The recent agreement by 131 countries to reform international corporate taxation is not the end of the road. But to bring about a more equitable outcome, developing countries must now push for a higher global minimum tax rate and a bigger reallocation of taxing rights, and refuse mandatory arbitration.
NEW YORK/NOTTINGHAM – The July 1 agreement by 131 countries to establish a global minimum tax rate of at least 15% for multinational corporations (MNCs) and reallocate taxing rights is a step forward. But the deal as it stands represents another missed opportunity to deliver an equitable outcome for developing countries.
It is good that multilateral efforts to reform global taxation are back in favor. This is largely because US President Joe Biden’s administration wants to end the race to the bottom in corporate tax rates – a contest that has benefited only tax havens. In most cases, lower tax rates not only failed to attract new investment to countries, but also deprived governments of the funds they need for social objectives and infrastructure improvements.
But the new tax deal reflects the imbalances in global power relations. G7 countries put the agreement they reached last month to the 139 countries that are part of the OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting. Faced with a take-it-or-leave-it choice, most developing countries agreed, despite significant reservations. But a handful – including Nigeria, Kenya, and Sri Lanka – did not sign up. And even some of those who did made it clear that the negotiations were not over.
Several significant issues remain. The first is that the proposed minimum tax rate of 15% is too low to deter profit-shifting by MNCs. This reflects several developed countries’ preference to protect their own global firms rather than follow the lead of the United States and Argentina, which had called for a minimum tax rate of 21%, and of many African countries, which proposed a 20% rate. And for most countries in Latin America or Africa, which had average corporate tax rates of 26% and 27%, respectively, in 2020, a global minimum rate of around 15% would do little to reduce incentives for profit-shifting. Several countries may thus unilaterally adopt a higher minimum rate.
Furthermore, under the proposal agreed at the OECD, most of the additional tax revenues will go to MNCs’ home countries, not to the so-called “source” countries where these companies do business and generate profits. A number of developing economies want source countries to have priority in applying the minimum tax, particularly to MNCs’ interest earnings, royalties, service payments, and capital gains. The current deal would allow them to apply the minimum tax only to interest, royalties, and a set of payments yet to be defined.
The amount of revenue the minimum tax generates will depend on the rate. This is vital for developing countries. A recent study by the EU Tax Observatory shows that with a 15% tax rate, Mexico, South Africa, and Brazil stand to gain an additional €500 million ($592 million), €600 million, and €900 million, respectively, of additional corporate income tax revenues in 2021, compared to €900 million, €2 billion, and €3.4 billion, respectively, with a 21% levy. The 25% minimum rate advocated by the Independent Commission for the Reform of International Corporate Taxation would yield an extra €1.3 billion for Mexico, €3 billion for South Africa, and €7.4 billion for Brazil.
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The OECD agreement also introduces a formula to allocate MNCs’ global profits for tax purposes. But it would apply only to firms with annual global turnover exceeding €20 billion and profit margins of at least 10% of revenue. Moreover, only 20-30% of their so-called “residual” profit above that threshold would be subject to tax in the countries where it is generated. This new rule may therefore generate less than $10 billion of additional revenue globally per year.
Developing countries’ main demand throughout has been for a meaningful reallocation of taxing rights to source countries. The G-24, the major grouping of developing economies in the talks, has called for 30-50% of residual profits to be reallocated, while the African Tax Administration Forum (ATAF) is now asking for at least 35%.
A simpler solution would be to allocate MNCs’ global profits among countries by a formula based on key profit-generating factors such as employment, sales, assets, and resource use. But previous demands by both the G-24 and the ATAF to apportion a percentage of all profits, whether routine or residual, to source countries have been rejected.
Another problem is that signatories to the OECD agreement are being asked to remove unilateral measures such as digital services taxes. Many developing economies are not happy about rescinding these levies, or about limiting their options to tax digital MNCs in the future.
The final concern is the demand that developing countries accept mandatory arbitration of disputes. Many have historically regarded this as an infringement on their national sovereignty. They also point to nontransparent outcomes and prohibitive costs, and the fact that most arbitrators come from developed countries.
But the July 1 announcement is not the end of the road. Although the G20 is likely to endorse the proposal this week, negotiations will continue, with a final agreement expected in October. To change the outcome, developing countries must now push for a higher global minimum tax rate and a bigger reallocation of taxing rights, and refuse mandatory arbitration.
The fight for a fairer international tax system will continue beyond this current process, perhaps in a more inclusive forum, as the United Nations Panel on International Financial Accountability, Transparency, and Integrity has recently argued. The coming months will be critical to ensuring that the final deal does not simply reflect rich economies’ interests, but rather generates significant extra revenues for all countries, including those that need them the most.
