But the devil is in the details. If your client or company is impacted by new global tax rules, focus on your tax base not your tax rate
By Cecil Nazareth | guest columnist
Treasury Secretary Janet Yellen announced last week that 130 of the 139 countries in the Organization for Economic Cooperation and Development (OECD) agreed to a conceptual framework to overhaul the global tax system. Those countries represent about 90% of the global GDP.
By far the most talked about provision is the proposed minimum income tax rate of at least 15% on multinational corporations, regardless of where they operate. The OECD estimates that governments lose between $100 billion and $240 billion in revenue to tax avoidance each year. The new plan, likely to be finalized this fall, has the potential to raise $150 billion in extra tax revenue annually, according to OECD.
In a rare display of unilateral support, Russia, China and India joined the U.S. and other G20 countries in supporting the global minimum corporate tax. That’s a huge step forward since China and India previously had concerns about the proposed overhaul. In fact, of the nine nations that refused to sign the tentative framework, only Ireland is a significant player in the global tax (avoidance) arena since it is the European headquarters for most of the large U.S. tech companies. The others are Barbados, Estonia, Hungary, Kenya, Nigeria, Sri Lanka, St. Vincent, Peru and the Grenadines.
Rationale behind the overhaul
As countries seek to attract more foreign investment, Yellen among others have long argued that they drive their tax rates lower as they compete to create the most favorable environment for businesses, which in turn drives tax revenues down for everyone—hence to so-called race to the bottom.
Steven Plotnick, an international taxation expert of counsel to McLaughlin & Stern, told me the other day that “the minimum global by-country corporate tax rate is designed to limit the use of tax havens to shield profit of multinational companies, while potentially giving smaller countries more tax revenue from the largest corporations.” By creating a more level playing field, Plotnick said the minimum global tax rate, which would now be the least amount applied to companies’ overseas profits, would eliminate racing to the bottom in terms of corporate taxes.”
As detailed in my forthcoming book, Global Accounting: 2021 & Beyond, corporations have long used a myriad of tactics to reduce their tax liability, often by shifting profits and revenues to low-tax countries such as Bermuda (7%), the Cayman Islands (0%) or Ireland (12.5%), regardless of which country or jurisdiction a sale is made. Multinationals are highly trained profit-shifters. Amazon, Google, Nike, Fedex and other U.S.-based multinationals generate billions of dollars in profit and pay little or nothing in corporate tax. That also deprives the U.S. of tax revenue it should have received in exchange for providing good infrastructure, law enforcement and military protection for companies doing business here.
For years, the OECD has pushed to eliminate corporate strategies that it believes “exploits gaps and mismatches in tax rules to avoid paying tax.” The global minimum tax would apply to companies’ foreign earnings, meaning that countries could still establish their own corporate tax rate at home.
But it’s not that simple.
It’s very easy for companies to move intangibles across borders and pay tax on it at the lowest possible rate. The U.S. isn’t the only country that’s been trying to curtail this process, but it hasn’t been easy.
For instance, France came up with a digital tax a few years ago in which they taxed all the big U.S. tech companies (Amazon, Google, Facebook) claiming those behemoths were doing business in their countries but not providing those countries with any tax revenue. However, after the European digital tax was passed, the U.S. retaliated by imposing tariffs on French wines and other popular goods that were being exported to the U.S. market, making those goods significantly more expensive to U.S. consumers, restaurants, and liquor distributors than they used to be.
So who wins? Nobody! Hence the proverbial race to the bottom.
Adapting tax policy to the modern world
I believe 15% is a reasonable corporate tax for multinationals to pay. When international tax laws were written a century ago, they were based on what’s called a “physical presence test.” In other words, wherever a company had a permanent physical establishment, they would have to pay tax to that jurisdiction.
But physical presence has no meaning in today’s digital world. For example, Amazon is selling product in France, Germany, and other European nations, but it doesn’t have a physical office or manufacturing facilities in those countries. Amazon, at a minimum, has major warehousing and distribution structures in France. It makes a lot of money selling to consumers in those countries, so it should pay a base level of tax to conduct business there. I’ve found that it’s all about moving from a physical presence test to a “revenue-earned” model. The logic being, if you earn money in a particular country, that country should get a fair share of the global minimum tax you pay.
Advantages of the global minimum tax
- It should eliminate significant profit-shifting to low-tax countries. According to Plotnick, who is also an adjunct professor of partnership taxation at New York Law School, with each country having at least a 15% corporate tax rate, most companies would not feel as incentivized to move their intellectual property abroad or otherwise shift profits from one jurisdiction to another. “Of course, 15% is less than the current U.S. corporate tax rate of 21%, so there will still be some incentive to shift profits,” noted Plotnick. But overall, assuming enhanced tax revenues are a positive development, all countries should benefit, he added.
