Global Corporate Minimum Tax: What Is It?
A global corporate minimum tax is an international proposal to impose a minimal rate of taxation on corporate income in the majority of nations.
136 nations and regions accepted a proposal from the Organization for Economic Co-operation and Development on October 8, 2021. Originally scheduled to go into effect in 2023, it will now do so in 2024. The plan was made to prevent multinational firms from transferring profits for tax purposes and from eroding their tax bases (MNCs).
The agreement established a two-pillar strategy to update tax laws in order to address issues like profit shifting and tax base erosion brought on by tax avoidance strategies, as well as problems brought on by the growing digitalization of the world economy. According to the OECD, the first pillar would reallocate more than $125 billion in corporate profits annually from the home nations of big corporations for taxation in the countries where the profits were produced. The second pillar would bring in an estimated $150 billion for nations that impose a corporate income tax with a minimum rate of 15%.
“Does not seek to eliminate tax competition, but puts multilaterally agreed limitations on it,” the OECD’s two-pillar proposal states. It was originally discussed at the Washington, D.C., G20 Finance Ministers meeting and approved at the October 2021 G20 Leaders Meeting in Rome.
Any global corporate minimum tax, including the version contemplated in the OECD plan, would not be self-implementing. Each nation’s tax system would need to include the rate and regulations. The United States would have to accept the two-pillar proposal and enact a minimum company tax of 15% in accordance with the OECD model in order to be a signatory to the global corporate minimum tax agreement.
A 15% alternative minimum corporate tax on large firms was included in the United States’ recently passed Inflation Reduction Act of 2022. This tax moves the United States closer to the OECD tax system by adopting some of the guidelines of the OECD’s global minimum tax. Nevertheless, until the OECD negotiators finish their final, comprehensive draft, it won’t be evident whether U.S. legislation needs any additional adjustments to comply with the OECD tax regulations.
The Internal Revenue Code (IRC) must be amended by Congress and signed by the president if the U.S. corporate minimum tax does not comply with the requirements for the worldwide corporate minimum tax. Moreover, modifications to bilateral and international tax treaties will be necessary in order to agree on the two pillars of the OECD plan. Treaties must be approved by the Senate and president in the US.
Key Aspects
- A worldwide corporate income base would be subject to a uniform minimum tax rate under a global corporate minimum tax.
- A 15% corporate minimum tax on large multinational corporations’ international profits was proposed by the OECD, and it would bring in $150 billion in additional annual tax income for the world’s governments.
- By lower tax rates that cause corporate profit shifting and tax base erosion, the framework seeks to deter nations from engaging in tax rivalry.
- 137 nations and areas of government signed up to the OECD plan and endorsed the framework.
- The G20 Leaders Summit in Rome in October 2021 authorized the global corporate minimum tax. The anticipated start date is now 2024.
Global Corporate Minimum Tax: The Basics
A global corporate minimum tax is a standard minimum corporate income tax rate that various jurisdictions establish in accordance with an international treaty. Its supporters are eager for it to become law because it would serve to deter MNCs from choosing international investment locations based on countries with low tax rates and from moving profits from high-tax to low-tax jurisdictions regardless of where the profits are generated.
The “Race To The Bottom” Is Fostered By Tax Competition
Finance authorities and economists agree that a race to the bottom has developed as countries compete on taxes to entice foreign investment. They worry that this rivalry will result in a large loss of tax income and will put the financing of government activities in nations with higher tax rates at risk. To entice foreign investment from nations with higher taxes, lower-tax jurisdictions advertise their low rates.
In order to avoid paying higher taxes imposed by both their home countries and the countries where their income is earned, 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. Irish companies with lucrative operations include Amazon, Meta (previously Facebook), and Google. Ireland’s top corporate tax rate is 12.5%, which is significantly lower than rates in the United States, the United Kingdom, and the European Union (EU).
According to a statement made by the U.S. Treasury Secretary Janet Yellen, international regulations that promote profit shifting to lower-tax jurisdictions and permit the countries where multinational corporations (MNCs) earn their profits to tax those profits and reap the benefits of the tax revenues would lessen tax competition and lead to a more equitable distribution of tax revenues.
A global corporate minimum tax might also drastically lessen country-based tax rivalry. But, it wouldn’t entirely get rid of it. If a common minimum tax rate gives multinational corporations (MNCs) little to no tax benefit from moving investments and shifting profits to lower-tax jurisdictions, then the comparative strength and quality of a country’s infrastructure and its workforce would have a greater impact on economic competition between nations.
As part of the Build Back Better Act, the Biden Administration and Democratic senators initially proposed a 15% alternative corporate minimum tax on extremely profitable firms in the United States beginning in 2021. It was revised, passed, and signed into law on August 16, 2022, as part of the Inflation Reduction Act.
