Over the last decade, many developed countries have competed against one another for investment from multinational corporations. This competition has led to a tax race to the bottom as one state after another has cut corporate income tax rates to be more attractive to investors than its rivals.
For international tax, most countries operate some version of either a worldwide or territorial tax system. In a worldwide system, domestic and foreign corporate income of corporations residing in the country operating the worldwide tax system are taxable in that country. To prevent double taxation, resident corporations can claim a tax credit to offset some or all of the foreign income tax they have paid in other countries. In a territorial system, corporate taxes are only paid on income that is generated within the country’s territory; income generated outside of the territory is not taxed by the territorial jurisdiction. Many advanced economies have adopted territorial systems, and the US has a hybrid system that is almost territorial, but not fully.
Under current international tax rules, companies can set up operations in countries that have relatively low corporate tax rates and declare profits there. This means they only pay the local rate of tax, even if the profits mainly come from sales made elsewhere. This is standard international tax planning. The G-7 finance ministers, representing the seven largest industrialized countries, have agreed to allow reallocation of some taxing rights so as to permit countries to tax multinational companies based on their economic activity in a country rather than physical permanent establishment. In other words, the idea is to make companies pay more tax in the countries where they are selling their products or services and making their profits, rather than where they have contrived to declare those profits.
The right to charge tax is the very definition of sovereign power which is why coordinated international action has proved so difficult in the past and may still prove to be a roadblock to a global minimum corporate tax rate. However, an idea which would have been dead on arrival in 2019 is moving forward apace in 2021 because of every government’s need to refill their treasuries emptied by pandemic spending. Despite all the publicity that the G-7 finance ministers’ announcement of a global minimum tax rate has brought, the idea still has a long way to go before becoming a reality.
Ireland, which currently has a 12.5% corporate income tax, is very cool on the idea, arguing that low tax rates are needed by smaller countries which lack the financial muscle and workforce resources available in larger economies. Cyprus, which also has a 12.5% corporate income tax rate, has come out against the concept of a global minimum corporate tax. Both these countries are in the EU, where all tax decisions to be made at the European level are subject to the unanimity rule. That is, all Member States must agree on any measure adopted in the taxation field.
Much will depend on the fine print which is currently subject to ongoing negotiations. These negotiations will move to the G-20 meeting which will take place in July. From there, the proposals will go to the Organization for Economic Co-operation and Development (OECD), an intergovernmental economic organization with 38 members. The proposed rules on making multinationals pay taxes where they operate will, under current plans, apply to profitable multinational companies which report a minimum of a 10% profit margin. Those that meet this criterion would have 20% of their profits reallocated and taxed in the countries where they make their sales or provide their services. This approach would provide transparency on corporate tax practices but be more complex to administer as it would require country-by-country reporting of corporate activities.
The idea of a global minimum corporate tax rate is an idea that has been pushed by certain governments for a number of years, but which gained little traction pre-COVID-19 within the wider international community. Now that we are entering the post-COVID-19 economic world, a global minimum corporate tax rate may just be an idea that the world’s economic powers can get behind; however, there are still a number of obstacles this proposed project will have to overcome.
If you have any further questions regarding international tax issues or planning, please contact Ian Shane.