Why is a global minimum tax required?
Tax systems around the world have been increasingly left behind in recent years by the rise of globalisation and digital media companies such as Google, Amazon, Apple and Facebook. They are firms operating across international borders that can shift profits around to exploit the most attractive low-tax locations.
Tax abuse by multinationals and avoidance by rich individuals costs countries around the world $427bn a year in lost revenues, according to research by the Tax Justice Network campaign group. The UK is estimated to lose £25bn of tax income due to profit-shifting.
Clamour for reform has grown as government finances have come under severe pressure during the Covid pandemic, and amid public anger over the relatively low tax rates paid by major corporations.
Proposals for a minimum global tax rate and allocating taxing rights based on where companies make their money – rather than whichever low-tax zone a firm chooses to book its profits – would help to end the “race to the bottom” where one nation slashes tax to attract business only to be outdone by another country. Such a plan would give governments greater certainty on revenue raising.
What is profit-shifting?
Multinationals exploit gaps and mismatches in the international tax system through a technique known as “profit-shifting”. This involves artificially allocating sales derived in one country to a lower-tax country. One of the ways this is achieved is by companies setting up a subsidiary in a tax haven and registering their intellectual property there. That entity then charges the company’s subsidiaries in other, higher-tax jurisdictions large royalty fees. By charging that “cost” to the market where the majority of revenues are made, profits can be reduced or eliminated, meaning no tax is paid. The royalty fees extracted in this way are booked as profit in the low-tax location. Profits are often shifted to countries such as the British Virgin Islands or Bermuda, which charge no corporation tax.
For US multinationals, corporate profit-shifting into tax havens has risen from an estimated 5-10% of gross profits in the 1990s to about 25-30% today, according to the OECD. The economist Gabriel Zucman has found the global effective corporate income tax rate of Amazon is as low as 11.8% and 12.2% for Facebook, substantially lower than the headline tax rates in many of the countries they operate in.
How would the Biden proposal work?
There are two key strands of the plan, broadly following the work of the OECD’s “pillar one” and “pillar two” blueprints for global tax reforms set out in October.
Under pillar one, taxing rights would be granted to a portion of a multinational’s profits based on where its customers reside, irrespective of the company’s physical presence in that location. The Biden plan includes a threshold that would mean this captures the world’s 100 biggest multinationals but not smaller companies.
Under pillar two, governments would still be able to set whatever local corporate tax rate they wanted. But as part of a global minimum rule, if companies paid lower rates in a particular country their home governments could claim “top-ups” to the agreed tax floor, eliminating the advantage of shifting profits to a tax haven.
Where would the rate be set?
In the months ahead negotiations will centre on the threshold for company profits, and the tax rate that would be applied. Washington has proposed a rate of 21%. However, several nations have much lower rates, while an agreement among EU nations might not be easy – with rates varying from as low as 9% in Hungary and 12.5% in Ireland to 32% in France and 31.5% in Portugal.
How close is an agreement?
Sealing a deal between 139 countries negotiating tax reforms at the OECD will not be easy. However, tax campaigners say the US intervention brings the prospect of a deal much closer. France and Germany have expressed support, while the UK has indicated that updating global tax rules is a priority.
While work remains to agree key details, the OECD is aiming for an agreement by mid-2021, with hopes a deal could be struck in time for a meeting of G20 finance ministers in July.
