No Better Time for a Global Corporate Tax Deal

By Frank-Jürgen Richter

September 3, 2021

Seven of the world’s ten largest companies by market capitalization are from the technology sector. As digitalization continues to become more central to every aspect of human life—a trend accelerated in no small measure by the COVID-19 pandemic—technology companies look set for continued growth, and dominance.

The growing prominence—and clout—of technology companies has coincided with growing disgruntlement over their seeming avoidance of tax payments by shifting digital revenues and profits to low-tax jurisdictions.

While a global minimum corporate tax rate has been mulled over by countries for close to three decades now, we’re finally seeing the wheels set in motion, with governments willing to collaborate to ensure legal tax loopholes are shut and large companies pay their fair share of tax.

This is an important development, particularly as it comes at a time when government expenditures have skyrocketed (where possible), given increased spending on public healthcare facilities and the procurement of vaccines, while economic activity has stuttered for the better part of 2020 and 2021.

A Race to the Bottom

It is not uncommon for multinational companies dodge taxes by shifting earnings to tax havens or to countries with low tax rates and significantly mitigate their tax exposure. This has arguably been one of the downsides of an increasingly globalized economy where large companies have footprints in dozens of countries and profits easily relocated across borders as it suits their interests.

The problems have become more acute in recent years as the global economy has become increasingly digitalized, making it particularly difficult to determine the source market of revenues in many instances.

For instance, when a company providing cloud services is headquartered in Ireland, where are its revenues from users located in China or India taxable? There are no clear answers yet, which means large tech companies have been able to selectively book their profits in friendly jurisdictions, and that the countries in which these companies actually earned their revenues—often developing countries—are losing out on a sizeable share of tax revenue.

This is but a simple example of the growing tax-related complexities that regulators are grappling with.

What’s Being Proposed?

Two months ago, G7 finance ministers endorsed a global minimum corporate tax rate of 15% or more on the 100 biggest corporations globally in an attempt to discourage countries from trying to attract these companies to their shores.

A many as 35 countries had a top corporate tax rate of less than 15% in 2020, according to the Tax Foundation, providing ample options to multinational corporations to pay less tax.

Commenting on countries lowering their corporate tax structures, often competing to do so, US Treasury Secretary recently called this phenomenon “a global corporate tax rate to the bottom”. She added: “I fear this race to the bottom globally with respect to corporate taxes is depriving economies of the revenue they really need to invest in infrastructure, education, research and development and other things to spur growth and also impact corporate competitiveness.”

In July this year, 132 countries, representing about 90% of global GDP, agreed implement a new tax system, following meetings conducted by the G20 and the OECD. According to this new proposal, which is expected to come into effect in 2023, an effective global minimum corporate tax rate of 15% will be set on corporations that have more than $890 million in annual revenue.

The proposed system also looks to redirect some taxes that multinational corporations pay to countries in which they make revenue by selling their products and services rather than just in the country they are headquartered in.

While there are a few countries with low tax rates that oppose this proposal—such as Estonia, Ireland and Hungary—it has received endorsement from across the political spectrum domestically within countries, and across countries. French Finance Minister Bruno Le Maire recently called the proposed system “the most important international tax agreement in a century.”

The Proposed Framework

According to the OECD, the global minimum corporate tax is framed under two broad spheres – Pillar One and Pillar Two. Under Pillar One, over $100 billion in tech company profits will be redistributed to ‘market jurisdictions’ annually. Pillar Two outlines a minimum tax rate of 15 percent.

Earlier in July, a White House statement stated that “with a global minimum tax in place, multinational corporations will no longer be able to pit countries against one another in a bid to push tax rates down and protect their profits at the expense of public revenue.”

“They will no longer be able to avoid paying their fair share by hiding profits generated in the United States, or any other country, in lower-tax jurisdictions,” it added.

There are still several spheres of the proposed framework being deliberated upon although a wider agreement has been reached. Ironing out these details is going to be a complicated affair, particularly as it entails the redistribution of tax revenue. Some of these details are expected to be ironed out at the next G20 gathering later in the year.

Conversations around it being a “top-up tax” don’t make the proposal easy to implement either, given the tax proposal requires a top-up tax to be paid at the parent company level if income earned lower in the ownership chain has been taxed at a rate lower than the set global minimum.

The framework, if successfully implemented, has the potential to benefit several large developing economies such as China, India, Brazil and Indonesia where the large technology companies make substantial revenues.

A Fine Balance

A look back into the recent past shows the average corporate tax rate globally has been lowered significantly since 1980. When weighted by GDP, the average global corporate tax rate stood at 46.5% in 1980, according to Tax Foundation, but has since been reduced to 23.9% when weighted by GDP.

The broad reduction in the global tax rates has benefitted large companies and their shareholders. It has also helped many countries draw investment as they have looked to attract companies by lowering their tax rates. In the process, however, we have witnessed a race to the bottom, with countries looking to outdo one another, and multinational companies happy to oblige.

Perhaps the pendulum has swung too far the other way, something governments now realise. However, they must also ensure that they don’t go too far the other way now, punishing multilateral companies and disincentivizing investment and innovation in the process, particularly given the fragility of the global economic recovery.

Photo caption: Dealing with tax avoidance is a difficult challenge for governments given the complexities involved, but some progress has been made in recent months.