OECD Two-Pillar Plan
The OECD plan contains a number of measures, including a global corporate minimum tax, to offset the loss of tax income brought on by profit-shifting and base erosion. The deal will change current laws that bar nations from taxing multinational corporation (MNC) profits earned within their borders unless those businesses have a physical presence there.
First Pillar
The first pillar of the OECD agreement permits countries where big MNCs’ goods and services are utilized to tax the income they generate, even if these businesses have no physical presence there. This applies particularly to IP and digital services.
France, the United Kingdom, and a number of other nations individually enacted unique, contentious digital taxes on such revenue in recent years. These taxes will be eliminated as part of the first pillar of the agreement. After the OECD agreement was struck, new levies on digital services are not permitted.
The regulation allowing taxation without nexus was first restricted to the largest MNCs, which totaled about 100 corporations. Now, MNCs with “global sales above €20 billion [approximately US$ 23.145 billion] and profitability above 10%” would be subject to this law. Providing MNCs get at least €1 million ($1.16 million) in revenue from the jurisdiction, a nation may tax 25% of the income over 10%.
Smaller nations with a GDP under €40 billion ($46.4 billion) may tax multinational corporations (MNCs) that bring in at least €250,000 ($290,102) in local revenue per year. Double taxation will be prevented through exemptions or credits. The rule would probably be more broadly applicable after a seven-year review.
Second Pillar
The second pillar of the OECD imposes a 15% global corporation minimum tax on the low-taxed overseas income of large MNCs. Only businesses with annual revenues over €750 million ($868,095) are subject to this global corporate minimum tax.
The parent MNCs’ relationships with the entities that make up those companies are taken into account by special regulations for imposing the 15% tax. A “top-up” tax must be paid by parent MNCs whose subsidiaries receive low-taxed foreign income in order to raise the tax rate applicable to such income to 15%.
Unless tax at a rate of 15% otherwise applies with respect to the income of the subsidiaries, deductions for parent payments to low-tax foreign companies will not be allowed. Certain related-party payments that are taxed at a lower rate than the minimum rate may also be subject to restricted source taxation in the source country.
The United States and 132 other nations backed this idea as of July 9, 2021. 15 With the signing of the agreement on October 8, the list of signatories expanded to include Estonia, Hungary, and Ireland, securing backing from all OECD, EU, and G20 members. The plan had 137 signatories as of May 2022. Yellen keeps pushing for the plan’s incorporation of regulations from other countries during her meetings with them.
The European Union’s 27 members declared on December 12 that they will put a significant portion of the base erosion and profit-shifting framework of the OECD into practice. This aligns them with Pillar Two16 and sets the road for them to implement a 15% corporate minimum tax.
How Could A Global Corporate Minimum Tax Work?
A global corporate minimum tax would impose a particular minimum rate of tax, but its overall structure may take various shapes and produce various results. The most contentious aspect of a tax system, aside from rate, is typically how it defines the proper tax base.
The net economic income of a taxpayer should be subject to income tax, in theory. Yet, reaching consensus on what counts as such revenue is difficult, if not impossible. Before the plan’s implementation in 2024, the OECD must decide on the definition of the tax base and any associated laws.
Defining The Tax Base Is A Challenge
The definition and computation of taxable income in the U.S. tax code serve as an excellent illustration of the difficulties in arriving at a just calculation of net economic income. Many different deductions, exclusions, exemptions, credits, temporary provisions, incentives, and other unique rules are included in the Internal Revenue Code (IRC).
These clauses were frequently passed in order to further social ideals like philanthropy or environmental preservation, or to benefit private interests with tax-saving benefits like the tax-free treatment of like-kind exchanges or oil depletion allowances. The laws of the United States are frequently modified as a result of shifting political and economic forces. There is therefore no reason to believe that these regulations offer an appropriate economic measurement. Instead, they highlight how difficult it is to determine a tax base.
The Biden Administration proposed a corporate minimum tax in the Inflation Reduction Act, and Congress enacted it as a result. This was done in recognition of the complexity of the U.S. tax code and the fact that its numerous adjustments to income have allowed some wealthy taxpayers to legally avoid any tax liability. The purpose of this levy is to stop highly lucrative businesses from paying little to no tax.
The recently passed corporate minimum tax bases its domestic company minimum tax on book income, or financial income calculated in accordance with generally accepted accounting principles (GAAP). The tax will only apply to very large businesses that record huge book profits but little or no taxable income.
International Tax Legislation
The structure and complexity of tax legislation in various nations also varies, leading to vastly diverse income tax bases and regulations. Yet, a global corporate minimum tax needs a uniform definition of income in order to be accepted and seen as fair.
As previously mentioned, the OECD determined that its agreement only applies to businesses with revenues more than €750 million ($868,095). Also, the writers created guidelines for its application, modification, and enforcement. The program also offers:
- Exclusions for industries that often do not contribute to tax competition, such as mining, shipping, regulated financial services, and pensions, or whose profits are tied to particular regions or are subject to unique tax and regulatory regimes.
