Corporate Tax

New OECD tax treaty of 15% creates international corporate tax minimal

About the author: Chye-Ching Huang is executive director of the Tax Law Center at NYU Law.

World leaders announced on Friday that 136 countries and jurisdictions have approved a new framework for taxing multinational corporations. This is a once-in-a-century moment in the century that prompts countries to take a more constructive approach to tackling the complicated economics and politics of taxing cross-border businesses.

In the 1920s, countries introduced an international tax system that lays down some rules for the taxation of companies operating across borders. It focused on avoiding double taxation that could occur when multiple countries tax the same income stream twice (or more) and could potentially mean extremely high tax rates on income from global trade and corporations.

While this centuries-old framework generally prevented double taxation, it was not designed to prevent double non-taxation. Double non-taxation occurs when multinational companies do not report their income in their home country or where they earned the income, but in tax havens where they are taxed at zero or very low rates or not at all.

This caused some countries to race down to lower their taxes on very large corporate profits – which undermined their ability to fund public investment or increased their reliance on income from other sources such as salaries and wages.

Countries conducted this race in three different ways. Initially, some were set up as tax havens. By and large, tax havens encourage multinational corporations to report their income as earned there and offer extremely low tax rates even if the company has had few or no employees, sales, or other real-world activity in the refuge. Second, countries of origin where companies actually do business – selling products or services, extracting raw materials, manufacturing products, or other real-world activities – also felt pressures to lower their corporate taxes, fearing that otherwise the activity would be theirs Could leave the area of ​​responsibility. Eventually, the countries of residence where multinational corporations live (their home or country of residence) enact leaky national tax laws that allow their corporations to use tax havens to lower their global effective tax rates. These laws aimed to give companies an incentive to keep their headquarters in the countries of residence.

Some countries had more than one strategy. Switzerland, for example, acts as a tax haven, but is also a country of origin where companies do real business.

Sporadic attempts to correct the problem have failed. The efforts were too often driven by clubs from mostly rich countries trying to discipline tax havens. They focused on the tax systems of low-income countries but ignored the similar systems of rich countries such as Switzerland and Ireland. They also failed to take into account the fact that high income countries backed the system with national laws that allow their multinationals to take advantage of tax havens.

But it became clear that not addressing this issue was no longer an option.

The Great Recession and the prolonged fiscal challenges, as well as growing inequality, put pressure on households. And reporters and civil society made sure that lawmakers and the public couldn’t ignore the issue. For example, the coverage led to a hearing in the UK which showed that

Starbucks

had paid no corporation tax in 2011 – or 12 of the 13 years before – in part by moving UK profits to tax havens. Coverage and hearings in the US showed how

Pfizer
,

Google, Apple and other very profitable companies had lowered their effective tax rates into the single digits using similar techniques.

This attention helped bring about Friday’s deal, which includes all of the Organization for Economic, Co-operation and Development countries, the European Union, as well as China, India and the low-tax countries where US multinationals have shifted their profits. Over 90% of the world’s economic output is covered.

The deal provides for a worldwide minimum tax of 15%, which removes the lower limit from the currently effective minimum tax rate of zero. Low-tax countries need to increase their corporate tax rates. And if not, the countries where the companies are headquartered will see to it that those profits are taxed at least 15%. This means that countries cannot trick companies into reporting profits in their territory by offering tax rates less than 15%.

The deal also looks at how market countries can tax revenue from “digital services”. In recent years, many countries have considered, proposed or introduced taxes on digital services. DSTs are excise duties levied by a country on the sale of digital services (such as streaming services or advertising on global platforms) to customers in those countries. Countries argued that they were entitled to tax part of these businesses’ economic activities depending on their markets, noting that profits from that activity were often completely tax-free. However, some DSTs had features that gave rise to claims that they were wrongly targeting only large US companies such as Facebook, Apple, Amazon, Netflix, and Alphabet (Google). Uncoordinated DSTs could have created an incoherent patchwork of taxation and raised the specter of double taxation.

The new agreement allows these countries to tax part of the profits that flow from their markets without discrimination and to assign taxation rights in such a way that double taxation is avoided.

No agreement of 136 countries will be ideal. We might have waited more than a hundred years for a perfect deal. The implementation requires careful balancing acts and a considerable amount of work.

But it is a very big deal for most countries to finally go in the right direction.

Congress should recognize this huge change as such and adopt proposals to raise the corporate tax rate and increase its minimum tax on corporate profits (currently between zero and 10.5%), a measure first enacted in 2017. The new global minimum tax rate of 15% from zero will give the US more leeway to introduce a more robust corporate tax based on income needs and the benefits US multinationals enjoy from being based in the US. With the increased revenue, the US can continue to invest and strengthen its competitive advantage based on the people, ideas, markets and institutions that warrant a more robust tax rate. Solid reforms would also reduce current US tax code incentives to expose profits and investments abroad.

Sometimes, as Friday’s agreement shows, difficult short-term policies can be overcome to achieve policy goals with great long-term benefits. Now is the time for Congress to take its own step towards better international tax policy.

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