It is expected that an individual who lives and works in any country that taxes earnings will have to pay an income tax in that country if he or she meets specific criteria set by the government. But the same cannot be said to be true for companies. Because it is a well-known fact of global commerce that multinational firms often report their profits not in the countries where they make it, but in countries that have the lowest tax rates. Such countries are called tax havens. An agreement signed by the top seven global economies, the so-called G7 countries, now seeks to discourage this practice through a global minimum tax that a company has to pay regardless of where they are based. Here’s what it means.
Why Is It Important?
Efforts have been on for years among the major economies to rein in the practice of companies shifting their profits abroad and thus avoiding the relatively higher rates of taxation in their home countries or the countries where they make the bulk of their profits. It may be frowned upon but it nonetheless is legal. But it ends up costing the major economies billions of dollars in taxes.
For example, UK daily The Guardian cited a report by a tax transparency campaign in 2019 to say that the big six US tech firms — Amazon, Facebook, Google, Netflix, Apple and Microsoft — are alleged to have avoided paying $100bn worth of global taxes over the past decade “by shifting revenue and profits through tax havens or low-tax countries”.
Given how complicated the workings of international business and multinational companies often are, it may be difficult to pin down clearly how tax avoidance works. But The Guardian report pointed to the case of global online shopping and cloud services giant Amazon to show that while it told US authorities that it made $14.5 billion in revenue in the UK in 2018, and $75.8bn over the decade, its two UK subsidiaries had “combined tax bills of only £83m over the decade, as the bulk of sales are booked via Luxembourg”, which serves as a tax haven for the company led by Jeff Bezos, the world’s richest man.
What Is The Agreement?
The “historic” deal announced during the G7 finance ministers’ meet in London is part of efforts to end what US Treasury Secretary Janet Yellen described as a “30-year race to the bottom on corporate tax rates”.
Designed to make multinational companies pay more taxes, it has two key components. First, it had the G7 countries agree that rules will be made to ensure that companies pay more in the countries where they actually do business. The second was an agreement in principle to mandate a global minimum corporate tax rate of 15% to avoid countries undercutting each other. With the backing of the G7 countries, this agreement could provide the ground for a worldwide deal.
The aim of the first component is to allow countries to tax a share of the profits earned by companies “that have no physical presence but have substantial sales”. It is in line with a US proposal that countries should tax the earnings of the largest and most profitable companies if they are doing business within their territory. According to the statement shared by the G7 meet, this rule is aimed at “the largest and most profitable multinational enterprises” and gives countries “taxing rights on at least 20% of profit exceeding a 10% margin”.
As to the minimum corporate tax, if there is a company that is paying lower rates in a particular country, their home governments could “top-up” their taxes to the minimum rate, thus cancelling out the advantage of shifting profits. This rule won’t stop countries from levying whatever rate of corporate tax they want within their territories.
Which Are The Major Tax Haven Countries?
Among the well-known tax havens are the Caribbean countries of the Bahamas or British Virgin Islands. In Europe, Ireland has a corporate tax rate of only 12.5%. Taxes in the biggest economies are substantially higher than in these tax haven destinations. For example, after a steep cut in 2019, the effective corporate tax in India is around 25% with China and South Korea levying a 25% tax on corporate profits.
What Next For The Global Minimum Corporate Tax Plan?
The agreement right now has been signed by the US, the UK, France, Germany, Canada, Italy and Japan, along with the EU. But, according to Reuters, more wide-ranging discussions have taken place globally to come up with such solutions. The Organisation for Economic Cooperation and
Development (OECD), an economic grouping of 38 countries, has for long been coordinating negotiations among 140 countries for taxing cross-border digital services and checking tax avoidance.
The G7 agreement is first expected to be taken up at a meeting next month of the G20 economies, which includes China, Russia, Brazil and India. Reuters said that OECD and the G20 countries would soon look to reach a consensus on the proposals agreed by the G7. “If a broad consensus is reached, it will be extremely hard for any low-tax country to try and block an agreement,” Reuters added.