Global Corporate Minimum Tax

What Is a Global Corporate Minimum Tax?

A global corporate minimum tax is a proposal to impose a minimum rate of taxation on corporate income in most countries of the world by international agreement.

On Oct. 8, 2021, 136 countries and jurisdictions agreed to a proposal from the Organisation for Economic Co-operation and Development with a prospective effective date of 2023, since delayed to 2024. The proposal was designed to discourage tax-motivated profit shifting and tax base erosion by multinational corporations (MNCs).

The agreement established a two-pillar solution revising tax rules to address profit shifting and tax base erosion caused by tax avoidance practices, as well as challenges posed by the increasing digitalization of the global economy. The OECD estimated that first pillar would reallocate more than $125 billion annually in corporate profits from large companies' home countries for taxation by jurisdictions where the profits were actually earned. The second pillar would raise an estimated $150 billion for countries applying the a 15% minimum tax rate to corporate income.

The OECD's two-pillar solution "does not seek to eliminate tax competition, but puts multilaterally agreed limitations on it." It was first presented at the G20 Finance Ministers meeting in Washington, D.C., and was endorsed at the G20 Leaders Summit in Rome in October 2021.

Any global corporate minimum tax, including the version contemplated in the OECD plan, would not be self-implementing. Each country would have to incorporate the rate and rules into its own tax system. As a party to the global corporate minimum tax agreement, the United States would have to agree to the two-pillar plan and impose a 15% minimum corporate tax that conforms to the OECD model.

The recently enacted Inflation Reduction Act of 2022 in the United Sates, included a 15% alternative minimum corporate tax on large corporations. This tax adopts some of the terms of the OECD’s global minimum tax and brings the U.S. closer to the OECD tax structure. However, it will not be clear if U.S. law needs further amendments to conform sufficiently to the OECD tax rules until the OECD negotiators complete their final, detailed draft.

If the U.S. corporate minimum tax does not meet conformity standards for the global corporate minimum tax, Congress will have to pass and the president sign amendments to the Internal Revenue Code (IRC) to participate in the OECD plan. In addition, agreement on the two pillars of the OECD plan will require amendments to bilateral and international tax treaties. In the United States, treaties require approval by the Senate and president.

Key Takeaways

  • A global corporate minimum tax would apply a standard minimum 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 137 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. Its prospective effective date is now 2024.

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. Meanwhile, lower-tax jurisdictions promote their low rates to attract foreign investment from higher-tax countries.

MNCs with income from intangible property (trademark and copyright royalties, patents, and software licenses) have been transferring 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, for example, 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 global rules that dsicourage 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 also 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 originally proposed a U.S. alternative corporate minimum tax of 15% on highly profitable corporations in 2021, as part of the Build Back Better Act. It was revised, passed, and signed into law on Aug. 16, 2022, as part of the Inflation Reduction Act.

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 would revise 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 large 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 would apply 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 large 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 specific minimum rate of tax, its overall design could take different forms and have varied effects. Beyond the issue of a rate, the most debated feature of a tax regime generally is 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 as well as related regulations for its plan in advance of its implementation set for 2024.

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—and Congress enacted—a corporate minimum tax in the Inflation Reduction Act. This tax is intended to prevent highly profitable companies from paying little or no tax.

The recently enacted corporate minimum tax uses book income, i.e., financial income determined under generally accepted accounting principles (GAAP), as the base for its domestic corporate minimum tax. Only very large companies that report high book profits—but little or no taxable income—will 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 use of book income by the new U.S. corporate minimum tax may serve well for the OECD tax.

Prospects for a Global Corporate Minimum Tax

The OECD agreement originally envisioned the implementation of the new rules in 2023. In March 2022, the OECD released technical guidance for model rules. However, with the development of the complex, detailed rules still continuing, OECD leaders more recently forecast that implementation would be delayed until 2024. Because the plan requires many countries to agree, and then amend their tax laws, a 2024 effective date may prove challenging

U.S. passage of a 15% minimum levy on corporations that report average annual financial statement incomes in excess of $1 billion for a three-taxable-year period is an important step toward implementing a global corporate minimum tax. U.S. participation in the global corporate minimum tax regime is essential to the plan's ultimate adoption. The Biden Administration strongly supports U.S. participation in global corporate minimum tax plan. The passage of the U.S. 15% corporate minimum tax by the Democratic majorities in the House of Representatives (220-207) and Senate (51-50) suggests that these members of Congress also would favor the global plan.

Congressional Republicans, however, voted unanimously against the U.S. corporate minimum tax. The Republican Party has argued that the global plan would harm the U.S. economically and the Republican Ranking Members of the House and Senate tax-writing committees have criticized the global plan. Thus, a change of party control in either the Senate or House as a result of the 2022 elections could threaten U.S. participation if tax code amendments or treaty approvals are necessary.

Tax code amendments may be necessary for the U.S. to achieve conformity with the global plan because some features of the new U.S. tax differ from some of the OECD's tax plan's rules.  For example, the two systems use different income bases and set different income thresholds to determine which corporations are subject to their respective taxes.

Moreover, in addition to the uniform, 15% global minimum tax that constitutes the OECD plan's second pillar, the OECD provides an additional requirement in its first pillar. The first pillar requires that qualifying large corporations pay taxes in foreign countries where they earn income even if they lack a legal presence in the countries. Thus, most participating countries, including the U.S., will have to amend their tax laws to incorporate the two pillars.

What Is a Global Corporate Minimum Tax?

A global corporate minimum tax would be an international minimum tax regime applying a
specific and uniform tax rate on the income of corporations in participating countries. Currently, 137 nations have agreed to a plan proposed by the Organisation for Economic Co-operation and Development (OECD) to impose a 15% global minimum tax on corporate income, measured by a company’s “book” profits. The tax would apply only to very large business corporations. Implementation is anticipated as early as 2024.

What Is the Purpose of the OECD Plan?

The OECD plan is intended to counter efforts by low-tax countries to attract investment away from higher-tax jurisdictions, a competition resulting in a race to the bottom. It also would address the widespread transfer of income earned from intellectual property—increasingly from digital products and activities—away from high-tax jurisdictions where the income is earned to lower-tax ones where the IP rights are strategically registered and owned.  

What Is the US Position on the OECD Proposal for a Global Corporate Minimum Tax?

The Biden Administration has agreed that the United States would participate in the OECD plan. Some Republican policymakers have expressed concern about the plan. However, the recent enactment of a U.S. corporate minimum tax of 15% on the book income of very large corporations brings the U.S. tax code closer to the OECD proposal.

Even though many U.S. corporations pay taxes at effective rates below the 21% statutory rate, the U.S. is losing tax revenues to low-tax and tax haven countries. The success of the OECD plan depends on U.S. support to ensure that other countries participate. Ultimately U.S. participation will depend on the tax structure and administration agreed upon by the participating nations.     

The Bottom Line

Although the OECD plan has received broad, multilateral support, its ongoing drafting and the necessary enactment of conforming national laws will delay its implementation until 2024 at least. While intervening crises—particularly the war in Ukraine and global inflation—have diverted policymakers' attention and hindered the plan's progress, technical experts and diplomats continue their work to make the OECD proposal a reality.

Article Sources
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