- what it means for Business and Investors in regions, markets and distribution.
From the outset, it must be stated very clearly that the good news is that companies in the financial industry, Insurance industry, and extractive industry like mining companies, oil and gas are excluded from this new law.
The background and milestones of Global Corporate Tax has spurned over the years and it is one of the most difficult processes in recorded history with careful and tentative steps.
It was in 1996 that G7 made the problems of tax evasion and avoidance a priority. In addition to that, in 1997 the OECD report: Harmful Tax Competition: An Emerging Global Issue, was released for emphasis and moreover in 2000 – 2007 the Development of international standards on tax transparency and securing commitments to a global level playing field was released. Furthermore, 2008 – 2009 saw the Global Financial Crisis, as a consequence, G20 pledged to end bank secrecy and establish the Global Forum on Transparency and Exchange of Information for Tax Purposes consequently, the report came out. Apart from that, July 2013, G20 identified tax avoidance as a priority; two years later in October 2015 as a result of that, this led to the Adoption of the Base Erosion and Profit Shifting (BEPS) package of 15 Actions to counter tax avoidance – Action 1 dealt with the digitalization of the economy.
In June 2016, the Establishment of the OECD/G20 Inclusive Framework on BEPS emerged, which grew in number and counted 140 members. From 2017 – 2020 an Active discussions in the Inclusive Framework on how to address the tax challenges of the digitalization of the economy culminated with the release of “blueprints” for a two-pillar solution in October 2020. Over 130 countries and jurisdictions joined the Statement on the Two-Pillar Solution to Address the Tax Challenges Arising from the Digitalisation of the Economy.
October 2021, the 136 members of the Inclusive Framework joined the Statement on the Two-Pillar Solution to Address the Tax Challenges Arising from the Digitalisation of the Economy with a Detailed Implementation Plan. 2022 is the Target date for development of model legislation, a Multilateral Convention and a multilateral instrument for the implementation of the Two-Pillar Solution. 2023 has been targeted for the implementation of the Two-Pillar Solution.
With that background in mind the process was clearly a difficult one, all issues of withholding money and the regulation that would follow are not issues that can ever be taken lightly or concluded without due regard to the stakeholders. It is for that reason that advantages and criticism have to be isolated carefully so that this new Global Corporate Tax can be carefully analyzed and processed over time.
GLOBAL TAX
Tax is revenue for most countries and is an indicator for stability and certainty, the more stable the Tax System is, the more certain for the tax payers and administrators and the more easy for businesses and investors to operate. The European Union was the first to propose uniform taxes, but that was never implemented. The Organization for Economic Cooperation and Development in 2019 proposed a global corporate minimum tax mostly because of digital products and services that needed a new tax update and to avoid the shifting of profits to jurisdictions with a lower corporate tax base. In June 2021, the G7 Summit endorsed it, to level the playing field, encourage competition and create a global network that would be a fair and sustainable International Tax System.
The Global GDP is the monetary value of all finished goods and services in the entire global economy has been described as subdued and was at 3.2% in 2019, increased to 3.5% in 2020 and so far the indication for this year, is that, it is weaker than anticipated, but the expectation was that it would grow to 5,6%.
Corporate profits and economic activities are part of The Global GDP; the balance of trade looks to historical data and provides a framework for decision. This time, the GDP is one of a global economy not limited geographically, it is extremely easy to track and forecast on data of both economic activities and the sources and amounts of tax involved. This essentially means that new laws have to be written and in some countries legislative drafters are busy making frameworks.
The proposal came from Germany and France with the aim of fair taxation and formed the solid basis of the resolution that would lead to Pillar one and Pillar Two.
Pillar One would bring dated international tax rules into the 21st century, by offering market jurisdictions new taxing rights over MNEs, whether or not there is a physical presence.
- Under Pillar One, 25% of profits of the largest and most profitable MNEs (Multinational Enterprises) above a set profit margin (residual profits) would be reallocated to the market jurisdictions where the MNE’s users and customers are located; this is referred to as Amount A. The estimated profits of affected groups amount to $125 billion; Amount A ignores all territorial tax systems.
