Taxes are an inevitable thorn for firms and companies around the world. The more you make, the more you have to shell out to the authorities. Money that is hard earned is taken away. Recently, the Organization for Economic Co-operation and Development (OECD), an international body designed to ease economic activities between countries, came up with a plan that would see offshore companies paying more taxes than they currently are.
But what prompted this action in the first place?
Tax Havens
Many Western countries like the United States have higher corporate taxes than others and for a justified reason (to some extent). Large companies make millions and even billions in revenues and the profits trickle down very slow to the employees.
As such, corporate taxes are implemented so that the money can be collected and used for welfare programmes and other basic facilities for the citizens. Though in concept this does sound good, but the reality is far different.
As taxes increase, it becomes difficult for corporations to save profits. Firms and companies for years have been using a method to lower their taxes and that is to move the company offshore. Countries like Belize, Ireland and Estonia offer much lower corporate taxes and many large companies (Google, Facebook, Microsoft etc.) have shifted their headquarters to these.
Though there is nothing illegal about it, the US is on a bullying campaign and wants these companies to pay up. How does it plan to do it? Let’s find out.
Global Minimum Tax
A world spanning minimum tax has been in the discussions for many years and the OECD has been mulling over it since 2019. Recently, this has progressed when in the last week of June this year, the OECD sat down and discussed it.
The result is that member countries have agreed to create a uniform tax regime so that no matter where a company is registered and incorporated, it cannot evade taxes anymore. The outline, if enforced, would mean that though US corporations outside the country that are paying a lower tax to Uncle Sam, they would end up paying a higher tax in the jurisdiction they are registered in.
The proposal includes a suggestion of a global minimum 15% tax, no matter where. Of the 139 OECD member countries, an overwhelming 130 have agreed to formalize this.
Global Pillars
The proposed tax regime consists of two parts, called the pillars. Each pillar is designed with its own agenda and has different elements within it.
Pillar 1
Taxes will be imposed on offshore companies which have more than EUR20 billion revenue generation and claim to have more than 10% in profit margins. The tax will be on profits these corporations generate from jurisdictions in which they have sales. This means that no matter where the multinational corporation exists on paper, it will have to pay taxes if they intend to do business in another country. The reason is explained as a fairer distribution of taxes to all countries where a company might have a presence in.
At the same time, the proposal does acknowledge that some industry sectors will be unduly taxed due to the very nature of their operations and are exempt from this pillar. Sectors like oil, gas and mining operations are in the exempt list.
Pillar 2
The second pillar is where the proposed minimum global tax of 15% resides. This is effectively split in three different conditions or rules.
The first is an inclusion rule which will be used to gauge how much of a foreign income will be included in the second pillar (the 15% tax). If it is lower, then more taxes will be imposed through the first pillar to compensate. The tax will be applicable to foreign profits (after 7.5% deduction on tangible asset and payroll, which will decrease to 5% after 5 years).
Secondly, an under-taxed payment rule will be enforced to tax all cross-border payments done where companies move money out of one jurisdiction to their low taxed parent offices. This is to counter any plans to shore up reserves in tax haven places.
Thirdly, a subject to tax rule will allow countries to enter agreements and impose higher taxes on payments which are originally low in their jurisdiction (the proposed increase is anywhere from 7.5% to 9%)
What Does it All Mean?
While the sudden announcement is only a proposal at the moment, this is going to create reverberations far more than one would expect.
First, a global tax regime that is uniform and seamless means that member countries will have a far easier time to cooperate and start gaining grounds on corporations that are avoiding justified taxes by registering themselves in countries and nations that have lower taxes.
This is especially targeted at mega corporations like Google and Facebook which are essentially US born, but have moved their headquarters to lower taxed jurisdictions like Ireland and end up paying far less than their counterparts who don’t have offshore headquarters. The proposal would make it difficult for companies to avoid paying their due taxes as the more they serve a country, the more they end up paying, negating the moving of the offices in the first place.
On the other hand, having this new taxation system will impact global economies. Countries that have little else in their economic infrastructure employ tax haven tactics to boost their economies. Estonia, Belize etc. have no other major activities that can sustain their economy, which is largely now centred on their ability to provide tax relief. With this gone, these countries will be hit hard.
Though they might be able to find loopholes to release the pressure, the fact of the matter is that the global minimum tax will be changing the economic and financial landscape in the coming months and years significantly, both for many countries and multinational corporations.
JUL
2021
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