What Is a Global Corporate Minimum Tax?
A global corporate minimum tax is a tax regime established by international agreement whereby countries adhering to the agreement would impose a specific minimum tax rate on the income of corporations 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, 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 Oct. 8 agreement establishes a "two-pillar solution" focused on revising tax rules to address profit shifting and base erosion caused by MNCs’ tax-avoidance practices and to meet challenges created by the increasingly digitalized global economy. According to the OECD, its 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." The agreement will be presented to the G20 Finance Ministers meeting in Washington, D.C., on October 13, 2021. Then, it will go to the G20 Leaders Summit in Rome scheduled for Oct. 30-31.
- A global corporate minimum tax would apply a standard tax rate to a defined corporate income base worldwide.
- Implementing a global corporate minimum tax requires international agreement and enactment by each signatory country.
- In July 2021, more than 130 countries agreed to support an Organisation for Economic Co-Operation and Development (OECD) tax reform framework to impose a global corporate minimum tax on foreign profits of large multinational corporations (MNCs).
- On October 8, 136 countries and jurisdictions signed on to the OECD proposal, which features a 15% corporate minimum tax.
- The OECD framework is intended to discourage nations from tax competition through lower tax rates that results in corporate profit shifting and tax base erosion.
- The OECD estimates that its plan will provide countries with new tax revenues of USD 150 billion annually.
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. In addition, international and bilateral tax treaties would require amendment.
U.S. Corporate Minimum Tax
To fund the roughly $2 trillion social infrastructure bill, Democratic senators have proposed a 15% minimum corporate tax on highly profitable corporations. to be paid in the U.S. This is different from the global corporate minimum tax.
Understanding 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 of a global corporate minimum tax urge its adoption 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. (The Organisation for Economic Co-Operation and Development [OECD] refers to these companies as multinational enterprises [MNEs]—a term basically analogous to the more familiar label multinational corporation.)
Tax competition fostering ‘race to the bottom’
Finance officials and economists worldwide recognize that tax competition among nations to attract foreign investment has resulted in a “race to the bottom.” They are concerned that this competition is causing substantial loss of tax revenue and endangering financing for government functions in higher-tax countries. Lower-tax jurisdictions have promoted their low rates to attract foreign investment from higher-tax countries.
Also, in recent years, MNCs with income from intangible property—such as royalties from trademark, patent, and software licenses—have located and/or relocated such rights in 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—have 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.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, but not completely eliminate, tax-based competition among countries. If a common minimum tax rate—e.g., the 15% rate in the OECD plan—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.
OECD '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 law rules that prevent countries from taxing MNC income earned in their jurisdictions unless the MNCs have a physical presence, i.e., nexus, in the country.
The OECD agreement’s first pillar allows jurisdictions, where MNCs’ products and services, particularly IP and digital services, are used, to tax the MNCs’ resulting profits, even if the MNCs have no presence in the country. In recent years, France, the United Kingdom, and a few other countries independently imposed special, controversial, "digital" taxes on such income. As part of the agreement’s first pillar, these digital taxes will be repealed. New digital services taxes have been barred since the OECD agreement was signed on October 8.
Initially, only the largest MNCs, approximately 100 companies, are subject to the rule permitting taxation without nexus. This rule 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 of such MNCs in excess of 10%, provided the MNCs derive at least €1 million [$1.16 million] in revenue from the jurisdiction. Smaller countries with GDP 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 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).3
Special rules for applying the 15% tax take into account the relationships of 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. Also, source jurisdictions are 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 Oct. 8 agreement, the signatories grew to include Estonia, Hungary, and Ireland—establishing support from all OECD, European Union, and G20 member countries. So far, Kenya, Nigeria, Pakistan, and Sri Lanka have not joined the agreement.
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. Generally, beyond rate, the most debated feature of a tax regime 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 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 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 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 tax. The proposal would use “book” income—i.e., 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.
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 drafters decided their agreement applies only to companies with revenues above €750 million ($868,095). They 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. The plan offers 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 present OECD framework for a global corporate minimum tax has a narrower, targeted design. Because the OECD goal is discouraging tax competition, the OECD plan requires that multinational companies’ overseas income be taxed at the prescribed minimum rate, which is set at 15%. 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.
As of July 9, 2021, both the G7 and G20, representing the world’s largest economies, endorsed the OECD’s development of an international tax reform framework that includes a global corporate minimum tax establishing a minimum tax rate on multinationals’ overseas income.
On Oct. 8, 2021, as noted above, 136 countries and jurisdictions agreed to the OECD plan. Detailed tax accounting rules have yet to be developed. Because the OECD global corporate minimum tax affects only large multinationals, generally public companies, the Biden Administration’s choice of standard “book” income, as reported in official financial reports as a minimum tax base, also might serve well for the OECD tax.
Prospects for a Global Corporate Minimum Tax
The OECD agreement envisions implementation of the new rules in 2023. Because the plan requires many countries to amend their tax laws, this timing may be overly optimistic. Moreover, U.S. participation, which is essential to the plan’s success, depends on Congressional action and likely will prompt objections from Republican legislators and business skeptics. Already the Republican ranking members of the Senate and House tax-writing committees, Sen. Mike Crapo (R-Idaho) and Rep. Kevin Brady (R-Tex.) have suggested that the agreement might result in tax increases for Americans.
On Oct. 26, as part of the effort to pay for President Biden's now roughly $2 trillion 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. These companies would still be entitled to tax credits such as those for R&D. Though it sounds similar, this proposal is not the same as a global corporate minimum tax, which would require qualifying large corporations to pay taxes in foreign countries where these companies earn income.
U.S. enactment of a global corporate minimum tax may need Democratic unanimity to have a majority Senate vote to pass necessary tax law changes through the Senate budget reconciliation process (it could be included in the $2 trillion bill). Treasury Secretary Janet Yellen, however, believes that American businesses “are going to be saying to members of Congress, ‘Please approve this,’” according to Bloomberg.
With 136 countries representing more than 90% of global GDP supporting the the OECD agreement and its global corporate minimum tax, its prospects have grown more favorable, but its ultimate implementation and timing remain uncertain.