The global minimum tax: how the latest tax reform will impact business

August 2022 | EXPERT BRIEFING | CORPORATE TAX

financierworldwide.com

The base erosion and profit shifting (BEPS) project of 2013 was designed to curb the tax avoidance practices of multinational enterprises (MNEs) and to make the international tax system fair. Over the last nine years, 141 countries have joined the project, including many developing countries. In 2015, the BEPS project delivered a comprehensive package of 14 actions aimed at tackling tax avoidance, improving the coherence of international tax rules and ensuring a more transparent tax environment. That left one action to be completed: the taxation of the digital economy.

Since 2015, BEPS has focused on this remaining action. Digitalisation has increased the percentage of intangibles in international commerce and investment, giving MNEs more opportunity to transfer profits to low-tax regions. In 2020, BEPS members agreed to use a two-pillar strategy to re-establish the link between value-added activities and profit taxation. The strategy also addresses issues caused by digitalisation. Pillar I aligns MNE profitability with value creation. It comprises three parts. The first reallocates the right to tax the biggest and most lucrative MNEs to jurisdictions where they offer goods and services. The second simplifies distribution transfer pricing. The third part introduces dispute resolution methods. It is aimed to limit profit shifting and lead to a fairer allocation of tax revenues, but it will not alter actual investment choices.

Pillar II advocates a global minimum tax. It applies to multinational groups with more than €750m in sales. Pillar II offers an inclusive framework which participants accept voluntarily. The Organisation for Economic Co-operation and Development (OECD) issued model guidelines, together with technical comments and examples, in March 2022. Implementation begins in 2023 and involves fundamental changes to the international tax architecture. It intends to decrease MNE profit shifting, enhance tax fairness, and boost revenue. It intends to eliminate harmful tax rivalry between nations and restrict the ‘race to the bottom’ in corporate income tax (CIT) which is often induced by governments vying for foreign direct investment (FDI).

The objectives of CIT

Pillar I is aimed at limiting profit shifting, leading to a fairer allocation of tax revenues, but it will not alter actual investment choices. It will impact mainly the biggest MNEs, including many digital enterprises with asset-light foreign operations. New tax responsibilities would emerge only beyond a specific profitability level. Pillar II is substantially larger and contains major tax reforms. It intends to reduce MNE profit shifting, enhance tax fairness and boost revenue. It intends to eliminate harmful tax rivalry between nations and restrict the ‘race to the bottom’. The implementation of a minimum tax rate mitigates tax rate disparities across nations by mechanically compressing effective tax rates (ETRs) into a narrower range. Setting a limit on the downward tax competition that results from governments’ attempts to attract or retain real investment is a fundamental purpose of the minimum taxation that Pillar II will create. The construction of Pillar II was primarily motivated by the desire to increase revenue collection, and the slowing of reductions in statutory company tax rates implies a diminishing demand for corporate tax cuts. Reflecting divergent perspectives on the objective of Pillar II, the carve out moderates the intention to minimise tax competition by reducing the minimum’s impact on actual activity. The global minimum tax might also reduce tax competitiveness between emerging nations in a variety of economic sectors, including mining, manufacturing and telecommunications, reversing a decades-long ‘race to the bottom’ on corporate taxes.

International tax rivalry is hard to measure. In picking the tax system most suited to its own interests, each nation neglects the potential damage the decision brings to others. Minimum taxation may be a partial solution to this dilemma. Inward profit transfer may help a nation. Pillar II tries to coordinate tax policy to minimise the downward cycle that might result, such as by placing a floor on how low taxes can fall. Not all nations profit from restricting tax competitiveness. Low-tax nations may lose, as the capacity to relocate profits earned by an extra investment in a high-tax nation to a low-tax country decreases the tax due on those gains. Profit shifting is thus anticipated to enhance investment in these nations.

