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by Alicia Nicholls and Tammi C. Pilgrim
The finance ministers of the seven richest democracies in the world (the Group of Seven or G7) have committed themselves to a global minimum corporate tax rate (CIT) of “at least 15 percent”. This decision has been hailed in principle as a “guide” to ensure that large multinational corporations (MNCs) pay their “fair share” of taxes.
While the details of the proposed tax are still unknown, the decision, if implemented, could potentially have non-negligible effects on tax-free or low-taxed countries around the world. This article provides an initial reflection on what this development could potentially mean for the international financial centers (IFCs) of the Caribbean, including Barbados.
What does a global minimum CIT include?
The global minimum CIT would require a company from a country introducing this lower limit (the “home country”) to pay tax on its profits at that particular rate, even if those profits are declared abroad, for example in a jurisdiction with lower taxes. It works as a “top-up tax” where the corporation’s home country (Country A) could levy the difference between the tax rate the corporation paid in the lower tax jurisdiction (Country B). This undermines any benefit of relocating to a lower tax area.
The idea of a global minimum CIT is not new. The introduction of common global minimum tax rules is currently part of Pillar 2 of the Organization for Economic Cooperation and Development (OECD) Base Erosion and Profit Shifting (BEPS) initiative, which aims to prevent companies from exploiting gaps and mismatches
in the tax systems of the countries to avoid taxes.
Why is this suggested?
Basically, this worldwide minimum CIT is intended to discourage multinational corporations from shifting profits to countries with low CIT rates in order to avoid paying the higher CIT imposed by their home countries. This inevitably leads to lower tax revenues for the home country.
The OECD argues that “BEPS practices cost countries US $ 100 to 240 billion in lost revenue annually, which is 4 to 10 percent of global corporate tax revenues.” Large countries, particularly some high-tax European countries like France and Germany, blame this tax competition for the erosion of their tax bases and point to the higher rates paid by small businesses and ordinary taxpayers.
However, very little is said about the tax laws of these large countries, which generally allow this “injustice” by allowing companies to exploit various tax loopholes. It also ignores the principle of law advocated by many common law jurisdictions, which allows taxpayers to regulate their affairs lawfully in order to minimize tax liability.
As part of the massive tax reform of the Trump administration under the Tax Cuts and Jobs Act of 2017, the statutory CIT rate in the USA was reduced from one of the highest in the world at 35 percent to a medium range (21 percent). However, the Biden administration first attempted to raise the statutory CIT rate to 28 percent to fund its ambitious $ 2 trillion infrastructure plan to stimulate the US economy. Therefore, the introduction of a global minimum CIT gained momentum again in April 2021 when US Treasury Secretary Janet Yellen called for such a 21 percent tax.
This “call to action” was enthusiastically received by many European countries, the Organization for Economic Co-operation and Development (OECD) and the International Monetary Fund (IMF). Perhaps unsurprisingly, the Republic of Ireland, which has a CIT rate of 12.5 percent and is home to the European headquarters of US tech giants Apple, Facebook and Google, has not had a similarly enthusiastic response.
How does this affect Caribbean IFCs?
Many countries, including Caribbean IFCs, have traditionally attracted foreign direct investment, thanks in part to lower CIT rates. Among the Caribbean IFCs, there are tax-free jurisdictions such as the Bahamas and the UK Overseas Territories of the Cayman Islands, British Virgin Islands (BVI) and Bermuda that do not levy personal or corporate tax. Then there are “low tax” areas like Barbados, whose CIT rate (one certificate – 5.5 percent) is now the lowest in the world.
These countries are now at risk of losing this business and related benefits as the global minimum CIT could be a deterrent for businesses to stay in non / low tax areas.
Although empirical data is limited, the global or international corporate sector is an important source of foreign exchange and direct employment in the Caribbean, but it also offers spill-over benefits through skill transfer, corporate rental income, and is an important source of income for corporate services.
