Last month, in a historic meeting of OECD countries, 130 countries of the world, which represents 90% of the global GDP, agreed to establish a new framework on international taxation. This new framework is meant to create a standardized international taxation system for top multinational companies engaged in business in multiple countries. The objectives behind this new framework, as per the statement provided by the OECD are 1) ensure that large Multinational Enterprises (MNEs) pay tax where they operate and earn profits 2) provide certainty and stability to the international tax system.
The 2 pillars of this framework are
- fairer distribution of profits and taxing rights among countries with respect to the largest MNEs, including digital companies.
- put a floor on competition over corporate income tax, through the introduction of a global minimum corporate tax rate that countries can use to protect their tax bases.
The first pillar will ensure that MNEs pay taxes in the countries where they have a significant market and earn their revenue from. MNEs, especially digital business like Google and Facebook have presence in every country of the world, in terms of customer base. However, they don’t have any physical presence in many countries, making it difficult to tax them in such countries. This called for taxes like GAFA tax i.e. Google, Apple, Facebook, Amazon tax in France and Equalization levy tax in India, and a Digital Service Tax in other countries. But this new provision will remove the need for such taxes.
Currently, it is proposed to apply this provision to Top 100 companies.
Global Minimum Tax
The second pillar of this framework is introducing a Global Minimum Tax on MNEs of 15% to stop competition between countries over who can offer companies the lowest rate — what critics call a “race to the bottom”.
A lot of countries move their business operations to countries that provide low or zero corporate tax rates (also known as Tax Havens). In our earlier articles, we have provided a list of such Tax Haven countries and an explanation of how charging nominal or zero tax benefits such countries.
To summarize them, a lot of countries that aren’t necessarily attracting naturally any business opportunities, need to provide low taxation to attract investments. Such countries include small, distant island nations, countries with low natural resources, countries with low economic development, and the need for infrastructure development among others.
Tax havens have been criticized a lot, as a medium of tax evasion by the rich and cause of reduction in local business and job creation. However, a lot of developed countries have used this method of low taxation to attract investment in the past. Now, the same developed countries are against it based on the fear that low taxes of other countries might affect their own economy.
The arguments given in favor of Global Minimum Tax are
- It will ensure that MNEs aren’t allowed to evade tax in their home country by getting themselves registered in Tax havens. According to some experts, a lot of MNEs thrive on making a living out of tax optimization and using their tax consultants, to hardly pay any tax anywhere in the world. Proponents argue that it is necessary to curtail such practices in order to have a fairer playing ground among MNEs and local businesses.
- Many countries have a low rate of corporate tax compared to personal income tax which creates a feeling of biasness towards big corporations against salaried individuals and small business owners.
- Developing countries use lower tax rates to lure foreign investment instead of creating a strong tax base with efficient administration. Proponents argue that it is necessary to curtail such lazy practices.
- Different tax laws create a lot of unnecessary complications and compliance requirements. In order to avoid difficulties of compliance and double taxation, countries need to enter into treaties with other countries known as DTAs i.e. double tax agreements. A global minimum tax rate will remove the need for such treaties.
However, even though there might be some truth in the above arguments, there are a lot of problems with a Global Minimum Tax that should be taken into consideration, especially from the point of view of small and developing countries and small business owners alike.
- Global Minimum Tax is a direct attack on the sovereign power of countries to tax their residents as they want. It deprives them of their principal tool to attract foreign investments in their country. As we said earlier, there are countries with very little resources, located in a remote, out of the supply chain location, and that have low human and infrastructure development. Such countries rely on low taxes to boost their investments. If they are forced to have a higher tax rate, they will lose out on one of their biggest investment attraction tools. It lowers the already poorer countries’ chances to get out of poverty.
At the time of writing, 6 countries have opted to vote against this framework. These countries include three EU countries (Estonia, Hungary, and Ireland), as well as Nigeria, Kenya, and Sri Lanka. 133 countries have agreed to the agreement.