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NEW YORK/NOTTINGHAM – The July 1 agreement by 131 countries to establish a global minimum tax rate of at least 15% for multinational corporations (MNCs) and reallocate taxing rights is a step forward. But the deal as it stands represents another missed opportunity to deliver an equitable outcome for developing countries.
It is good that multilateral efforts to reform global taxation are back in favor. This is largely because US President Joe Biden’s administration wants to end the race to the bottom in corporate tax rates – a contest that has benefited only tax havens. In most cases, lower tax rates not only failed to attract new investment to countries, but also deprived governments of the funds they need for social objectives and infrastructure improvements.
But the new tax deal reflects the imbalances in global power relations. G7 countries put the agreement they reached last month to the 139 countries that are part of the OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting. Faced with a take-it-or-leave-it choice, most developing countries agreed, despite significant reservations. But a handful – including Nigeria, Kenya, and Sri Lanka – did not sign up. And even some of those who did made it clear that the negotiations were not over.
Several significant issues remain. The first is that the proposed minimum tax rate of 15% is too low to deter profit-shifting by MNCs. This reflects several developed countries’ preference to protect their own global firms rather than follow the lead of the United States and Argentina, which had called for a minimum tax rate of 21%, and of many African countries, which proposed a 20% rate. And for most countries in Latin America or Africa, which had average corporate tax rates of 26% and 27%, respectively, in 2020, a global minimum rate of around 15% would do little to reduce incentives for profit-shifting. Several countries may thus unilaterally adopt a higher minimum rate.
Furthermore, under the proposal agreed at the OECD, most of the additional tax revenues will go to MNCs’ home countries, not to the so-called “source” countries where these companies do business and generate profits. A number of developing economies want source countries to have priority in applying the minimum tax, particularly to MNCs’ interest earnings, royalties, service payments, and capital gains. The current deal would allow them to apply the minimum tax only to interest, royalties, and a set of payments yet to be defined.
The amount of revenue the minimum tax generates will depend on the rate. This is vital for developing countries. A recent study by the EU Tax Observatory shows that with a 15% tax rate, Mexico, South Africa, and Brazil stand to gain an additional €500 million ($592 million), €600 million, and €900 million, respectively, of additional corporate income tax revenues in 2021, compared to €900 million, €2 billion, and €3.4 billion, respectively, with a 21% levy. The 25% minimum rate advocated by the Independent Commission for the Reform of International Corporate Taxation would yield an extra €1.3 billion for Mexico, €3 billion for South Africa, and €7.4 billion for Brazil.
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The OECD agreement also introduces a formula to allocate MNCs’ global profits for tax purposes. But it would apply only to firms with annual global turnover exceeding €20 billion and profit margins of at least 10% of revenue. Moreover, only 20-30% of their so-called “residual” profit above that threshold would be subject to tax in the countries where it is generated. This new rule may therefore generate less than $10 billion of additional revenue globally per year.
Developing countries’ main demand throughout has been for a meaningful reallocation of taxing rights to source countries. The G-24, the major grouping of developing economies in the talks, has called for 30-50% of residual profits to be reallocated, while the African Tax Administration Forum (ATAF) is now asking for at least 35%.
A simpler solution would be to allocate MNCs’ global profits among countries by a formula based on key profit-generating factors such as employment, sales, assets, and resource use. But previous demands by both the G-24 and the ATAF to apportion a percentage of all profits, whether routine or residual, to source countries have been rejected.
Another problem is that signatories to the OECD agreement are being asked to remove unilateral measures such as digital services taxes. Many developing economies are not happy about rescinding these levies, or about limiting their options to tax digital MNCs in the future.
The final concern is the demand that developing countries accept mandatory arbitration of disputes. Many have historically regarded this as an infringement on their national sovereignty. They also point to nontransparent outcomes and prohibitive costs, and the fact that most arbitrators come from developed countries.
But the July 1 announcement is not the end of the road. Although the G20 is likely to endorse the proposal this week, negotiations will continue, with a final agreement expected in October. To change the outcome, developing countries must now push for a higher global minimum tax rate and a bigger reallocation of taxing rights, and refuse mandatory arbitration.
The fight for a fairer international tax system will continue beyond this current process, perhaps in a more inclusive forum, as the United Nations Panel on International Financial Accountability, Transparency, and Integrity has recently argued. The coming months will be critical to ensuring that the final deal does not simply reflect rich economies’ interests, but rather generates significant extra revenues for all countries, including those that need them the most.