A New Way to Tax Global Corporations, Explained

(Bloomberg) -- More than six years of work has produced an agreement to update the global tax system, targeting so-called tax havens and addressing complaints that giant technology companies don’t pay enough. For the first time there would be a minimum corporate tax rate applied around the world, set at 15%, so companies have less incentive to move operations to low-tax jurisdictions. The profits of about 100 of the biggest multinational corporations, including Amazon.com Inc., would be sliced differently for taxation purposes, so that more countries share in the tax revenue. And there would be an end to the so-called digital services taxes that have angered the U.S. The next challenges are ratification and enactment of the deal, but already, some nations are changing their tax policies to get ahead of the change.

1. What’s wrong with the system now?

The minimum tax is designed to stop what U.S. Treasury Secretary Janet Yellen called “a 30-year race to the bottom on corporate tax rates,” which created an incentive for multinational companies to attribute as much profit as possible to places that charge them little or no taxes. The jurisdictions “most complicit in helping multinational corporations underpay corporate income tax,” according to the U.K. advocacy group Tax Justice Network, are the British Virgin Islands, the Cayman Islands and Bermuda, which don’t tax corporate income. Use of tax havens costs governments $500 billion to $600 billion in lost tax revenue each year, according to estimates cited by the International Monetary Fund. Meanwhile, some governments have argued that tech companies aren’t properly taxed in countries where they have users but little or no physical presence. That’s what the profit reallocation aims to address.

2. How would the minimum tax work?

Countries that adopt the minimum tax rules would apply them to most multinational companies making more than 750 million euros ($844 million), though some types of income would be exempt from that calculation. A country where a company is headquartered -- call it Country A -- could “top up” its taxation of the company if it’s paying less than 15% in Country B. So if the company is effectively paying a 10% tax rate in Country B, Country A can collect the extra 5%. This “top up” mechanism may give low-tax nations sufficient incentive to raise their rates.

3. How would the tax reallocation work?

Multinationals that make more than 20 billion euros a year in revenue and have profitability above 10% would pay a portion of their taxes differently. A share of the company’s profits -- 25% of profits above that 10% margin -- would be reallocated among the “market” countries where the company has consumers or users. This money paid to market countries will lower what is owed to the countries where the company books most of its profits and pays most of its taxes under the current system. (Companies in regulated financial services and extractive industries such as mining would be exempt from the changes.) The European Network for Economic and Fiscal Policy Research forecast in July 2021 that 78 multinational companies, most of them American, were likely to be affected and that Apple; Microsoft; Google’s parent, Alphabet; Intel; and Facebook (now Meta Platforms Inc.) would be responsible for $28 billion of a total $87 billion in tax payments that would be divided differently.

4. Why would digital taxes be ended?

With France leading the way, some nations have imposed taxes on local revenues of digital companies including Amazon, Google and Meta. Putting an end to these taxes has been a key aim of the U.S., which says they unfairly target American companies, and which threatened to enact retaliatory trade measures. The tax agreement calls for a freeze on any new digital taxes and says existing ones can’t continue once the new deal is in place.

5. Who’s on board?

As of November, of the 141 countries involved in negotiations overseen by the Organization for Economic Cooperation and Development, 137 had signed on. (The holdouts were Kenya, Nigeria, Pakistan and Sri Lanka.) Crucially, those on board included Ireland and Hungary, which until now have wielded some of the lowest corporate tax rates in Europe to attract foreign direct investment. 

6. What changes have been made already?

The United Arab Emirates announced in January that, for the first time, it will tax corporate earnings, at a rate of 9%, starting in June 2023 -- though many large corporations will continue to operate inside free zones and remain exempt provided they don’t do business with the mainland. Ireland is set to increase the tax rate for its largest businesses to 15% from 12.5%. Spain enacted a 15% domestic minimum tax this year. Switzerland intends to implement a 15% domestic minimum tax as of 2024. The U.K. is considering doing the same. 

7. What happens next?

The new system is supposed to be adopted by the end of 2023, which is an ambitious timetable, given the work still to be done. Adopting the global minimum tax is a country-by-country decision, though the European Commission will look to pass a directive requiring all 27 members of the European Union to do so. To implement the reallocation of taxes paid by multinationals, the OECD will produce a kind of super-treaty for countries to sign and ratify. Approval of the treaty might face particular trouble in the U.S. Congress, where some Republican lawmakers have assailed the agreement as bad for American companies. Practically speaking, the proposed new system probably wouldn’t work without U.S. buy-in.

The Reference Shelf

• The text of the agreement.
• A QuickTake on the rise of digital taxes around the globe.
• The Urban-Brookings Tax Policy Center breaks down how the international tax rules currently work.
• Corporate America found ways to dodge taxes in the current tax system.
• The Tax Foundation ranks countries on the competitiveness of their tax systems.

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