Global Corporate Minimum Tax

What Is a Global Corporate Minimum Tax?

A global corporate minimum tax is a tax regime established by an international agreement whereby participating countries would impose a specific minimum tax rate on corporate income subject to the respective jurisdictions’ tax laws. Each country would be entitled to share in the revenue generated by the tax. The agreement also would prescribe a definition of income and other technical and administrative rules.

On Oct. 8, 2021, 136 countries and jurisdictions agreed to a proposal developed by the Organisation for Economic Co-operation and Development (OECD) that includes establishing a 15% global minimum tax starting in 2023. The proposal was designed to discourage tax-motivated profit shifting and base erosion by multinational corporations (MNCs).

The agreement established a two-pillar solution focused on revising tax rules to address profit shifting and base erosion caused by tax avoidance practices and to meet challenges created by the increasingly digitalized global economy. The OECD's two-pillar solution "does not seek to eliminate tax competition, but puts multilaterally agreed limitations on it, and will see countries collect around USD 150 billion in new revenues annually." It was first presented at the G20 Finance Ministers meeting in Washington, D.C., and again at the G20 Leaders Summit in Rome in October 2021.

Any global corporate minimum tax, including the OECD plan, would not be self-implementing. Each country would have to incorporate the rate and rules into its own tax system. In the United States, the global corporate minimum tax would have to be passed by Congress and signed into law by the president. The agreement would also require the amendment of international and bilateral tax treaties.

Key Takeaways

  • A global corporate minimum tax would apply a standard tax rate to a defined corporate income base worldwide.
  • The OECD developed a proposal featuring a corporate minimum tax of 15% on foreign profits of large multinationals, which would give countries new annual tax revenues of $150 billion.
  • The framework aims to discourage nations from tax competition through lower tax rates that result in corporate profit shifting and tax base erosion.
  • The framework received the support of 136 countries and jurisdictions, each of which signed on to the OECD proposal.
  • The global corporate minimum tax was approved at the G20 Leaders Summit in Rome in October 2021.

The Basics of a Global Corporate Minimum Tax

A global corporate minimum tax is a standard minimum rate of tax on corporate income adopted by individual jurisdictions pursuant to an international agreement. Proponents are keen to see it adopted as it would serve to discourage MNCs from making foreign investment decisions on the basis of low tax rates and from shifting profits from high-tax to lower-tax jurisdictions regardless of where the profits are earned.

Tax Competition Fostering "Race to the Bottom"

Finance officials and economists recognize that tax competition among nations to attract foreign investment has resulted in a race to the bottom. They are concerned that this competition causes a substantial loss of tax revenue and endangers financing for government functions in higher-tax countries. Lower-tax jurisdictions promoted their low rates to attract foreign investment from higher-tax countries.

MNCs with income from intangible property (trademark royalties, patents, and software licenses) transferred such rights to corporate subsidiaries in lower-tax jurisdictions to avoid paying higher taxes imposed by their home countries and by the countries where their income is earned. American MNCs, including Amazon, Meta (formerly Facebook), and Google, established profitable operations in Ireland whose top corporate tax rate of 12.5% falls far below rates in the U.S., United Kingdom, and European Union (EU).

A statement by U.S. Treasury Secretary Janet Yellen concluded that the global rules that eliminate profit shifting to lower-tax countries—and that enable countries where MNCs earn their profits to tax those profits and benefit from the 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 among countries. But it wouldn't completely eliminate it. If a common minimum tax rate provides MNCs with little or no tax advantage from moving investments and shifting profits to lower-tax jurisdictions, then economic competition among countries would be influenced more by the comparative quality and strength of their infrastructure and the skill of their workforce. 

The Biden Administration and Democratic senators proposed a U.S. corporate minimum tax of 15% on highly profitable corporations in 2021. The proposal has not advanced in the Congress.

The OECD's "Two-Pillar" Plan

In addition to a global corporate minimum tax, the OECD plan includes several measures to address the tax revenue loss caused by profit-shifting and base erosion. The agreement revises present regulations that prevent countries from taxing MNC income earned in their jurisdictions unless those companies have a physical presence in the country.

The First Pillar

The OECD agreement’s first pillar allows jurisdictions, where MNCs' products and services are used to tax their resulting profits, even if these companies have no presence in the country. This applies particularly to IP and digital services.

In recent years, France, the United Kingdom, and several other countries independently imposed special, controversial, digital taxes on such income. As part of the agreement’s first pillar, these taxes will be repealed. New digital services taxes have been barred since the OECD agreement was signed. 

Only the largest MNCs, which numbered approximately 100 companies, were initially subject to the rule permitting taxation without nexus. This rule now applies to MNCs having "global sales above €20 billion [roughly US$ 23.145 billion] and profitability above 10%." A country can tax 25% of the income in excess of 10%, provided the MNCs derive at least €1 million [$1.16 million] in revenue from the jurisdiction.

Smaller countries with a gross domestic product (GDP) of under €40 billion ($46.4 billion] can tax MNCs with €250,000 [$290,102] in revenue from the jurisdiction. Exemptions or credits will prevent double taxation. After a seven-year review, the rule likely would apply more broadly.

The Second Pillar

The OECD’s second pillar imposes a global corporate minimum tax of 15% on MNCs’ low-taxed foreign income. This global corporate minimum tax applies only to companies with annual revenues above €750 million ($868,095).

Special rules for applying the 15% tax take into account the relationships between parent MNCs and their constituent entities. Parent MNCs whose subsidiaries have low-taxed foreign income must pay a “top-up” tax to increase the tax rate with respect to such income to 15%.

