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New tax agreement, the end of tax havens?

Frankfurt, Germany.

More than 130 countries have concluded agreements to implement fundamental changes in the way profits of large transnational corporations are taxed. The goal: to prevent multinational corporations from placing their profits in countries with very low or no corporate taxes, known as tax havens.

The agreement was reached on Friday between 136 countries after negotiations overseen by the Organization for Economic Co-operation and Development (OECD). It will bring about a century of international tax rules to respond to the changes brought about by globalization and digitalization.

The most important point: a global minimum tax of 15%, a major initiative promoted by US President Joe Biden and Treasury Secretary Janet Yellen.

Yellen said the minimum tax would end decades of a “race to the bottom” in which corporate tax rates have fallen as tax havens have sought to lure companies looking to profit from lower rates even though they do little business in those locations.

Here’s a look at the key aspects of the deal.

What problems does he respond to?
In today’s economy, multinational corporations earn more and more revenue from intangible assets, such as brands and intellectual property. These intangible assets are easy to transfer and global companies can allocate the profits they generate to a subsidiary in a country at very low tax rates.

Some countries compete for foreign income, using very low rates to attract businesses, and creating huge tax bases that generate significant revenue despite tax rates that barely exceed zero. Between 1985 and 2018, the global corporate tax rate fell from 49% to 24%. By 2016, more than half of all US corporate profits were in seven tax havens: Bermuda, Cayman Islands, Ireland, Luxembourg, the Netherlands, Singapore and Switzerland. By one estimate, that costs the US Treasury $100 billion annually.

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How does the global minimum tax work?
The basic idea is simple: countries will legislate a minimum global tax rate of at least 15% for large transnational corporations with revenues exceeding 750 billion euros ($864 billion).

So if companies have untaxed earnings or are barely taxed in a tax haven, their home country will impose a countervailing tax that will raise the rate to 15%.

This would make it unfeasible for a company to use tax havens, as taxes evaded would be collected there in their country. For this same reason, it means that the minimum rate will come into effect even if individual tax havens are not involved.

How does the plan deal with the digital economy?
The plan would also allow states to tax a portion of the income of the 100 largest companies when they do business in places where they do not have a physical presence. This could be through retail sales or online advertising. The tax will only be applied to the portion of profits greater than 10% of the profit margin.

In return, other countries will cancel their unilateral taxes on the digital services of US giants such as Google, Facebook and Amazon. That would avoid trade conflicts with Washington, which says these taxes unfairly target US companies and has threatened new tariffs.

Does everyone agree to the deal?
Some developing countries and advocacy groups such as Oxfam and Britain-based Tax Justice Netwok say the 15% rate is too low, leaving a lot of potential tax revenue intact. And while the global bottom line would bring about $150 billion in new revenue to governments, most of it would go to rich countries because that’s where the bases of most multinational corporations are.

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A United Nations Commission on International Financial Accountability, Transparency and Integrity recommended a minimum rate of between 20% and 30%. In this year’s report, the commission said that the very low rate could motivate countries to lower their rates to stay competitive.

The countries that participated in the talks but did not sign the agreement are Kenya, Nigeria, Pakistan and Sri Lanka.

What is the role of the United States in the agreement?
Biden’s tax agenda has been stranded by negotiations among Congressional Democrats, with proposed spending and interest rate hikes still up for debate, but the administration said it should expand the global US tax floor to persuade other countries to do so as well.

Biden has backed away somewhat from his initial proposals for the views of lawmakers. The latest plan by the House Tax and Resources Committee would have raised the global minimum tax to 16.5% from 10.5%. Initially, the president wanted 21% as the minimum fixed rate in the United States. National corporate income will be taxed at 26.5% from the current 21%.

The participation of the United States in the agreement is critical, because many multinational companies have their headquarters in the country. A complete rejection of Biden’s proposal for a global minimum tax would severely undermine the deal.

Repealing unilateral digital taxes (DST) would provide a “very strong incentive” for the United States to participate, said Manal Corwin, chief tax officer for professional services firm KPMG and a former Treasury official in the Barack Obama administration. That’s because the deal would avoid a devastating trade dispute that could spread to companies in other sectors of the economy.

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“When you get into a tariff duel, tariffs are not necessarily imposed on the companies at the heart of the issue at hand,” he said. “Today DST could be another one-sided measure tomorrow, tomorrow.” He said international taxation needs stability and consistency “to encourage investment and growth… and the collapse of the global consensus, if it begins with daylight saving time, could expand to other things.”

How will the agreement enter into force?
The agreement will be presented to the G20, where it is very likely to agree, given that these 20 members signed it on Friday. The implementation then moves to individual states.

The tax on profits in which companies have no physical presence requires countries to sign an intergovernmental agreement by 2022, with implementation in 2023. The global minimum would be applicable by individual countries using rules set by the Organization for Economic Co-operation and Development. If the United States and European countries where the majority of multinational corporations are located legislated these minimums, it would have much of the desired effect.

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