- Pillar One also provides for a simplified and streamlined approach to the application of the arm’s length principle to in-country baseline marketing and distribution activities (Amount B).
- Pillar One includes features to ensure dispute prevention and dispute resolution in order to address any risk of double taxation, but with an elective mechanism for some low-capacity countries.
- Pillar One also entails the removal and standstill of Digital Services Taxes (DST) and similar relevant measures, to prevent harmful trade disputes.
Essentially, Pillar one focuses on charging tax where large companies pay tax with a very simple method by using marketing and distribution. Pillar One works effectively upon adoption by all signatories, the resolution means that multinational companies will allocate part of their profit that earn a rate of return over a threshold to countries in which they make sales. For the first time ever, profit is taxed in the market country
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Pillar Two provides a minimum 15% tax on corporate profit, putting a floor on tax competition. Governments worldwide agree to allow additional taxes on the foreign profits of MNEs (Multinational Enterprises) headquartered in their jurisdiction at least to the agreed minimum rate. This means that tax competition will now be backstopped by minimum level of taxation wherever an MNE operates.
A carve-out allows countries to continue to offer tax incentives to promote business activity with real substance, like building a hotel or investing in a factory.
Pillar Two focuses on the 15% global minimum tax, the rules in Pillar Two apply to companies that have earned a threshold amount of revenue or more. The taxable income is determined by the parent company and other additional taxes in the company’s home jurisdiction. This increases the tax costs of cross-border investments in addition to that, remember tangible assets have to be taxed as well as the payroll cost. If a company pays tax to its parent company, then, it can refuse to pay tax on cross-border payments. Exclusion Rule: for under tax rules to apply, the time frame of operation and value of tangible assets and number of entities in the areas of business jurisdiction have to be considered.
Pillar Two is more optional and countries need to adopt the described model.
The parent company is the deciding factor on the model to follow in as far as which country has the best effective tax rates that are economically efficient with the rising cost of capital and erosion of profit shifting. Transfer Pricing is still driven by tax differentials because the Multinational companies still need to make profits worldwide. The concerns of developing countries are addressed in Pillar Two and capacity building is offered to support the countries that need it. Under Pillar One, the reallocation of profits to developing countries each year means a gain in revenue.
The Global Minimum Corporate Tax base rate that has been created makes certain multinational companies subject to 15% tax rate and if a multinational company has excess profits that are 10% above the revenue that it has, there is an imposition of tax of 25%. It does not matter in which part of the world it is based. This has led to the creation of the Global Minimum Corporate Tax and tax rights have been reallocated from home countries to their market. This simply means that billions of dollars are expected to be reallocated to market jurisdictions. The market jurisdictions are where your products and services have been marketed and are bringing in revenue, if sales are above the stipulated thresholds. The threshold of 10% for pre-tax profits over sales uses that small fraction to measure the rate of return.
AFFECTED INDUSTRIES: The affected industries for the effective tax rates increases are: non metallic, transportation, computer and electronic product manufacturing. Decreases are on machinery manufacturing, motion picture and sound recording, fabricated metal and product machinery. The Technology industry includes: computer and electronic product manufacturing, pharmaceutical manufacturing, Electrical equipment appliance and component manufacturing and Information other than recording and publishing.
The Organization for Economic Cooperation and Development has 140 members out of which 136 countries and jurisdictions signed, with promises and assurances made that the minimum tax base would not be raised above 15% and that the time for implementation would be adequate. All countries in the G20 have signed the agreement. The Global Minimum Corporate Tax only applies to foreign earnings, but countries can still establish their own domestic corporate tax rate.
This is a major shift globally, because policymakers globally have to be careful in redesigning their policies and implementing this new tax.
CRITICISM
- The first criticism is that the 15% minimum tax rate is lower than the average income tax rate paid by Americans for Federal Tax and State Tax.
