On October 31st, 2021, years of negotiation between the members of the Organisation for Economic Co-operation and Development (OECD)/G20 inclusive framework on tax base erosion and profit shifting (BEPS) finally materialised in a new agreement in the form of a global minimum corporate tax rate of 15% that is set to take action by 2023. The agreement marks a significant development in the field of international taxation and will have far reaching implications for multinational enterprises (MNEs) and governments all over the world. So far 137 countries have agreed to the global minimum corporate tax rate of 15% which will be a key player in counteracting tax avoidance by setting a floor on tax competition. This way multinationals can no longer escape taxation through profit shifting and base erosion, and is said to generate an additional $150 billion in global tax revenue per year.
Tax avoidance has previously been difficult to indict as it reads between the lines of the law and interprets in such a way as to minimise the tax liability of MNEs. Thus in practice, those involved in active tax avoidance do not strictly speaking break the law, but do not abide by the spirit of the law either. Its ambiguous nature has encouraged multinationals to adopt this strategy as a way to alleviate their tax base, undermining the integrity of the law, tax treaties and democracy as a whole. This is especially devastating for developing countries whose existing challenges associated with tax collection hampers the funding of public expenditures. Add to this a loss of corporate tax revenue, their economic development is limited to a great extent. The COVID-19 pandemic has had additional adverse effects on the global economy and exacerbated the incessant demand for scarce resources to tackle the dual health and economic crisis that have had a disproportionate impact on low-income and emerging markets. The difficulty in financing the recovery of the COVID-19 pandemic has motivated policy makers to take the final steps in a new deal that will require MNEs to pay their ‘fair share’ at last.
The global minimum corporate tax rate will eliminate the freedom to lower the corporate tax rate below a certain threshold, and will apply to MNEs with global revenues exceeding €750 million. Countries like Bermuda and the Cayman Islands who are notorious for their 0% corporate tax rate must renew their advantageous tax status to meet the standards of the new deal, eliminating many of the incentives to shift profits through a letterbox company. Additionally, under Pillar I of the BEPS project, MNEs are required to pay tax to the jurisdiction in which they generate profit irrespective of their physical presence, targeting digital companies including ‘big tech’. This policy leads to greater long-term sustainable economic development whereby the corporate tax revenue that is generated, creates a more tolerable environment for investors by stimulating growth and innovation. Former Treasury Secretary Larry Summers has even gone as far as to call it “the most important economic agreement of the 21st century”.
Similarly, Janet Yellen, the United States Secretary of the Treasury as of January 2021, has been a strong proponent of the new tax deal and tweeted the following in response to the “historic agreement”:
“This deal will remake the global economy into a more prosperous place for American business & workers. Rather than competing on our ability to offer lower rates, America will now compete on the skills of our people, our ideas & our capacity to innovate—which is a race we can win.”
Levelling the playing field in this way will promote a healthier form of international competition, i.e. competition on the basis of fostering economic growth through increasing the quality of labour and capital. The ever-lasting ‘race-to-the-bottom’ has seen countries lower their tax rate in an attempt to attract foreign direct investments. This loss of corporate tax revenue is subsequently compensated by placing a higher tax burden on individuals, thereby generating a greater disparity between the wealthy and the poor, contributing to issues of inequality and poverty. Inequality in the distribution of income and wealth continues to be a prominent issue, and is accelerated by a set of rules that favour large corporations yet ignore the interests of the average person. The new proposal will finally put an end to such a system by implementing a floor of 15% which MNEs must adhere to.
However, the attitude surrounding the prospect of a global minimum tax rate has previously been rather sceptical. The OECD in article 1.24 of their 2010 ‘Review of Comparability and of Profit Methods’ concluded the following on a global minimum tax rate: “It presents enormous political and administrative complexity and requires a level of international cooperation that is unrealistic to expect in the field of international taxation.” One such complexity was the precarious task of establishing the rate that the global minimum would take on. Initially, the Biden administration advocated for a rate of 21%, thereby essentially doubling the Irish 12.5% making Ireland a less favourable location for multinationals and deterring the influx of capital. Finding common ground on an agreement with this many players has been a bumpy road, and still a number of countries do not agree to the terms of a global minimum corporate tax rate of 15% including Kenya, Nigeria, Pakistan and Sri Lanka.
These countries have in place their own digital service tax (DST) on certain digital services which have seen a rise in popular demand over the past two years. Such taxes will have to be given up in support of a more unified approach in the form of a global minimum rate. The pitfall here is that the new deal only applies to roughly 100 of the biggest companies whereby the revenues collected will be redistributed for the most part back to the biggest economies where the companies headquarters are located. Is giving up a more attainable source of tax revenue in the form of digital service tax really the right decision when there is no guarantee that the revenues coming from the new deal are substantially higher? The question arises if the OECD must lead these negotiations at all, or if the United Nations is better equipped to ensure equal footing for all parties involved.
Nonetheless, the European Commission has acted swiftly on the prodigious global tax rate, by taking strides towards developing regulation for the 27 member states of the European Union (EU). The global minimum tax rate, as far as the EU is concerned, will therefore not stay an empty formality or ‘show piece’, but will ignite sooner rather than later an immediate effect on the multinationals, creating a well-needed shift of the burden of taxes from citizens and small businesses to the big corporate world. Whether or not a global minimum corporate tax rate of 15% is the optimal solution, the agreement has been an achievement in its own right: It is a big step towards recognizing the need for a united effort against tax avoidance.