- It eliminates trade wars. With every company paying a significant effective corporate tax rate on income regardless of where that income is earned, it would eliminate silly disputes in which you have a digital tax (i.e., France) being imposed by one country and retaliatory tariffs (i.e., United States) on the other. “Unfortunately, as the ’income base’ upon which each company imposes this 15% minimum tax has not been explicitly defined, it is unclear that manipulations cannot still continue to occur,” Plotnick cautioned.
- It makes it easier for multinationals to plan their tax burden so they can allocate profits and taxes accordingly.
Which multinationals will be impacted?
Roughly four in five Fortune 500 companies (80%) are based in the United States. If we shift to a revenue model instead of the traditional physical presence test, then a U.S. multinational like Apple Computer, currently paying 12.5% income tax to Ireland would have to pay an annual additional 2.5% minimum tax to the United States. The United States would still be entitled to another 6% tax on dividends when a dividend is paid from Ireland to the United States. As a result, there would still be some tax incentive to maintaining a presence in Ireland. However, Ireland may not like that arrangement.
According to Plotnick, if Ireland decides to bump its corporate tax rate up to 15%, then a company like Apple would presumably have no tax incentive to be in Ireland as opposed to any other 15%-taxing jurisdiction. Thus, the overseas countries Apple then chooses to operate in going forward will be driven by non-tax business factors (e.g., qualified work force, manufacturing capabilities, etc.). But, Plotnick said, to the extent that Apple continues to operate overseas and does not bring jobs and operations back to the United States, the U.S. could end up receiving less in tax revenues as creditable taxes paid by Apple (for example) would now be increasing to 15% on its overseas income.
“Of course, countries do not always define income in the same manner (see Challenges, below),” noted Plotnick. For example, the United States allows for “bonus depreciation” and certain income to be tax-exempt, while other countries do not. So, the exact “interplay of this 15% minimum tax” remains to be seen, Plotnick added.
Challenges
The global minimum tax has challenges, of course. What should a company’s taxes in each country be based on? Will it be on net profits, allocated profits, sales, advertising, or some other metric? As Plotnick observed, the United States presumably believes its 21% tax rate exceeds the 15% global minimum. The U.S. may believe it does not need to change its definition of income that’s subject to tax or how that income is sourced (U.S. or foreign) to comply with the proposed 15% global minimum tax–perhaps apart from getting rid of the artificial deduction for Foreign Derived Intangible Income (FDII).
From where I sit, the global minimum tax makes sense at the 30,000-foot level, but there’s a lot of finetuning to do. As always, the devil is in the details.
Again, the tax base (not the tax rate) is what will be the most challenging aspect of the global minimum tax. That’s because it’s very unclear what you will base the 15% tax on. If it’s based on revenues, then you’re essentially talking about a sales tax. And nobody likes the sound of that.
Also, we still need Congressional approval for the global minimum tax. It all comes down to members resolving two critical questions:
1. What are we giving up by moving our tax base outside our borders?
2. What are we getting in return?
If we believe that our 21% corporate tax rate satisfies the 15% minimum, “I think we might just be done,” suggested Plotnick. “If we want to impose a new top-up regime to add to Subpart F and GILTI, to make sure income from certain jurisdictions are subject to a 15% tax, then that would require legislation, but I am not sure that part is required necessarily,” Plotnick added.
In either case, I’m confident the global minimum tax is not likely to come to fruition until 2023. Multinationals are going to benefit greatly by this type of simplified, across-the-board tax, other than perhaps having to pay more in tax currently. As with any new legislation there will be winners and losers. Countries that were not able to collect tax on multinationals in the past may now be able to collect some money and improve their tax base. But Ireland, Cayman Islands and other low-tax havens could see the tax coffers shrinking at a time when they are still digging themselves out of the COVID-induced recession.
Conclusion
This fall, there should be a more formal sign off on the global minimum tax by 130-plus countries that support it. Obviously, there will need to be some fine-tuning, but moving to a revenue-based model from the century-old physical presence test is much more valid in this inter-connected digital age.
Taxing multinationals at 15 percent would still leave them facing a lower rate than the average American pays in state and federal income tax. But it’s a step in the right direction and halts the suicidal tax race to the bottom.
Cecil Nazareth is a partner with Nazareth CPAs–Global Accountants, a CPA firm with offices in New York, New jersey and Connecticut. The firm specializes in international tax and accounting, particularly for SME companies, subsidiaries of foreign parents and high-net-worth families in India and the U.S. Nazareth is a member of the AICPA’s Global Issues Task Force and author of the books, International Tax & Compliance Handbook and Global Accounting: 2021 & Beyond.
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