Corporate tax avoidance costs countries between $100 billion and $240 billion a year, equivalent to 4-10% of global corporate income tax revenue, according to estimates by the Cooperation Organization and Economic Development or the OECD.
Developing countries are disproportionately affected as they tend to be more dependent on corporation tax than advanced economies.
The existing international tax rules are based on agreements concluded in the 1920s and are today enshrined in the global network of bilateral tax treaties. But they present two problems.
The first is that the old rules provide that the profits of a foreign company can only be taxed in another country where the foreign company has a physical presence. But in today’s digitalized world, multinational companies often conduct large-scale operations in one jurisdiction with little or no physical presence.
The second problem is that most countries only tax the domestic business income of their multinationals, but not foreign income, assuming that foreign business profits will be taxed where they are earned. The growth of intangible assets, such as trademarks, copyrights and patents, and the ability of companies to shift their profits to jurisdictions that impose little or no tax, means that the profits of multinationals often escape scrutiny. ‘tax.
This situation is further complicated by the fact that many jurisdictions engage in tax competition by offering reduced taxation – and often zero taxation – to attract FDI.
The OECD/G20 Inclusive Framework, which has 140 members, has been mandated to provide a solution to these two problems in 2021.
And in October 2021, 136 countries and jurisdictions representing over 90% of global GDP, including India, reached a landmark agreement in October 2021 on a global minimum corporate tax rate. Known as the two-pillar solution, it ensures that large multinationals pay taxes where they operate and make profits.
Each pillar fills a different gap in the existing rules that allow multinationals to avoid paying taxes. Members of the Inclusive Framework have set 2023 as the ambitious deadline for the entry into force of the new international tax rules.
Under the first pillar, 25% of the residual profits of around 100 of the largest and most profitable multinationals will be reallocated to the market jurisdictions where the corporate users are located. Residual profit is defined as profit above 10% of sales. The first pillar applies to multinational groups whose annual worldwide turnover exceeds €20 billion, which can potentially be reduced to €10 billion, and whose pre-tax profit exceeds 10% of turnover. ‘business.
Each year, the taxing rights on more than $125 billion in profits would have to be reallocated to the countries where the multinationals sell their products and provide their services, where their consumers are. The first pillar also involves the removal of Digital Services Taxes (DSTs) and similar relevant measures, to prevent harmful trade disputes. Meanwhile, the second pillar provides for an overall minimum tax of 15% on corporate profits.
This will apply to multinational groups whose annual worldwide turnover exceeds 750 million euros and, as such, thousands of companies will be subject to it. Governments around the world will impose additional taxes on the foreign profits of multinationals headquartered in their jurisdiction at least at the agreed minimum rate.
This means that if a company’s profits are untaxed or lightly taxed in one of the tax havens, its home country will impose an additional tax which will bring the effective rate to 15%. Governments could always set whatever local corporate tax rate they want.
An exclusion allows countries to continue to offer tax incentives to promote business activity with real substance, such as building a hotel or investing in a factory.
The global minimum tax is expected to generate approximately $150 billion in new global tax revenue each year. The cumulative impact of the two pillars means that tax havens would no longer exist since the taxes avoided in the haven would be collected at home.