What happened here?

Over the weekend, the G20 countries signed off on a global minimum tax of 15% on big multinational businesses. They essentially endorsed an agreement signed at a meeting of the Organization for Economic Cooperation and Development by 136 countries in October. President Biden underlined the significance of the decision:

“Here at the G20, leaders representing 80% of the world’s GDP—allies and competitors alike—made clear their support for a strong global minimum tax. This is more than just a tax deal—it’s diplomacy reshaping our global economy and delivering for our people.”

Why are they doing this?

One: Because multinational giants have been stashing their profits in low-tax havens to avoid paying up. The problem is even bigger when there are no fixed assets—like factories etc.—involved. These companies can easily move their money around to duck high rates. For example: Apple could make huge profits by selling its products in the US but attribute those profits to a subsidiary in Ireland—where the tax rate is only 12.5%.

Data point to note: In 2017, roughly 40% of profits earned by the world’s multinational firms—or more than $700 billion—were stashed in tax havens. 

Two: The current system forces governments into a race to the rock-bottom—where they compete to offer the lowest tax rate to attract big business. The reason: it also brings big benefits for the handful willing and able to slash taxes. Example: More than $100 billion in multinational profits was shifted to Ireland alone in 2015. But this becomes a zero sum game where companies play governments off each other to gain the sweetest benefits.

Data point to note: The average corporate tax rate globally has fallen by more than half over the past three decades, from 49% in 1985 to 24% in 2018.

Three: The loss of tax revenue drains governments of funding in health care and other key areas—and often forces them to hike up sales taxes which are borne by customers, i.e. people like us. 

Four: Multinationals can make massive profits in foreign countries and yet pay no taxes there—because they are taxed in the jurisdiction where they declare profits, not where they do business. This is especially true for tech giants like Facebook, Google etc. India, for example, imposes a digital tax of 2% on these companies to compensate for the loss of tax revenue.

Data point to note: By 2016, over half of all US corporate profits were booked in seven tax havens: Bermuda, the Cayman Islands, Ireland, Luxembourg, the Netherlands, Singapore and Switzerland.

The big benefit: The OECD estimates that the minimum tax will result in $150 billion in additional global tax revenue every year. Taxing rights on more than $125 billion of profit will also shift to countries where profits are earned—from tax havens where they are currently declared.

Ok, so how will this work?

The new tax rules apply to multinational companies with annual revenues of more than $864 billion per year. So these are corporate giants, not startups or mid-sized companies.

Imposing a ‘top up’ rate: Companies will have to pay 15% on their profits in countries irrespective of where they declare their profits. So going back to the Apple example, say the company declares its profits in a tax haven where the rate is only 10%. Then the US—its home country where its headquarters are located—can ‘top up’ that rate by imposing an additional 5% tax on those profits. Tax havens would become pointless, since taxes dodged in the haven will still be collected at home.

PS: This will also hold if the reverse is true. If the company reacts by shifting its headquarters to a tax haven, it will still have to pay a ’top up tax’ in the country where its subsidiary is located. 

Closing the digital loophole: Technology companies do a huge share of their business in foreign markets, but often don’t pay taxes there. The new rules allow countries—where a business’s customers are located—to tax 25% of its “residual profits.” These are defined as profits in excess of 10% of its revenue. The aim here is to ensure benefits of the minimum tax don’t flow only to countries like the US—where most tech companies are headquartered. In turn, countries like India will stop imposing a digital tax on tech companies.

So this is a good thing?

It is certainly a good thing for governments which are struggling to raise tax revenue—especially in the wake of the pandemic. But there are many who criticise the plan, and from opposite ends of the political spectrum. 

One: The 15% minimum is well below the average corporate tax rate, especially in industrialized countries where it is 23.5%. So it may create a global race to the minimum instead.

Two: Most of the tax benefits accrue to richer countries where these companies are headquartered. This is why Nigeria, Kenya, Pakistan and Sri Lanka did not sign off on the OECD agreement. 

Three: The proposal contains exemptions from the 15% rate for companies that conduct actual physical activities in a given country—which will be in place for a grace period of 10 years. This may encourage them to move their business operations—and therefore also jobs etc.—to tax havens. 

Four: Free market advocates insist a minimum tax will discourage foreign investment in both developed and developing countries—taking away a vital incentive they can offer to attract business. And stifling the profitability of these companies will have a knock-on effect on the benefits that flow back to their home countries. Typical data point: When a US multinational increases hiring abroad, 67% of the time the company also increases employment in the US.

Big point to note: Signing a global agreement is all very well, but each country will have to pass domestic regulation that puts this minimum tax in place. And that will be an uphill task for many—especially the United States, where the Republicans remain fiercely opposed to the plan. As ABC News points out:

“U.S. participation in the minimum tax deal is crucial, simply because so many multinationals are headquartered there—28% of the 2,000 biggest global companies. Complete rejection of Biden’s global minimum proposal would seriously undermine the international deal.”

The bottomline: To quote the Washington Post: “A global minimum tax is more easily declared than enacted, and more easily enacted than enforced.”

Reading list

New York Times via The Telegraph reports on the G20 agreement. ABC News and The Hindu have very good explainers on the minimum tax. Washington Post reports on the falling corporate tax rate across the world. The Tax Foundation offers a detailed critique from a US perspective. Reuters reports on why those on the left are unhappy.