But
the devil is in the details. If your client or company is impacted by new
global tax rules, focus on your tax base not your tax rateBy
Cecil Nazareth, guest columnist
Treasury
Secretary Janet Yellen announced
last week that 130 of the 139 countries in the Organization for Economic
Cooperation and Development (OECD) agreed to a conceptual framework to overhaul
the global tax system. Those countries represent about 90% of the global GDP.
By
far the most talked about provision is the proposed minimum income tax rate of
at least 15% on multinational corporations, regardless of where they
operate. The OECD estimates that governments lose between $100 billion and
$240 billion in revenue to tax avoidance each year. The new plan, likely to be
finalized this fall, has the potential to raise $150 billion in extra tax
revenue annually, according to OECD.
In a rare display of unilateral support, Russia, China and India joined the
U.S. and other G20 countries in supporting the global minimum corporate tax.
That’s a huge step forward since China and India previously had concerns about
the proposed overhaul. In fact, of the nine nations that refused to sign the
tentative framework, only Ireland is a significant player in the global tax
(avoidance) arena since it is the European headquarters for most of the large
U.S. tech companies. The others are Barbados, Estonia, Hungary, Kenya,
Nigeria, Sri Lanka, St. Vincent, Peru and the Grenadines.
Rationale behind the overhaul
As countries seek to attract more foreign investment, Yellen among others
have long argued that they drive their tax rates lower as they compete to
create the most favorable environment for businesses, which in turn drives tax
revenues down for everyone—hence to so-called race to the bottom.
Steven Plotnick, an
international taxation expert of counsel to McLaughlin &
Stern, told me the other day that “the minimum global by-country corporate tax
rate is designed to limit the use of tax havens to shield profit of
multinational companies, while potentially giving smaller countries more tax
revenue from the largest corporations.” By creating a more level playing field,
Plotnick said the minimum global tax rate, which would now be the least amount applied
to companies’ overseas profits, would eliminate racing to the bottom in terms
of corporate taxes.”
As detailed in my forthcoming book, Global Accounting: 2021 & Beyond, corporations
have long used a myriad of tactics to reduce their tax liability, often by
shifting profits and revenues to low-tax countries such as Bermuda (7%), the
Cayman Islands (0%) or Ireland (12.5%), regardless of which country or
jurisdiction a sale is made. Multinationals are highly trained profit-shifters.
Amazon, Google, Nike, Fedex and other U.S.-based multinationals generate
billions of dollars in profit and pay little or nothing in corporate tax. That
also deprives the U.S. of tax revenue it should have received in exchange for
providing good infrastructure, law enforcement and military protection for
companies doing business here.
For
years, the OECD has pushed to eliminate
corporate strategies that it believes “exploits gaps and mismatches in tax
rules to avoid paying tax." The global minimum tax would apply to
companies' foreign earnings, meaning that countries could still establish their
own corporate tax rate at home.
But it’s not that simple.
It’s very
easy for companies to move intangibles across borders and pay tax on it at the
lowest possible rate. The U.S. isn’t the only country that’s been trying to
curtail this process, but it hasn’t been easy.
For
instance, France came up with a digital tax a few years ago in which they taxed
all the big U.S. tech companies (Amazon, Google, Facebook) claiming those
behemoths were doing business in their countries but not providing those
countries with any tax revenue. However, after the European digital tax was
passed, the U.S. retaliated by imposing tariffs on French wines and other
popular goods that were being exported to the U.S. market, making those goods
significantly more expensive to U.S. consumers, restaurants, and liquor
distributors than they used to be.
So who wins? Nobody! Hence the proverbial race to the bottom.
Adapting tax policy to the modern world
I believe
15% is a reasonable corporate tax for multinationals to pay. When international
tax laws were written a century ago, they were based on what’s called a
“physical presence test.” In other words, wherever a company had a permanent physical
establishment, they would have to pay tax to that jurisdiction.
But physical
presence has no meaning in today’s digital world. For example, Amazon is
selling product in France, Germany, and other European nations, but it doesn’t have
a physical office or manufacturing facilities in those countries. Amazon, at a minimum,
has major warehousing and distribution structures in France. It makes a lot of
money selling to consumers in those countries, so it should pay a base level of
tax to conduct business there. I’ve found that it’s all about moving from a
physical presence test to a “revenue-earned” model. The logic being, if you
earn money in a particular country, that country should get a fair share of the
global minimum tax you pay.
Advantages
of the global minimum tax
1. It should
eliminate significant profit-shifting to low-tax countries. According to Plotnick, who is also
an adjunct professor of partnership taxation at New York Law School, with each
country having at least a 15% corporate tax rate, most companies would not feel
as incentivized to move their intellectual property abroad or otherwise shift
profits from one jurisdiction to another. “Of course, 15% is less than the
current U.S. corporate tax rate of 21%, so there will still be some incentive
to shift profits,” noted Plotnick. But overall, assuming enhanced tax revenues
are a positive development, all countries should benefit, he added.