- The enforcement of these rules is allegedly associated with life science and technology at the expense of other countries.
- Tax haven operations were highly associated with Manager Misconduct and higher cost of raising capital, nevertheless, shareholders and corporate stakeholders will still benefit from reduced negative consequences because greater incentives can still be made to shift operations.
- Employees can still be located abroad; therefore, it is not that big of an issue.
The criticism as it may be, just means that companies in the USA will pay less to the US government and more to the governments that have their investment holdings, 64% of generated profits in this margin are from US headquartered companies, other companies are located in the United Kingdom, Switzerland and Ireland. The 45% of the affected companies in this threshold are generated by technology companies
HOW TAX WAS PREVIOUSLY AVOIDED
Tax was previously avoided by Intellectual Property holders like Microsoft, Google, Apple and Oracle, undoubtedly, this extended to patents, digital assets and software in the international market by shifting profits from higher tax jurisdictions to lower tax jurisdictions, but that will not be easy since the 15% global minimum tax rate has already been agreed on and implementation of the resolution is until 2023. This means that the previous habit of eroding the tax base of higher jurisdictions will be a thing of the past, there will be no more exploiting gaps and mismatches. Ireland used to be the biggest tax hub, much bigger than the Caribbean followed by Singapore, Switzerland and Netherlands in that order, for the avoidance of tax, but that has changed because foreign earnings will now face higher taxes.
IS THERE ANY WAY TO AVOID THIS TAX?
The smart move or ‘Crook’s Law’ as we fondly called it in Law School (nothing crooked, but legal tactics one can use) or in the Corporate World, simply termed as ‘Knowledge Economies’ is to head to Cyprus and why Cyprus? Cyprus is the country to go to and invest in for now, when it comes to Corporate activities because it is not a signatory to the resolution, although it is a member of the European Union and Eurozone and is one of the most attractive corporate destinations for individuals, investors and businesses. Other countries that have not signed are Nigeria, Kenya, Sri Lanka and Pakistan, but one has to compare and contrast whether the tax system is favorable to their profit margins as opposed to the expenses that may be incurred. A Tax haven should be attractive and favorable despite the regulatory regimes in place.
While the focus will be on compliance and transparency to effect control measures, there will be no deliberate departure from the OECD tax network to effectively control profit shifting and base erosion.
The litanies of avoidance will continue as countries entice corporations to set up operations in their own jurisdiction because the domestic setting allows countries to enforce whatever tax laws and rates that would be a tax haven by lowering liabilities, corporate inversions and tax motivated income shifting. The new rules have an impact on business and investment decisions as well as tax compliance, administration and tax revenue.
Arbitration Agreements may become mandatory in the foreseeable future because some jurisdictions may become sidelined on some tax avoidance methods.
The location of taxable profits will now shift to the customers, and now each country has to pay 15% minimum tax for multinational companies. This will see a net increase in domestic revenue and increase in domestic profits, in this case, the OECD is truly a global policy forum that promotes policies to preserve individual liberty and improve the economic and social well being of the masses.
REFERENCES:
Daniel Bunn(2021)What’s in the New Global Tax Agreement. taxfoundation.org.
Lorraine Eden and Martin Simmler (2021)Is the World Economy Ready for a new Global Tax System.taxfoundation.org.
Nathan C. Goldman and Christina M. Lewellen (2021)The Basement on the Race to the Bottom.Poole.ncsu.
Kallen Cody (2021) Options for Reforming the Taxation of US Multinational.taxfoundation.org.
Henney, Megan (2021t) Global minimum tax spurned by 9 countries, complicating new deal. FOXBusiness
Martin Simmler and Michael Devereux (2021) Who will pay amount A? Oxford University press. United Kingdom.
Zucman, Gabriel (2021) Common Dreams. University of California. California
Zucman, Gabriel; Thomas Wright (2018)The Exorbitant Tax Privilege. National Bureau of Economic Research
OECD.org