The story so far: As many as 136 countries entered into an agreement earlier this month to redistribute taxing rights and impose a global minimum corporate tax on large multinational corporations. With the new agreement signed at a meeting of the Organization for Economic Cooperation and Development, countries want to put an end to tax competition that has over the years forced global corporate tax rates to drop.
Why do governments want a global minimum corporate tax rate?
Large multinational corporations have traditionally been taxed based on where they declare their profits rather than where they actually do business. This allowed several large companies to avoid paying high taxes in countries where they do most of their business by shifting their profits to low-tax jurisdictions. So, an American company like Apple, for instance, can avoid paying high taxes in the United States by declaring its profits as belonging to a subsidiary company in Ireland, where tax rates are lower. This practice of profit shifting has affected the tax revenues of governments and forced them to act.
Governments have actually been deliberating on the idea of a global minimum corporate tax for a while. Global corporate tax rates have steadily declined since the 1980s when the then U.S. President Ronald Reagan and British Prime Minister Margaret Thatcher enacted significant tax cuts to boost their economies.
The average global corporate tax rate was over 40% in the early 1980s and dropped to well below 25% in 2020 as governments competed against each other to lower their tax rates in order to attract businesses. This “race to the bottom” has forced losing governments to wake up. Many believe that the most immediate trigger for the current tax agreement may have been the COVID-19 pandemic, which has severely battered economies and affected the tax revenues of governments. U.S. President Joe Biden has also been trying to gather funds worth at least $3 trillion to fund his social welfare programmes.
What does the new agreement say?
The new global tax agreement consists of two pillars, of which the second is the most important. It backstops the corporate tax rate at 15% across the world by letting governments impose a “top-up” tax on home companies that pay lower than 15% tax on profits they declare abroad. So, if an American company pays only 5% taxes on profits that it declares as that of its subsidiary in Ireland, the U.S. government will now be able to impose a 10% additional tax on these profits. It is expected to add about $150 billion in additional annual revenues to the budgets of governments.
The deal also allows a government to impose top-up taxes on the subsidiary of a foreign company if it declares profits through its home headquarters in a different country and pays less than 15% taxes on those profits. The latter rule may be to prevent companies from trying to avoid taxes by shifting their home to low-tax countries.
The first pillar of the agreement has to do with the basis on which taxes should be collected. Traditionally, companies have been taxed based on where they declare their profits rather than based on where they do business. Today, with many large technology companies carrying out a huge share of their business in foreign countries, many countries have begun to demand a share of their profits. So, pillar one of the new agreement ensures that 25% of residual profits, which is defined as profits in excess of 10% of revenue, is allocated to the relevant foreign country to tax. This is expected to help shift the right to tax profits worth over $125 billion to countries where MNCs actually earn their profits.
Will it help the global economy?
Supporters of the global minimum corporate tax agreement believe that it will help stop the “race to the bottom” as countries compete against each other to cut taxes to attract businesses. They believe this will shore up tax revenues and help governments invest in social development. Others, however, have not been impressed. Non-profit organisation Oxfam International has criticised the deal, arguing that the minimum corporate tax rate of 15% is in fact too low. It has also argued that most of the tax collected under the new setup will go to rich countries and widen inequality between countries.
Other critics believe that the global minimum corporate tax may kill the various economic benefits that come with tax competition among countries. They see tax competition as a force of good that compels governments to keep taxes low and helps the world economy grow. They also defend so-called tax havens such as Ireland, Switzerland, Bermuda and other countries, saying that they benefit citizens of high-tax countries. Without tax havens, they argue, companies will be subject to much higher taxes in their home countries, which in turn will suppress their ability to serve consumers in their countries.