Deductions will be denied for parent payments to low-tax, foreign subsidiaries unless tax at a rate of 15% otherwise applies with respect to the subsidiaries' income. Source jurisdictions are also allowed to impose limited source taxation on certain related-party payments, which are taxed below the minimum rate.

As of July 9, 2021, the United States and 132 other countries supported this proposal. With the October 8 agreement, the signatories grew to include Estonia, Hungary, and Ireland—establishing support from all OECD, EU, and G20 member countries. As of May 2022, 137 countries signed on to the plan. Yellen continues to promote the plan and meet with foreign leaders to urge their adoption of laws to make it effective.

How a Global Corporate Minimum Tax Could Work

While a global corporate minimum tax would apply a specified minimum rate of tax, its overall design could take different forms and have varied effects. Beyond the issues of a rate, the most debated feature of a tax regime is generally its definition of the appropriate tax base.

In theory, an income tax should apply to a taxpayer's net economic income. But agreement on what constitutes such income is elusive, perhaps impossible. The OECD must decide on the definition of the tax base for its plan before 2023.

Challenge: Defining the Tax Base

The U.S. tax code’s definition and calculation of taxable income illustrate well the challenges involved in determining a fair calculation of net economic income. The Internal Revenue Code (IRC) contains many types of deductions, exclusions, exemptions, credits, temporary provisions, incentives, and other special rules.

These provisions often were enacted to advance social policies, such as environmental conservation or philanthropy, or to serve special interests with tax-reducing benefits such as tax-free treatment of like-kind exchanges or oil depletion allowances. Changing economic conditions and political winds produce frequent changes to the U.S. rules. As a result, there is little pretense that these rules provide an accurate economic measurement. Rather, they demonstrate the complexity of determining a tax base.

Acknowledging the U.S. tax code’s complexity and recognizing that its many adjustments to income have enabled some rich taxpayers to legally avoid any tax liability, the Biden Administration proposed adding a corporate minimum tax to the IRC. This tax is intended to prevent profitable companies from paying little or no tax.

The proposal would use book income or financial income determined under generally accepted accounting principles (GAAP) as the base for its domestic corporate minimum tax. Only large companies that report high profits—but little or no taxable income—would be subject to the tax.

International Tax Laws

Tax laws in other countries also vary in design and complexity, resulting in very different income tax bases and rules. However, to be recognized as fair and achieve acceptance, a global corporate minimum tax requires a standard definition of income.

As noted above, the OECD decided that its agreement applies only to companies with revenues above €750 million ($868,095). The authors also established rules for its implementation, amendment, and enforcement. The plan also provides:

  • Exclusions for mining companies, shipping, regulated financial services, and pensions, which generally do not contribute to tax competition because their profits are tied to specific locations or are subject to special tax and regulatory regimes.
  • Some flexibility to permit countries, particularly the U.S, that have tax rules similar, but not identical to, the agreement’s rules, to use their own rules provided their effect is comparable to the OECD rules' impact.

Minimum Tax Structure: Comprehensive or Targeted

In its simplest form, a global corporate minimum tax might be structured to require countries to impose no rate lower than a specified rate on all corporate income, whether earned at home or abroad. This approach, which would remove countries’ control of domestic corporate taxation, would be a significant incursion on national sovereignty.

More realistically, the OECD's current framework for a global corporate minimum tax has a narrower, targeted design. Because its goal is to discourage tax competition, the OECD plan requires that multinational companies’ overseas income be taxed at the prescribed 15% minimum rate. Thus, assuming that a country’s regular corporate tax rate is 10%, the OECD would oblige the country to top up its corporate tax on income earned overseas by an additional 5%, for a total 15% rate.

Detailed tax accounting rules have yet to be developed. Because the OECD's minimum tax affects only large multinationals, the Biden Administration’s choice of standard book income may also serve well for the OECD tax.

Prospects for a Global Corporate Minimum Tax

The OECD agreement envisions the implementation of the new rules in 2023. Because the plan requires many countries to amend their tax laws, this timing may be overly optimistic.

U.S. participation, which is essential to the plan’s success, depends on Congressional action. Republican legislators and business skeptics openly criticize the tax. Republican ranking members of the Senate and House tax-writing committees, Sen. Mike Crapo (R-Idaho) and Rep. Kevin Brady (R-Tex.) suggest that the agreement may result in tax increases for Americans.

As part of the effort to pay for President Biden's Build Back Better social infrastructure bill, Senators Elizabeth Warren (D., Mass.), Angus King (I., Maine), and Ron Wyden (D., Ore.) proposed a U.S. corporate minimum tax on companies whose financial statements show at least $1 billion in profit in 2021.

This proposal is different from a global corporate minimum tax, which would require qualifying large corporations to pay taxes in foreign countries where these companies earn income. The failure of the Build Back Better agenda doomed current prospects for this proposal.

The Bottom Line

Despite initial broad, multilateral support for the OECD plan, the enactment of conforming national laws may delay its implementation.

U.S. action is uncertain and foreign jurisdictions are slow to enact the necessary legislation. In some countries, adoption of the legal changes has slowed because of a lack of political support. This means that putting the OECD plan in place in 2023 seems overly optimistic.

Although the plan enjoyed some business sector proponents and continues to have administration support, intervening crises, particularly the war in Ukraine and global inflation, have diverted policymakers' attention and hindered the plan's implementation.

Article Sources
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