The measure aims to deter multinationals from shifting their profits internationally to benefit from lower tax rates. However, although it’s been reported as a simple headline, what does it mean in practice?
Earlier this month, the Organisation for Economic Co-operation and Development (OECD) announced that 132 countries, representing more than 90% of global gross domestic product (GDP), have agreed to back plans for a global minimum Corporation Tax rate of 15%. These countries include Bermuda, the Cayman Islands and the British Virgin Islands, all traditionally thought of as tax havens.
The Two-Pillar approach
It’s planned to implement the changes via a two-pillar approach. Pillar One will affect only the very largest multinational businesses and aims to reallocate profits (and taxing rights) from the jurisdiction in which they are reported to those jurisdictions where they actually operate and have customers. Pillar Two looks at the minimum global Corporation Tax rate paid by the group overall to address distortions arising from shifting profits to low tax jurisdictions purely to secure that lower rate.
Increasingly, income from intangibles such as software and royalties on intellectual property patents and drug patents has allowed companies to pay lower taxes away from their traditional home countries.
Pillar One is directed at the top 100 companies globally with worldwide turnover exceeding €20 billion (a lower threshold will be considered after a review) and a pre-tax profit margin above 10%. Above this threshold, between 20% to 30% of profits will be taxed in the countries where the company operates and earns its profits. An additional amount (primarily based on existing Transfer Pricing principles) will standardise the earnings considered to be from marketing and distribution activities.
This solution allows a move away from traditional tax legislation where profits of a foreign company are only taxed in another country where the foreign company has a physical presence. Instead, it looks at customer and market locations to address the challenges of taxing operators in the digital economy.
Pillar Two is the new minimum Corporation Tax rate of 15% and applies to groups with turnover above €750 million. Under this regime, if companies pay lower taxes in one country, the tax authority in the parent company’s jurisdiction will impose a top-up tax to achieve a global tax rate on those profits of 15%.
This will apply on a country by country basis, so a higher tax rate of, say, 25% in Country A cannot be averaged out against a lower tax rate in Country B of 12% to give a 15% effective global tax rate.
The OECD and national governments still have many obstacles in introducing legislation and getting new rules defined before their introduction. However, the plan is to agree a full framework at the next meeting of the G20 in October 2021. Unsurprisingly, OECD members such as Ireland, Estonia, Cyprus and Hungary that already have a low Corporation Tax rate or other incentives to attract inward investment aren’t fully signed up.
If things go according to plan, it will be interesting to see how global Corporate Tax rates develop. A jurisdiction offering incentives to multinational subsidiaries will see these incentives neutralised by the Parent Jurisdiction applying a Pillar Two levy. Therefore, a possible outcome may be for those jurisdictions with lower tax rates or other Corporate Tax incentives to increase their tax rates to the global minimum and secure that tax revenue for themselves. It’s notable, however, that these changes affect only Corporation Tax rates, so there may be a shift to other forms of tax-based incentives, such as employment taxes by jurisdictions to attract new inward investment.
More specifically, many tax regimes will likely change to remove duplication that these rules would otherwise create. As a result of Pillar One, the EU Commission has already announced that the proposed Digital Services Levy has been put on hold. Similarly, UK tax measures that tackle diversion of profits such as the Digital Services Tax and Diverted Profits Tax will probably be superseded or, at the very least, refined to accommodate these new rules.