What is a global corporate minimum tax?
A global minimum corporate tax is a tax system created by international treaty whereby countries that accede to the treaty levy a certain minimum tax rate on the income of corporations subject to the tax laws of their respective jurisdictions. Every country would be entitled to the income from the tax. The agreement would also require a definition of “income” and other technical rules.
A global corporate minimum tax would not be self-implementation. Each country would have to incorporate the rate and the rules into its own tax system. In the US, the global minimum corporate tax would have to be passed by Congress and put into effect by the President. In addition, international and bilateral tax treaties would have to be changed.
The central theses
- A global corporate minimum tax would apply a uniform tax rate to a defined corporate income base worldwide.
- The introduction of a global corporate minimum tax requires an international agreement and approval by each signatory country.
- Determining the taxable income base and the rules on coverage, deductions, exclusions and other adjustments poses complex legal, technical and political challenges.
- In July 2021, more than 130 countries agreed to support an Organization for Economic Co-operation and Development (OECD) tax reform framework to introduce a global minimum corporate tax on foreign profits of large multinational corporations (MNCs).
- The OECD framework aims to deter nations from tax competition through lower tax rates that lead to a shift in corporate profits and the erosion of the tax base.
- International business leaders believe a US agreement is essential to the success of a global corporate minimum tax.
Understand a global corporate minimum tax
A global minimum corporate tax is a standard minimum tax rate on corporate income determined by individual jurisdictions in accordance with an international agreement. Proponents of a global corporate minimum tax are pushing for adoption to deter multinational corporations (MNCs) from making overseas investment decisions based on lower tax rates and shifting profits to lower-tax countries regardless of where profits are made. (Organization for Economic Cooperation and Development) [OECD] refers to these companies as multinational companies [MNEs]- a term that essentially corresponds to the more well-known label of multinational corporations.)
Tax competition promotes “race to the bottom”
Tax officials and economists around the world recognize that tax competition among nations for foreign investment has resulted in a “race to the bottom”. They fear that this competition will lead to significant revenue losses and jeopardize the funding of government functions in high-tax countries. Lower tax countries have encouraged their lower tax rates to attract foreign investment from higher tax countries.
In recent years, multinational corporations with income from intangible assets, such as royalties from trademarks, patent and software licenses, have located and relocated such rights to lower-tax jurisdictions to avoid paying higher taxes from their home countries and imposed by the countries where their income is generated. Global rules preventing profits from shifting to countries with lower taxes – and allowing countries where multinational corporations make their profits to tax those profits and benefit from tax revenues – would reduce tax competition and create a fairer distribution of tax revenues.
A global corporate minimum tax could significantly reduce tax-based competition between countries, but not completely eliminate it. If a common minimum tax rate gives multinational corporations little or no tax advantages by relocating investments and profits to countries with lower taxes, economic competition between countries would be more influenced by the comparable quality and strength of their infrastructure and the skills of their workforce. Currently, a global corporate minimum tax is part of a broader proposal by the OECD to address tax-motivated profit shifting and the erosion of the tax base by multinational corporations. On July 9, 2021, the United States and 132 other countries supported the proposal.
How a global corporate minimum tax could work
While a global corporate minimum tax would apply a specific tax rate, its overall design can take different forms and have different effects. In general, besides the tax rate, the most talked about feature of a tax system is the definition of the appropriate tax base. In theory, income tax should be levied on the taxpayer’s net economic income. But an agreement on what constitutes such an income is difficult to reach,
Challenge: Establishing the tax base
The definition and calculation of taxable income in U.S. tax law includes many types of deductions, exclusions, exemptions, credits, temporary provisions, incentives, and other special provisions. These provisions were often enacted to promote social policy measures such as environmental protection or employee benefits or to serve special interests through advantages such as the tax-free treatment of similar exchanges or oil consumption allowances. Changing economic conditions and political winds lead to frequent changes in US rules. As a result, there is little claim that these rules provide an accurate economic measurement. Rather, they illustrate the complexity of determining a tax base.
Recognizing the complexities of U.S. tax law and recognizing that its numerous income adjustments have allowed some wealthy taxpayers to legally evade any tax liability, the Biden government has proposed adding a corporate minimum tax to the Internal Revenue Code. This tax is intended to prevent profitable companies from paying little or no taxes. The proposal would use “book income” – that is, financial income determined according to generally applicable accounting principles – as the base for the minimum domestic corporate income tax. Only large companies with high profits – but little or no taxable income – would be subject to the tax.
The tax laws in other countries also differ in terms of design and complexity, which leads to very different income tax bases and rules. However, in order to be recognized and accepted as fair, a global corporate minimum tax requires a uniform definition of income. The drafters of a global corporate minimum tax must also decide whether it applies generally or only to multinational companies with revenues above a certain threshold; whether some industries or regions are excluded; and how it is implemented, changed and enforced.
Minimum tax structure: comprehensive or targeted
In its simplest form, a global corporate minimum tax could be structured in such a way that it requires countries not to levy a rate lower than a certain rate on all corporate income, regardless of whether it is domestic or foreign. This approach, which would remove control of domestic corporate taxation from countries, would be a major encroachment on national sovereignty.
More realistically, the current OECD framework for a global corporate minimum tax has a narrower, more focused design. Since the aim of the OECD is to discourage tax competition, the OECD plan provides that the foreign income of multinational corporations will be taxed at the minimum prescribed rate, which is at least 15%. Assuming that a country’s regular corporate tax rate is 10%, the OECD would therefore oblige the country to “top up” its corporate tax on income generated abroad by a further 5%, for a total of 15%.
On July 9, 2021, both the G7 and G20, representing the world’s largest economies, advocated the development of an international tax reform framework by the OECD that would provide for a global minimum corporate tax to set a minimum tax rate on the foreign income of multinational corporations.
Final agreement on the OECD plan is not planned for later this year, and detailed tax accounting rules have yet to be developed. Since the global OECD minimum corporate tax only affects large multinational corporations, generally publicly traded companies, the choice of the Biden government, which is shown as the minimum tax amount in official financial reports, could also benefit the OECD tax.
Prospects for a global minimum corporate tax
The OECD’s timetable for the implementation of its tax reform proposal provides for a final agreement in autumn 2021 and implementation in 2023. However, with the plan requiring many countries to change their tax laws, this time may be too optimistic. Additionally, U.S. involvement, essential to the plan’s success, depends on action by Congress and is likely to be opposed by Republican lawmakers and business skeptics. The U.S. passage will likely require Democratic unanimity to pass necessary tax law changes through the reconciliation process. However, Treasury Secretary Janet Yellen believes American corporations “will tell members of Congress, ‘Please approve,'” according to Bloomberg.
The fate of the global OECD minimum corporate tax is uncertain for the time being.