To note: This article was originally published on July 1, 2021, but has been updated to reflect the latest details on the global tax deal.
In recent years, countries have debated significant changes to the international tax rules that apply to multinational companies. Following an announcement made in July by countries involved in negotiations within the Organization for Economic Co-operation and Development (OECD), there was today a new agreement on the broad outlines of the new rules. tax. If fully implemented, large U.S. corporations would pay less to the U.S. government and more to foreign governments, while foreign corporate profits would be subject to higher taxes.
Large companies would pay more taxes in the countries where they have customers and slightly less in the countries where they have their headquarters, employees and operations. In addition, the agreement puts in place the adoption of a global minimum tax of 15%, which would increase taxes on companies with profits in low-tax jurisdictions.
Of the 140 countries involved in the negotiations, 136 have joined the new scheme. The refractories were Kenya, Nigeria, Pakistan and Sri Lanka.
Ireland, Estonia and Hungary have all recently given their approval after initially pulling away from the deal in July.
The proposal follows a general pattern that has been discussed since 2019. There are two âpillarsâ of reform: the first pillar focuses on changing where large companies pay taxes; Pillar 2 includes the overall minimum tax. The two pillars consist of several elements.
Pillar 1 contains the âamount Aâ which would apply to companies with a turnover above 20 billion euros and a profit margin above 10%. For these companies, a portion of their profits would be taxed in the jurisdictions where they make sales; 25 percent of profits above a 10 percent margin may be taxed. After a review period of seven years, the threshold of 20 billion euros could increase to 10 billion euros.
Extractive sector companies (such as oil, gas and other mining companies) and financial services companies would be excluded from the policy.
Amount A is a partial redistribution of tax revenues from countries that currently tax large multinationals based on the location of their headquarters and operations to the countries where these companies sell. US companies are likely to be a large portion of the companies within the scope of this policy.
The United States may lose tax revenue because of this approach. However, US Treasury Secretary Yellen previously wrote that she believed the A amount would be roughly revenue neutral for the United States. desks.
Pillar 1 also contains âAmount Bâ which would provide businesses with a simpler method of calculating the taxes they owe on overseas operations such as marketing and distribution. The sketch does not provide new details on this approach.
Pillar 2 is the global minimum tax. It includes two main rules and then a third rule for tax treaties. These rules are intended to apply to companies whose turnover exceeds 750 million euros.
The first is an âincome inclusion ruleâ, which determines when a corporation’s foreign income should be included in the taxable income of the parent corporation. The agreement sets the minimum effective tax rate at 15 percent, otherwise additional taxes would be payable in a company’s home jurisdiction.
The income inclusion rule would apply to foreign profits after deducting 8 percent of the value of tangible assets (such as equipment and plant) and 10 percent of labor costs. These deductions would be reduced annually over a 10-year transition period. At the end of the transition, the deduction for property, plant and equipment and payroll would be 5%.
Like other rules that tax foreign income, the income inclusion rule will increase the tax costs of cross-border investments and affect business decisions about where to hire and invest around the world, including domestic operations. .
The second rule in pillar 2 is the âunder-taxed payments ruleâ, which would allow a business to deny a deduction or apply withholding tax on cross-border payments. If a business in a country makes payments back to its parent entity (which is in a low-tax jurisdiction), the rule of under-taxed payments could apply.
There is an exclusion from the under-taxed payments rule for businesses that have been under Pillar 2 for less than five years, have a maximum of EUR 50 million in foreign tangible assets, and operate in up to five other jurisdictions.
Taken together, the income inclusion rule and the under-taxed payments rule create a minimum tax on both corporations investing abroad and foreign corporations investing domestically. They are both tied to the minimum effective rate of at least 15%, and they would apply in every jurisdiction where a business operates.
The third rule in pillar 2 is the “subject to tax” rule, intended for use in a tax treaty to give countries the option of taxing payments that would otherwise have only one low tax rate. The tax rate for this rule would be set at 9%.
Pillars 1 and 2 represent major changes to international tax rules, and the plan suggests that the changes should be in place by 2023. Countries should write new laws, adopt new tax treaty language and repeal some policies that conflict with the new rules.
The plan specifically states that taxes on digital services and similar policies will need to be removed as part of the implementation of Pillar 1.
The Biden administration issued a statement with warm approval of the deal, although it may be difficult to get Congress to follow through on the implementation of these policies.
There are three reasons for this. First, the priorities that President Biden has set for taxes on the foreign profits of American businesses follow a different approach than agreed today. Second, the current low-tax global intangible income tax (GILTI) and base erosion and anti-abuse tax (BEAT) are only roughly aligned with the new agreement, but GILTI can benefit of special treatment according to the main lines. Third, a tax treaty change requires 67 votes in the Senate, and this will prove difficult if there is not broad bipartisan support for the new rules.
For Pillar 1 to work well, it would be easier for all countries to adopt the rules in the same way. This would prevent companies from having to deal with multiple approaches around the world. The plan mentions a streamlined system that may require some sort of clearinghouse for A-amount payments and credits, as well as a dispute settlement mechanism.
Pillar 2 is more optional. The sketched version of Pillar 2 looks more like a model than a requirement for countries to adopt exactly what is described. If enough countries adopt the rules, then a large chunk of corporate profits around the world would be subject to an effective tax rate of 15%.
Today’s agreement represents a major change for tax competition, and many countries will rethink their tax policies for multinationals in light of this agreement. Policymakers around the world need to be careful when designing measures to implement this and be aware of the various new distortions these rules will create.
United States International Tax Resource Center