Global Corporate Tax – Move To End The Attraction Of Tax Havens

A milestone global deal to ensure large multinationals enterprises pay a minimum tax rate of 15% and avoid taxation in countries considered as tax havens. The deal aims to end a four decade long “race to the bottom” by governments that have tried to attract investment and jobs by offering low taxes for multinational companies and allow them to do treaty shopping. Years of negotiations have produced an agreement to overhaul the global tax system in ways that will change where and how some of the world’s largest companies are taxed. Getting almost 140 nations on board was a huge breakthrough which is a landmark achievement for the Group of 20 nations and OECD.

Features of imposition

For the first time, there would be a minimum corporate tax rate applied around the world, set at 15%, so companies have less incentive to move their operations to low-tax jurisdictions. The profits of about 100 of the biggest multinational corporations would be divided differently for taxation purposes and would be shared across more countries. And there would be dissolution of the digital taxes which has been opposed by some countries specially the U.S. and considered as discriminatory.

Signatories to the deal

The Group of 20 nations which represent about 90% of the global economy — finalized key details in October. This pact has been signed by 136 countries out of 140 countries involved in negotiations which were supervised by the Organization for Economic Cooperation and Development, with Kenya, Nigeria, Pakistan, and Sri Lanka holding out. Crucially, those now on board include Ireland, Hungary and Estonia, which until now have gained from having some of the lowest corporate tax rates in Europe.

Mechanism of Global Minimum Taxation

This system will ensure that MNEs having consolidated group revenue of at least US$ 870 million dollars (similar to CbC reporting) are subject to a minimum tax rate of 15%. Financial companies, mining companies, investment funds, pension funds, government entities, International organizations, non-profit entities are to be excluded from its scope. In this system of taxation profits of group companies that are taxed at an effective tax rate lower than 15% will be included where the company is headquartered and will be subjected to top up tax in that jurisdiction. In case the country where the company has headquarters does not levy the top up tax then the next intermediate holding company in the ownership change would have to pay the top up taxes in respect of their low taxed subsidiaries.

To understand with an example, primarily the rules will allow a country where a company is headquartered — call it Country A — to “top up” its taxation of the company if it’s paying less than 15% in Country B. For example, if the company is effectively paying a 12.5% tax in Country B, Country A can collect the extra 2.5%.

Importance of a resolution on digital taxes

Seeing an end to digital taxes has been a key aim throughout the negotiations for the U.S., which labels the measures as discriminatory against its own companies. Some nations have imposed these taxes on local sales of companies such as Facebook, Amazon and Google — grabbing a bigger share of the pie. France led the way with a tax on tech giants’ revenues along with India which has levied Equalisation levy in two forms and other countries have also followed suit. The U.S. now has retaliatory trade measures against Austria, India, Italy, Spain, Turkey and the U.K. that are on pause until an end-of-November deadline. The OECD has warned that a cascade of trade retaliations could bite into a full 1% of world gross domestic product.

Fallacies of the present system

The objective of the proposed global minimum rate is to end a three decade long race to the bottom on corporate tax rates. International Monetary Fund has estimated that the “legal and not-so-legal” use of tax havens costs governments $500 billion to $600 billion in lost corporate tax revenue each year. Some governments have also argued that tech giants aren’t being properly taxed in countries where they have users. And many countries, particularly in the developing world, say the current system of global tax rules and agreements concentrates corporate profits in richer countries, giving developing countries too small a share of taxes based upon economic presence of the MNEs.

Way forward

The October deal settled most of the major political battles, but technical details remain to be worked out — including clarification on determining which countries will give up the revenues that are reallocated. In the meantime, implementation moves ahead on two tracks. Adopting the global minimum tax is a country-bycountry decision. The European Union will look to pass a directive requiring all 27 member states to pass legislation enacting it. To implement the new way to distribute taxes paid by multinationals, the OECD will produce a kind of supertreaty for countries to sign and ratify. At what point the treaty would take effect is still to be decided.

Challenges ahead

It is being discussed in the tax circles that large multinational could restructure their holding patterns. Already some US majors have changed their IP holding structures. The impact of this could be that developing countries like India will not be able to adequately tax the MNEs under the new Pillar 2 system based upon the profits being generated due to their economic presence. For the countries which have levied digital tax like India has imposed Equalisation levy will have to withdraw the same according to the terms of the pact when the system kicks in 2023. This will result in loss of revenue to such jurisdictions.

Compiled by Sandeep Bhatnagar

FCA, DISA (ICA)

Associate – KCC Group

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Contributing Advisors