2. It
eliminates trade wars. With every company paying a significant effective corporate tax rate on
income regardless of where that income is earned, it would eliminate silly
disputes in which you have a digital tax (i.e., France) being imposed by one
country and retaliatory tariffs (i.e., United States) on the other. “Unfortunately,
as the ’income base’ upon which each company imposes this 15% minimum tax has
not been explicitly defined, it is unclear that manipulations cannot still
continue to occur,” Plotnick cautioned.
3. It
makes it easier for multinationals to plan their tax burden so they can allocate profits and
taxes accordingly.
Which
multinationals will be impacted?
Roughly four
in five Fortune 500 companies (80%) are based in the United States. If we shift
to a revenue model instead of the traditional physical presence test, then a
U.S. multinational like Apple Computer, currently paying 12.5% income tax to
Ireland would have to pay an annual additional 2.5% minimum tax to the United
States. The United States would still be entitled to another 6% tax on
dividends when a dividend is paid from Ireland to the United States. As a
result, there would still be some tax incentive to maintaining a presence in
Ireland. However, Ireland may not like that arrangement.
According to Plotnick, if Ireland decides to bump its corporate tax rate up to
15%, then a company like Apple would presumably have no tax incentive to be in
Ireland as opposed to any other 15%-taxing jurisdiction. Thus, the overseas
countries Apple then chooses to operate in going forward will be driven by
non-tax business factors (e.g., qualified work force, manufacturing
capabilities, etc.). But, Plotnick said, to the extent that Apple continues to
operate overseas and does not bring jobs and operations back to the United
States, the U.S. could end up receiving less in tax revenues as creditable
taxes paid by Apple (for example) would now be increasing to 15% on its
overseas income.
“Of course, countries do not always define income in the same manner (see
Challenges, below),” noted Plotnick. For example, the United States allows for
“bonus depreciation” and certain income to be tax-exempt, while other countries
do not. So, the exact “interplay of this 15% minimum tax” remains to be seen,
Plotnick added.
Challenges
The global
minimum tax has challenges, of course. What should a company’s taxes in each
country be based on? Will it be on net profits, allocated profits, sales,
advertising, or some other metric? As Plotnick observed, the United States presumably
believes its 21% tax rate exceeds the 15% global minimum. The U.S. may believe
it does not need to change its definition of income that’s subject to tax or
how that income is sourced (U.S. or foreign) to comply with the proposed 15%
global minimum tax--perhaps apart from getting rid of the artificial deduction
for Foreign Derived Intangible Income (FDII).
From
where I sit, the global minimum tax makes sense at the 30,000-foot level, but
there’s a lot of finetuning to do. As always, the devil is in the details.
Again, the
tax base (not the tax rate) is what will be the most challenging aspect of the
global minimum tax. That’s because it’s very unclear what you will base the 15%
tax on. If it’s based on revenues, then you’re essentially talking about a
sales tax. And nobody likes the sound of that.
Also, we
still need Congressional approval for the global minimum tax. It all comes down
to members resolving two critical questions:
1. What are we giving up by moving our tax base outside our borders?
2. What are we getting in return?
If we
believe that our 21% corporate tax rate satisfies the 15% minimum, “I think we
might just be done,” suggested Plotnick. “If we want to impose a new top-up
regime to add to Subpart F and GILTI, to make sure income from certain
jurisdictions are subject to a 15% tax, then that would require legislation,
but I am not sure that part is required necessarily,” Plotnick added.
In either
case, I’m confident the global minimum tax is not likely to come to fruition
until 2023. Multinationals are going to benefit greatly by this type of
simplified, across-the-board tax, other than perhaps having to pay more in tax
currently. As with any new legislation there will be winners and losers.
Countries that were not able to collect tax on multinationals in the past may
now be able to collect some money and improve their tax base. But Ireland,
Cayman Islands and other low-tax havens could see the tax coffers shrinking at
a time when they are still digging themselves out of the COVID-induced recession.
Conclusion
This fall,
there should be a more formal sign off on the global minimum tax by 130-plus
countries that support it. Obviously, there will need to be some fine-tuning,
but moving to a revenue-based model from the century-old physical presence test
is much more valid in this inter-connected digital age.
Taxing
multinationals at 15 percent would still leave them facing a lower rate than the average American pays in state and federal
income tax. But it’s a step in the right direction and halts the suicidal tax
race to the bottom.
Cecil
Nazareth is a partner with Nazareth CPAs–Global Accountants,
a CPA firm with offices in New York, New jersey and Connecticut. The firm
specializes in international tax and accounting, particularly for SME
companies, subsidiaries of foreign parents and high-net-worth families in India
and the U.S. Nazareth is a member of the AICPA’s Global Issues Task Force and
author of the books, International Tax & Compliance Handbook and Global
Accounting: 2021 & Beyond.
#Globaltax, #CecilNazareth, #StevenPlotnick
