Historical agreement on corporate minimum global tax

Source: Pixabay.

On Friday October 8th, an agreement, later approved even by G20 leaders, to radically change the international taxation system was finally reached. The purpose of the global deal, which was agreed under the OECD framework, is to ensure that big companies pay a minimum tax rate of 15 per cent. In addition, the agreement provides for the introduction of a mechanism for redistributing part of the profits, and then part of the tax base, of the largest MNEs between countries on the basis of sales geography instead of residence. Only four countries, according to the OECD, have not joined the agreement yet, but the ones which did account for over 90 per cent of the global economy.

For decades, many big companies have been implementing the so-called “race to the bottom”, that means attempts to minimize the tax they pay, by channelling profits through nations which have low tax rates; among the tax havens we find Ireland, Singapore, Porto Rico and the Cayman Islands. Today more than ever, with budgets strained due to the pandemic, governments want to discourage MNEs from shifting profits and tax revenues to low-tax countries. But how have most multinational enterprises been acting until the reaching of the deal? They have been used to shift more and more income from intangible assets, such as brands, royalties or software to the before mentioned jurisdictions, in order to pay a lower taxation on the produced income.

In essence, we are talking about a tax on multinationals with revenues exceeding 750 million euros. The global minimum tax works this way: if a company pays taxes in a country where the actual tax is less than 15 percent, the remaining percentage to reach the 15 percent threshold will have to be paid in the state of residence. Let’s make an example: if Apple paid taxes in Ireland instead of the United States, which is its parent country, on profits of 30 billion dollars at a rate of 12.5 percent, the American government would pick from Apple 750 million dollars (2.5 percent of 30 billion) in addition to the normal domestic taxation, bringing the total taxation on Apple’s profits to at least 15 percent.

It’s easy to understand that the country of residence which previously got nothing from the companies de facto belonging to a country that was not actually the real one of residence, only chosen in order to avoid a higher taxation, receives now a tax advantage. This allows to avoid a loss of tax revenue that was, before the deal, very high; the OECD estimates that the minimum global tax will raise a total revenue of approximately 125 billion dollars per year, and 2.7 billion euros in Italy, which are today revenues that escape the tax system.

It is estimated that 40 per cent of global foreign direct investment takes place for fiscal reasons and not to gain real economic benefits. Will this change? More generally, what will be the real effects of this decision?

Many economists expect the agreement to encourage multinationals to repatriate capital to their home countries, giving a boost to such economies. However, the various deductions and exceptions set in the agreement have been designed to limit the impact on low tax countries such as Ireland, where many US groups base their operations in Europe.

Also, there is a second key issue which has been brought to the attention of the discussion, that is, as previously said, the geographical distribution of profits and, consequently, of tax bases. Where should a multinational corporation that has its residence in the United States and generates half of its profits in Europe pay its taxes? The agreement provides for the introduction of a formulaic approach to make this distribution more equitably, both in relation to the current system and to a system in which the vast majority of taxes on profits are paid in the parent state. This new way of allocation will only affect multinationals with more than 20 billion euros of revenues: their profits will be distributed between countries on the basis of the geography of the sales and use of the products (e.g. for digital services sold online).

Some people complain that the minimum taxation, which amounts up to 15 per cent, may not be sufficient, since it’s not able to stimulate the development in the poorest countries. Anyway, it is an important innovation, even if the involved amounts are, as of today, limited.

I strongly recommend listening to the Global Insider podcast episode on Spotify published on November 10th 2021. Furthermore, I’ll leave here a link to an interesting article from the Guardian.