- When MNEs are forced to pay higher tax, as historic evidences suggest, they tend to lower their expenses by cutting jobs, cutting down on pay raises for workers, delaying or scrapping investments in new machinery and equipment etc. to compensate for the loss. This harms the public at large of the country in which such MNEs operate.
- Companies aren’t the ultimate taxpayers, they are just a mode of collecting the tax from investors, employees, laborers, and lenders. If there is no corporate tax, then ultimately these incomes will be taxed as dividends, salaries, wages, and interest income respectively anyway. But the increase in corporate taxes falls in the end on the shoulders of the consumer. Who pay what is not decided by financial ministers but simply by the invisible hand of demand and supply. Basic economics. And if you don’t think that MNEs would actually pass on their higher compliance costs to its customers think again. Google is already passing on digital service taxes to advertisers for ads served in Austria, Turkey, the UK, France, Spain, India and Italy…
- Let’s be real honest here. Tax policies are a means for politicians to attract more voters. Therefore, governments are always hesitant to increase personal income tax due to their popularity and public perception. Taxing the corporates who can’t vote themselves and who are generally controlled by far less people doesn’t affect politicians’ popularity, especially in developing countries with socialist outlooks. However, higher corporate taxes are shown to cause a dip in your wealth even if you aren’t directly invested in them, by the way of pension plans, lower investments available for growth and job creation, the net amount of dividend income from personal investment in stocks.. etc.
- Taxing the big listed corporations has an adverse effect on the vision of small businesses. Big corporations also started as small businesses at some point in time. Higher tax on corporations discourage the current small businesses to expand their business into large corporations. This will hamper them and the economy to achieve economies of scale leading to job creation and development.
- There are plenty other tax exemption schemes available that have shown that even though there is no direct contribution in tax form, revenue can be created through other forms. Let’s take the latest 15 Digital Nomad Visas that were all created in the last year and for which some you can get a full tax-free year stay because countries have realized that people moving somewhere and spending money in the local economy actually contributes a lot to the economy and therefore, they chose to not tax them.
So why are we talking about MNEs when you’re a small business owner?
It’s no surprise that governments tend to try new tax rules first with the minority.. so whether that would be a wealth tax that only applies to high net worth individuals or a minimum global tax that first applies to MNEs and then, later on, might start including medium-sized enterprises, etc. That might very well be a possibility.
We also know that different countries shine for different reasons and that especially global citizens like digital nomads tend to choose the best that each country has to offer. So, does this all mean that there won’t be any more tax havens? Not really. In fact, no one is quite clear yet about the details and fine print and how the law will become operational. Which if the OECD nations can come to an agreement it won’t probably be operational until later in 2023.
The way the minimum global tax has so far been presented to the public it looks like governments might still be free to set corporate tax rates at any level, but if subsidiary profits are taxed at a lower rate than 15 percent in a particular country, the government of the country where the company is headquartered can apply a top-up tax to bring the tax rate applied to profits in the low tax country up to the 15 percent minimum.
So, no more tax havens?
Ha, I doubt it. Even though Tax Havens like Barbados have joined the agreement they may have also done so under a lot of international pressure. It wouldn’t be the first agreement that is drafted at the international level but then sees a completely different application once it goes through the whole national legislative system to effectively become law.
If you were planning to register your company in an overseas tax territory to enjoy lower corporate tax, as suggested by us in earlier blogs in detail, you might want to keep this new agreement in mind (although if you aren’t a MNE it shouldn’t just yet apply to you).
All is not lost, as there are a lot of detailed rules and regulations of this policy that are yet to be designed. These rules might have exceptions for small and developing economies as demanded by them. Further developments are yet to be seen.
If anything, I think our nomadic entrepreneurs need to be the least worried ones as they’re the ones that are flexible and quite mobile in terms of relocating themselves. But for those that are still living in high taxing Western countries and try to set up overseas structures to benefit from, you might want to pay closer attention to this new policy if it is successful.
We will keep you updated.
Thanks to Werner Heyvaert’s article on the Kluwer Tax Blog that inspired this blog post created for Global Citizens.
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