Allan Lanthier is a retired partner of an international accounting firm and has served as an advisor to the Department of Finance and the Canada Revenue Agency. |
MONTREAL – The 15% global minimum corporate tax negotiated by the OECD and championed by US Treasury Secretary Janet Yellen has been rejected by Democratic Senator Joe Manchin. With the world’s largest economy and Canada’s fiercest competitor for business investment out of the deal, Canada is also expected to pull out.
Part I of this article discusses recent developments in the United States and the European Union and sets out the basic reasons why Canada should reject the OECD proposal.[1] Part II is a technical analysis explaining why the OECD backstop — the “undertaxed profit rule” — will be unworkable if a country decides to withdraw, and why the backstop is therefore of little relevance to the Canada’s decision.
Introduction
As of October 2021, over 130 countries have agreed to a general framework for the OECD tax – although none have actually agreed to implement the tax, only to later consider whether or not to proceed. That time has come and Canada should withdraw. What’s really driving the proposal isn’t corporate tax avoidance: it’s the fact that cash-strapped governments around the world need new tax revenue, and big business is still a political target. easy.
There are actually two proposals (or there were, until the United States abandoned its own initiative). The United States has its own global tax — “GILTI” (for “global intangible low-taxed income”) with very different rules from those of the OECD. Ms. Yellen wanted to bring the GILTI framework as close as possible to OECD rules and become “OECD-compliant”: she will not succeed.
The OECD proposal
The OECD proposal applies to multinational groups whose consolidated annual gross revenue is at least 750 million euros (approximately 1 billion Canadian dollars) and to all entities whose results are included in the financial statements of the group. The “effective tax rate” must be calculated for all group entities in each country and, if the rate is less than 15%, an “additional tax” must be paid to make up the shortfall: at least that is the theory. The group entity that is expected to pay the additional tax is discussed in Part II of this article.
What about the OECD proposal? Prior to the U.S. withdrawal discussed below, many countries, including Canada, said they intended to proceed. However, with the United States out of the deal, the countries could reconsider.
The European Union is a particular question mark. Under EU rules, changes to tax laws require the unanimous agreement of all 27 member countries, and at the last meeting of the EU’s finance committee in mid-June, Hungary alone and defiantly voted against implementing the OECD tax at this time. His government has raised concerns about an additional tax cost for Hungarian businesses when they are already under economic pressure following Russia’s invasion of Ukraine.
The new Czech chairman of the EU finance committee will try to convince Hungary to reconsider its position at the committee’s next meeting in early October: whether he will succeed is far from clear. In short, the United States is out of the game and unified global support for the OECD tax evaporates.
The American GILTI proposal
GILTI was added to US tax law in a massive bill signed by Donald Trump in December 2017. Among many other measures, the bill reduced the US federal corporate tax rate by 35 to 21%, but also added GILTI as a minimum tax on profits of foreign subsidiaries of American multinationals. However, the GILTI rate is only 10.5% and the rules allow low-tax foreign income from tax havens to be averaged with high-tax income from other countries. As a result, GILTI generates only modest annual tax revenue and is not OECD compliant.
The Biden administration wanted to enact its own ambitious package – the “Build Back Better Act” (BBB) and, as part of BBB, strengthen GILTI to make it OECD compliant. In November 2021, the House of Representatives passed the BBB by a narrow vote of 220 to 213, with no Republican support: the bill included two major corporate tax increases:
- A new alternative minimum corporate tax (AMC) of 15% that would apply to the largest US corporations – those with annual book profits over US$1 billion. The CMT would apply to both domestic and foreign income, with income being calculated according to accounting principles and not according to tax rules; and
- As an additional and separate global tax of 15%, changes to the GILTI rules that would have made the rules OECD compliant. The GILTI rate was to drop from 10.5 to 15% and the rules were to apply country by country. Foreign income that is tax-exempt in Bermuda, for example, would no longer be averaged with income from Mexico, which is taxed at 30%: the US parent company would be liable for immediate tax on Bermuda income.
BBB has never voted in the Senate. With a 50-50 split in the Senate, the Biden administration needed every Democratic vote, and Mr. Manchin would not support the package. And so BBB languished for months, until last week.