Corporate tax revenue from the global corporate sector makes up the lion’s share of Barbados’ CIT revenue and has proven resilient even in the face of the COVID-19 pandemic. Any negative impact on the global corporate sector at this point could cause even greater economic devastation in the fragile economies of these countries.
Aside from the potential loss of business and tax revenue, Caribbean IFCs can also face significant international pressure (including reputational damage) to adhere to the global norm. While the ability to collect taxes is a sovereign right stemming from statehood, the Caribbean IFCs could not inappropriately fear being hit with tactics like blacklisting or denying deductions on US income , could be forced to introduce the global minimum tax rate, a jurisdiction that did not adopt the minimum CIT.
Barbados, for example, lowered its CIT rate from 30 percent to its current low rate in response to OECD allegations of earmarking, as international companies (now abolished) would then enjoy a lower CIT rate than domestic companies. Barbados also passed significant economic substance laws that require businesses to demonstrate that they are doing their core business of generating income in the countries where they declare profits. This has made it even more difficult for jurisdictions to compete for investment based on tax rate alone.
Finally, Caribbean IFCs following these developments may find it increasingly necessary to use alternative methods to increase their investment attractiveness. A look at Invest Barbados’ Why Barbados page reveals that Barbados is increasingly basing its value proposition on non-tax factors, including promoting substantial businesses, its human resources, lifestyle and its network of tax treaties
The Barbados response to this latest initiative is aimed at attracting more companies to their headquarters here, where they would be taxed as Barbados companies. As Barbados Government Advisor Professor Avinash Persaud said at a recent business forum, “America and the UK can decide to have a global minimum tax rate … they can choose how to tax a Barbadian subsidiary of a UK company, but they can not “determine how they tax a Barbados based company. So we have to bring these companies to Barbados to do real business in Barbados and have their headquarters here. “
What happens next?
The fundamental commitment of the G7 states to a global minimum CIT is an important decision, but not yet a fait accompli. Talks in the Group of 20 (G20) and the OECD will continue with the aim of reaching a consensus by July. The fact that the phrase “at least 15 percent” is used in the G7 communiqué, however, speaks for possible disagreement among proponents as to whether the rate should actually be 15 percent or even higher. There are of course other questions that still need to be clarified, such as which companies this tax would apply to.
Further disagreements have come to light since the announcement of the G7. The City of London (UK) as well as Hungary and Poland have announced their intention to seek spin-offs (of the global minimum CIT rate) for financial services companies or income from the essential activities of a company in one jurisdiction. Such exemptions may be necessary to reach international consensus.
The issues raised by the introduction of a global minimum tax rate are complex. They bring the tensions between the competing needs of one home country (to retain tax revenue) and those of another country (to attract foreign direct investment) into focus, mostly with the common goal of promoting their own development and their respective economic and economic goals to achieve social goals.
Undoubtedly, the question of whether MNCs pay their “fair share” of taxes needs to be addressed multilaterally. However, this discussion should probably take place in a forum like the United Nations, in which all countries of the world – large and small, industrialized and developing countries – sit around the table, in order to avoid the impression that rich countries set the rules and their wills change and movable goal posts based on their own narrow political interests and economic needs.
Furthermore, as all too often, it is the little ones – the little IFCs – who are likely to bear the brunt of the economic fallout in trying to hunt the “big fish”. The IFCs in the Caribbean should therefore develop strategies to best combat this recent onslaught.
One possibility could be to join forces internationally with other similarly positioned IFCs, to object to this proposal and to request a seat at the table. As Barbados is currently doing, they will also need to put in place alternative strategies to attract investment if this latest proposal wins “global” approval.
Alicia Nicholls is an international trade advisor and founder of www.caribbeantradelaw.com. Tammi C. Pilgrim is an attorney specializing in commercial dispute resolution through arbitration, litigation and mediation. She is lead arbitration partner at Lex Caribbean, Barbados. The views expressed in this article are solely those of the authors and do not necessarily represent the views of any companies with which they may be affiliated.