explained | Why do governments want a global lowest corporate tax rate?

the story So Far: as 136 countries entered into an agreement earlier this month to redistribute tax rights and implement a global minimum corporate tax on large multinational corporations. With the new agreement signed at a meeting of the Organization for Economic Co-operation and Development, countries seek to end tax competition that has forced global corporate tax rates to drop for years.

Why do governments want a global lowest corporate tax rate?

Large multinational corporations are traditionally taxed based on where they declare their profits, not where they actually do business. This allowed many large companies to avoid paying higher taxes in the countries where they do most of their business by moving their profits to lower-tax jurisdictions. So, for example, a US company such as Apple can avoid paying higher taxes in the United States by declaring its profits to belong to a subsidiary in Ireland, where tax rates are lower. This practice of profit transfer has affected the tax revenue of governments and forced them to act.

Why now?

Governments have actually been considering the idea of ​​a global minimum corporate tax for some time. Global corporate tax rates have fallen steadily since the 1980s when then-US President Ronald Reagan and British Prime Minister Margaret Thatcher introduced significant tax cuts to boost their economies.

The average global corporate tax rate was over 40% in the early 1980s and fell below 25% in 2020 as governments competed against each other to lower their tax rates to attract businesses . This “ten to the bottom” has forced the losing governments to wake up. Many believe that the most immediate trigger for the current tax settlement may be the COVID-19 pandemic, which has badly hit economies and dented governments’ tax revenues. US President Joe Biden is also trying to raise at least $3 trillion in funding for his social welfare programs.

What does the new agreement say?

The new global tax agreement consists of two pillars, of which the second is the most important. It capped the corporate tax rate at 15% By allowing governments around the world to levy “top-up” taxes on domestic companies that pay less than 15% tax on profits declared overseas. Therefore, if a US company pays only a 5% tax on profits declared as its subsidiary in Ireland, the US government will now be able to impose an additional 10% tax on these profits. This is expected to add about $150 billion in additional annual revenue to governments’ budgets.

The deal allows the government to levy a top-up tax on a subsidiary of a foreign company if it declares profits through its home headquarters in a different country and pays less than 15% tax on those profits. . The latter rule may prevent companies from trying to evade taxes by relocating their home country to lower tax countries.

The first pillar of the agreement deals with the basis on which the taxes should be collected. Traditionally, companies are taxed based on where they declare their profits, not on the basis of where they do business. Today, with many large technology companies taking a substantial portion of their business overseas, many countries have begun to demand a share in their profits. Therefore, one of the pillars of the new agreement ensures that 25% of residual profit, defined as profit in excess of 10% of revenue, is allocated to tax to the foreign country concerned. This is expected to help transfer more than $125 billion of tax benefits to countries where MNCs actually make their profits.

Will this help the global economy?

Proponents of the global minimum corporate tax agreement believe it will help prevent a “downward race” as countries compete against each other to cut taxes to attract businesses. They believe this will increase tax revenue and help governments invest in social development. However, others have not been affected. The non-profit organization Oxfam International has criticized the deal, arguing that the minimum corporate tax rate of 15% is actually too low. It has also been argued that most of the taxes collected under the new setup will go to richer countries and increase inequality between countries.

Other critics believe that a global minimum corporate tax could kill off the various economic benefits that come with tax competition between countries. They see tax competition as the good force that forces governments to keep taxes low and helps the world economy grow. They defend so-called tax havens such as Ireland, Switzerland, Bermuda and other countries, saying they benefit citizens of high-tax countries. Without tax havens, he argues, companies would be subject to much higher taxes in their home countries, which in turn would stifle their ability to serve consumers in their own countries.