The 15% CMT is not the same as a 15% worldwide tax:
The estimated additional tax revenue from the two separate taxes under the BBB was substantial: more than US$300 billion over ten years from CMT, and nearly US$300 billion more from GILTI and other international tax changes. These two taxes have been the source of some confusion in recent days, even for some within the international tax community. So, to be clear, the CMT only applies to the largest US multinationals, such as Amazon and Nike, and is not applied country by country. The American CMT does not conform to the OECD: it is not even close.
The twists of Mr. Manchin:
As BBB languished, negotiations continued between Mr. Manchin and Senate Majority Leader Chuck Schumer. All in vain it seems. On July 15, speaking to a radio host, Mr. Manchin said that he could not even support a scaled down version of BBB at the moment: he also said that he did not support the GILTI modifications because other countries had not yet adopted the OECD. taxation, and he does not want to put American companies at a competitive disadvantage and hurt the American economy. Mr. Manchin said he would be prepared to reconsider those issues in September, after receiving further reports of inflation rates and interest rate hikes.
And then came the shock. On July 27, less than two weeks later and with no new inflation reports in hand, Senators Manchin and Schumer announced that they had reached agreement on a scaled-down BBB – the “Bullet Reduction Act”. 2022 inflation” (IRA). The IRA includes CMT – the 15% tax on corporate giants with a consolidated annual profit of over US$1 billion – but does not include any GILTI measures.
Could the US reconsider changes to GILTI later this year? It seems unlikely. There will be fierce partisan fighting in both houses of Congress over the next few days, and the IRA may or may not pass. Either way, it’s hard to see Democrats introducing new laws in September, so close to the midterm elections — elections that could hand Republicans control of Congress. If anything, Mr. Manchin’s reversal on the other issues made it clear that the GILTI changes will not continue. In practice, the United States has rejected the global agreement it was defending. Canada should also reject the OECD tax.
Canada should reject OECD proposal
In addition to the fact that the United States — the world’s largest economy and Canada’s main competitor for business investment — has rejected the OECD tax, there are three other fundamental reasons why Canada should remove.
First, the OECD tax has very little to do with corporate tax avoidance: this problem has been addressed by previous OECD initiatives. In 2015, the OECD released a 15-point plan to tackle tax avoidance, and Canada is acting on many of those recommendations. For example, Finance Canada released a bill in February to limit interest expense deductions to a fixed ratio of tax EBITDA (earnings before interest, taxes, depreciation and amortization) – 26 pages of legislation and 68 pages explanatory notes. This was followed by another bill in April to deal with so-called ‘hybrid devices’ – 15 pages of some of the most complex legislative proposals ever seen, plus 71 pages of explanatory notes.
Second, there is a much simpler way to close the remaining opportunities for corporate tax avoidance, using targeted changes to Canada’s tax code to close the loopholes. For example, there is a provision in our code that allows multinational corporations to shift income from high-tax countries to tax havens, using intragroup royalties and interest payments.[2] The problem was pointed out by the Auditor General 30 years ago, but Finance Canada never acted. This loophole could be repealed with the stroke of a pen – a repeal that would bring more money into our government’s coffers than the OECD’s 70-page set of model rules.
Finally, the tax will hit big business and the Canadian economy at the worst possible time. Large companies — those with more than 500 employees — account for more than 40% of private sector jobs in Canada — jobs that tend to pay higher wages than small businesses and contribute more to innovation and the productivity. We must not paralyze our job creators at the precise moment when our giant competitor to the south has rejected the tax.
Closing comments
Some countries will apply the OECD tax. The UK, for example, has published a partial set of draft rules (116 pages) — rules that do not yet include the support measures discussed in Part II of this article. Some other countries will also do so. Leave them. As for Canada, it is time for the federal government to put job creation and economic growth in the country before political action. Canada should withdraw from the initiative.
Footnotes
[1] An earlier version of Part I of this article was published in the Financial item July 26, 2022.
[2] Subparagraph 95(2)(a)(ii) of the income tax law.
Allan Lanthier is a retired partner of an international accounting firm and has served as an advisor to the Department of Finance and the Canada Revenue Agency. Top image: image modified by Jason Hafso, Unsplash. Photo courtesy of the author: Allan Lanthier.
