130 countries reached an agreement on major changes in the tax system for the largest companies in the world. This was done to prevent international avoidance schemes, which have cost governments billions of dollars.
This is an attempt to better deal with a world in which globalization and a growing digital economy means that profits can easily move from one jurisdiction into another. Although the Paris-based Organization for Economic Cooperation and Development mediated the agreement, there are still details to be worked out and hurdles to overcome before it becomes effective in 2023.
The main feature of the proposal is a global minimum corporate income tax of at least 15%. This endorses the broad outline of Joe Biden’s proposal.
Although the tax deal may be complex, the basic idea behind the minimum tax is simple. If a multinational company is exempted from taxation overseas, it would need to pay the minimum domestic tax.
Here are the reasons it was suggested and how it would work.
THE PROBLEM: TAX HAVENS & THE ‘RACE to the BOTTOM’
Many countries tax only the domestic business income of multinational companies. They assume that foreign profits will be taxed wherever they are earned.
Profits can slide across borders in today’s economy. Intangibles such as patents, brands and copyrights are often what earn you income. These are easy to transfer to areas with low taxes — and some jurisdictions are willing to reduce or eliminate taxation in order to attract foreign investment and revenue even though companies don’t actually do business there.
According to U.S. Treasury Secretary Janet Yellen, this has led to a decline in corporate tax rates over the past few years.
The global average corporate statutory tax rate dropped from 49% down to 24% between 1985 and 2018. U.S. companies received half of their foreign profits from 2000-2018 in seven low-tax countries: Bermuda, Ireland, Luxembourg and the Netherlands. According to the OECD, tax avoidance costs can range from $100 billion to $240 trillion or 4% to 10% of global corporate income taxes revenues.
This is money that governments could use to offset rising deficits from pandemic relief spending.
THE SOLUTION: THE GLOBALD MINIMUM TALE
Talks aim to bring down corporate tax rates and have countries establish a minimum amount they will levy on foreign income that is not subject to tax. The idea is that if Company X was headquartered in Country Y, it would pay no or very little tax in Country Z on its profits. Country Y would then tax the profits at home at the minimum rate.
This would eliminate the need to use a tax haven or set one up. Biden suggested a 15% ceiling for global negotiations, but it could be higher.
