.
• Pillar 2 includes the introduction of the global minimum corporate tax of 15 percent. The rules contained in Pillar 2 are meant to apply to companies with more than 750 million euros in annual revenues, but each country has the choice of using a different threshold.

Why is a global minimum tax needed?

The deal is the result of fraught negotiations over the past few years. One of the reasons behind the endorsement of the global minimum tax deal is that the rules and concepts of international taxation are based on principles developed according to the economic reality of the 20th century and thus are no longer entirely relevant in the 21st century. Countries have realised that tax policy challenges posed by big tech companies such as Facebook, Google, and Apple cannot be addressed by an outdated international taxing system. These multinational corporations make huge revenues and profits but pay disproportionately little in taxes compared to their profits.

In the economy of the 20th century, businesses were characterised by physical presence in the tax jurisdictions, a reliance on tangible assets, and production of goods by machines, the taxation of these ‘bricks and mortar’ businesses was thus relatively simple. In contrast, Facebook, Google, and other tech giants mainly rely on intangible assets and their economic activities are not carried out in plants. It is increasingly difficult to determine where value is generated for tax purposes. The major digital companies produce a significant part of global GDP, while not taking on their fair share of the tax burden and contributing as little as possible to public costs.

Eureka!

The plan of the global minimum tax attempts to address current challenges, i.e. tax avoidance and tax optimisation by multinational corporations through the legal (but not ethical) circumvention of regulations. Initially, the global minimum tax will be expected to put an end to tax evasion by tech giants. This will be its first major trial. However, the devil is in the detail: at issue are what exactly rules will be and whether they could be circumvented. Indeed, in case some countries and companies can circumvent the new tax rules, there will be no point in having the rules in the first place. However, the countries that have not joined the agreement are likely to come under international pressure, it should not be overlooked, however, that, thanks to the toolbox of the tax reform set out in the agreement, there is no need for all countries to be part of the deal for its effective functioning. Another question is whether the measure will create a groundswell, i.e. whether it will be required to reform other taxes and to harmonise national practices.

The need for great caution should be emphasised with respect detailed rules concerning the global minimum tax in order to ensure the success of the tax reform and to have the desired result, i.e. to eradicate the current practices of international corporations relating to tax optimisation.

Further information on the international tax reform negotiations is available at:
OECD.org