Many companies across virtually all countries will be affected by CIT. For instance, since India’s effective domestic tax rate is higher than the threshold, the country is likely to benefit from the global minimum 15 percent corporate tax rate pact that was signed by the world’s wealthiest countries. This is because India will continue to attract investment even after the pact comes into effect. However, only 20 percent of the profit will be subject to the 15 percent tax rate that countries are allowed to impose. The resulting tax rate is 0.2 percent when calculated. As a result, a significant amount of money from taxes will be lost. China and India would suffer the largest income shortfalls because of this. The equalisation charge that has been imposed by the government will no longer be valid once the global minimum tax is put into effect, which will result in developing nations incurring financial losses while wealthy countries would suffer no losses because of the new accord. According to the statement released by the G7, certain tax components related to digital services would be eliminated in cooperation with the deployment of new international tax standards. The equalisation levy has generated around 4 trillion Indian rupees in income for India. It is anticipated that India would suffer a loss in income because of the elimination of the equalisation levy.

Another interesting example is Singapore. The headline corporate tax rate in Singapore is 17 percent, yet the effective tax rate of many firms in Singapore might be lower than this rate, potentially even lower than 15 percent. This is despite the fact that Singapore’s headline corporate tax rate is 17 percent. In addition to certain privileged industries, such as financial, maritime and global trading companies, which enjoy preferential tax rates when qualifying conditions are met, gains derived by companies from the disposal of certain assets, such as equities, are normally not taxable in Singapore if they are held for long-term investment. This is the case even if the asset was sold for less than it was originally purchased for. When this happens, it erodes Singapore’s competitive tax system, which has been a major draw for foreign investors for many years because of its favourable tax advantages and lack of capital gains taxation.

The US approach to tax incentives is in doubt with the new global minimum tax. These programmes lower taxes below 15 percent but do not remove them. ‘Yellow light’ tax breaks are common in the US, if a firm is subject to a 21 percent statutory tax rate in the US, but it also benefits from the R&D tax credit and other tax advantages related to its investments in climate-friendly activities, for instance. These tax reductions may lower the company’s US effective tax rate to 10 percent, below the global minimum of 15 percent. Because of the global minimum tax, Congress may rethink tax breaks. In any case, US authorities must consider the global minimum tax. A tax advantage at home would just raise taxes abroad. US opponents argue the proposed minimum tax would make America less competitive and cause job losses, thus passage from other countries is important.

Overall, it is clear that the whole business world will need to make many changes to comply with CIT. In fact, it seems that 40 percent of companies recently claimed they had explored increasing employment, outsourcing tax department activities and investing in new technology to satisfy BEPS 2.0 compliance requirements. It is estimated that a multinational must maintain compliance with the new BEPS tax regime by providing 200 distinct data types. These requirements will require enormous resources from corporations. Tax, finance and human resources must collaborate to gather compliance data. Data collecting systems must be updated. This entails additional government restrictions and potentially hiring and training new personnel to understand all the new rules, which are currently being written.

CIT is a major change in international tax regulation and coordination. Under the OECD/G20 Inclusive Framework on BEPS, the Pillar II model rules provide governments with a precise template for moving forward with the two-pillar solution to address the tax challenges arising from the digitalisation and globalisation of the economy. This solution was agreed upon in October 2021 by 137 countries and jurisdictions. The regulations specify the scope and provide the procedure for the so-called worldwide anti-base erosion (GloBE) rules that will be implemented under Pillar II. These rules will result in the introduction of a global minimum corporate tax rate that is set at 15 percent. The minimum tax will be applicable to MNEs with revenue in excess of €750m, and it is anticipated that this would raise around $150bn annually in extra worldwide tax collections. In 2022, the new Pillar II model rules will be of assistance to nations as they work to incorporate the GloBE guidelines into their own national legislation. They provide for a coordinated system of interlocking rules which: (i) define the MNEs that are subject to the minimum tax; (ii) set out a mechanism for calculating an MNE’s effective tax rate on a jurisdictional basis, and for determining the amount of top-up tax payable under the rules; and (iii) impose the top-up tax on a member of the MNE group in accordance with an agreed rule order.

Julien Chaisse is a professor of law at City University of Hong Kong. He can be contacted on +852 3442 6594 or by email: julien.chaisse@cityu.edu.hk.

Julien Chaisse

City University of Hong Kong