- A degree of flexibility to allow nations, especially the U.S., with tax policies that are similar to the agreement’s norms but not exactly the same to employ their own rules as long as their impact is comparable to that of the OECD rules.
Minimum Tax Structure: Targeted or Comprehensive
In its most basic form, a global corporate minimum tax might be designed to mandate that nations levy no rate lower than a given rate on all business income, whether it is produced domestically or internationally. This strategy, which would take away nations’ ability to govern domestic corporation taxation, would constitute a serious violation of national sovereignty.
The OECD’s current proposal for a global corporate minimum tax includes a more specific, targeted structure. The OECD proposal mandates that multinational corporations’ overseas income be taxed at the stipulated 15% minimum rate in order to deter tax competitiveness. The OECD would therefore require a country to top up its corporation tax on revenue made abroad by an additional 5%, for a total rate of 15%, assuming that the country’s usual corporate tax rate is 10%.
Detailed tax accounting rules have yet to be developed. The new U.S. corporate minimum tax’s use of book income may be advantageous for the OECD tax because it only applies to large multinational corporations.
Global Corporate Minimum Tax: Prospects
The new regulations were supposed to go into effect in 2023 according to the OECD agreement. The OECD published technical recommendations for model rules in March 2022. However, OECD leaders more recently predicted that implementation will be postponed until 2024 because work on the intricate, specific guidelines is still ongoing. A 2024 effective date may be difficult because the concept needs many countries to agree and then alter their tax legislation.
The adoption of a 15% minimum tax in the United States on businesses with three taxable years of average annual financial statement incomes over $1 billion is a significant step toward introducing a global corporate minimum tax. The final implementation of the plan depends on U.S. involvement in the global corporate minimum tax framework. The U.S. participating in the global corporate minimum tax plan has the strong support of the Biden Administration. The fact that the Democratic majorities in the House of Representatives (220-207) and Senate (51-50) approved the 15% corporate minimum tax in the United States shows that these lawmakers would support the worldwide proposal as well.
The U.S. corporate minimum tax, meanwhile, received an unified no vote from congressional Republicans. The Republican Party and the Republican Ranking Members of the House and Senate Tax-Writing Committees have both stated that the global plan would be detrimental to the economy of the United States. So, if tax code changes or treaty approvals are required, a change in party leadership in the Senate or House as a result of the 2022 elections could jeopardize U.S. participation.
Because some aspects of the new U.S. tax code deviate from some of the rules of the OECD’s tax plan, tax code adjustments may be required for the U.S. to achieve conformity with the global plan. For instance, when determining which corporations are liable for each system’s taxes, the two systems employ various income bases and set various income thresholds.
The OECD plan also includes an additional obligation in its first pillar in addition to the uniform, 15% global minimum tax that makes up the second pillar. Even if they don’t have a legal presence there, the first pillar mandates that major firms that meet the requirements pay taxes in the foreign nations where they generate profits. As a result, the majority of participating nations, including the United States, will need to change their tax laws to include the two pillars.
Global Corporate Minimum Tax Summary
An international minimum tax system known as a global corporate minimum tax would impose a set and consistent tax rate on the profits of firms in participating nations. A plan put up by the Organisation for Economic Co-operation and Development (OECD) to impose a 15% global minimum tax on corporate income, calculated by a company’s “book” earnings, has gained support from 137 countries as of right now. Only extremely large commercial corporations would be subject to the tax. The first phase of implementation is planned for 2024.
Purpose of the OECD Plan
The OECD plan is intended to counter efforts by low-tax nations to entice capital away from tax-intensive jurisdictions, preventing a race to the bottom. Additionally, it would address the widespread transfer of income from intellectual property, particularly from digital goods and services, from high-tax jurisdictions where it is generated to low-tax locations where the IP rights are strategically registered and owned.
What Is the United State Position on the OECD Proposal for a Global Corporate Minimum Tax?
The United States will take part in the OECD proposal, according to the Biden Administration. Concern about the plan has been expressed by certain Republican policymakers. The U.S. tax structure is now more similar to the OECD proposal because to the recent implementation of a 15% corporate minimum tax on the book income of very large firms.
The United States is losing tax money to low-tax and tax haven nations, despite the fact that many US corporations pay taxes at effective rates below the 21% statutory rate. The success of the OECD plan depends on U.S. support to ensure that other countries participate. In the end, U.S. involvement will be based on the administration and tax system that the participating countries decide upon.
Final Thoughts
Although the OECD proposal has garnered widespread, multilateral approval, its implementation won’t happen until at least 2024 due to continuous revisions and the requirement to adopt compliant national laws. Technical experts and diplomats continue to try to make the OECD idea a reality despite intervening crises, including the war in Ukraine and the worldwide inflation. These issues have diverted politicians’ attention and slowed the plan’s implementation.
