- International corporate taxation is a pretty abstract topic. What exactly is being changed?
- Why is a global minimum tax a question of fairness?
- Where do things currently stand with the minimum tax?
- What is the minimum tax rate?
- Which companies will be affected by the minimum tax?
- What will be done to make sure that the minimum tax is actually paid?
- How will tax revenue be reallocated?
- Which companies are subject to the new rules reallocating taxing rights?
- What do the new rules mean for Germany in terms of revenue?
- Critics have complained that some tech companies will still be able to use clever accounting methods to circumvent the rules and avoid paying taxes in countries where they make profits. Is that true?
- Why is the reallocation of tax revenue a question of fairness?
- What happens next?
International corporate taxation is a pretty abstract topic. What exactly is being changed?
The recent agreements reached by the international community constitute one of the biggest-ever reforms to international corporate tax rules. The reform blueprint encompasses two “pillars” that aim to ensure all companies pay their fair share to help finance public goods. To this end, former German Finance Minister Olaf Scholz and French Finance Minister Bruno Le Maire, teamed up in October 2018 to propose a global minimum effective tax. This global minimum effective tax is the “second pillar” of the agreed reform. Its ultimate aim is to introduce a minimum level of tax, in order to increase the size of the pie for all countries and put a stop to aggressive tax planning.
The “first pillar” will ensure greater fairness in the allocation of taxing rights and tax revenue among the world’s countries. To stick with the pie metaphor, the first pillar is about who gets which piece of the pie. The new rules will ensure greater fairness in the international allocation of tax revenue. Such rules are particularly important for the taxation of tech companies – for example, companies that can reap extremely high profits from internet sales or ad clicks even in countries where they have no factories or other branches. Under the current rules, taxes are payable primarily in the countries where firms have a physical presence. This has to change. Companies should also pay taxes in the countries where they generate profits.
Why is a global minimum tax a question of fairness?
When large, multinational corporations end up paying very little tax because they can shift their profits to tax havens, this is unfair in the extreme: First, because money goes missing that is needed to pay for public goods such as schools, childcare facilities, hospitals, pensions, transport networks and well-kept streets. Second, because it is unacceptable when small businesses such as the local plumber or bookshop pay their taxes properly while wealthy corporations deploy tricks to save billions in taxes. This will now be put to a stop.
Where do things currently stand with the minimum tax?
On 1 July 2021, a broad-based international agreement was reached by the members of the OECD’s Inclusive Framework on base erosion and profit shifting (BEPS), the body which has been working on this issue under the auspices of the OECD. This approach was approved by the finance ministers of the 20 leading advanced and emerging economies – the G20 – at their meeting in Venice on 9–10 July 2021. However, some technical details remained open. These were successfully clarified at another meeting of the Inclusive Framework on BEPS on 8 October 2021. In addition, the participating countries agreed on a roadmap to implement the approved measures.
A total of 137 (out of 141) members of the Inclusive Framework on BEPS have joined the international agreement (up from 134 countries in July). The outcomes were approved at the meeting of G20 finance ministers in Washington, D.C., on 13 October 2021.
What is the minimum tax rate?
The minimum tax rate will be 15%. No company will pay less than that in the end.
Which companies will be affected by the minimum tax?
The minimum tax will apply to all companies that do business internationally and that generate annual revenues above €750 million. In future, multinational firms will have to pay a tax rate of 15% on all of the profits they make worldwide, regardless of where the profits are generated. Under current rules, corporate subsidiaries located in tax havens pay very little in taxes, which of course benefits the corporation as a whole. This will no longer be possible in future.
What will be done to make sure that the minimum tax is actually paid?
If, for example, profits earned by a group subsidiary located in a tax haven are taxed at an effective rate of only 5%, then the new rules will come into play.
With a global minimum tax rate of 15%, the country where the parent company is based will have the right to charge an additional 10% in taxes on the subsidiary’s profits. This will ensure that even those profits located in the tax haven are ultimately subject to an effective tax rate of 15%.
Furthermore, the new rules will prevent corporations from using tricks to shift profits to tax havens. One of these tricks is the payment of royalties to related group companies located in tax havens. Royalties include things like payments for the use of brand names, patents and other rights.
Continuing with the example cited above, let’s say that some of the group’s rights are held by a subsidiary located in a tax haven. The subsidiary then receives regular royalty payments from other group companies located in countries with high tax rates. This allows the companies in high-tax countries to lower their profits, because they can deduct the royalties as business expenses.
Tricks like this will no longer be possible in the future. Royalty payments will no longer be fully deductible expenses in a company’s home country if they are paid to a company based in a tax haven. This too will ensure effective taxation at no lower than the global minimum rate.
How will tax revenue be reallocated?
If, for example, a search engine uses user data to place targeted ads and thus to generate large profits in a particular country, there are currently no rules in place to ensure that taxes on these profits are actually paid in that country if the company has no physical presence there. To ensure fairness, however, countries where profits are actually generated (called “market jurisdictions”) must be able to collect commensurate taxes. With the search engine example, taxes should be paid in the country where the user resides.
Which companies are subject to the new rules reallocating taxing rights?
The new allocation rules will apply to large, highly profitable corporate groups. This includes the major tech companies that have been the real winners of globalisation.
What do the new rules mean for Germany in terms of revenue?
Germany will benefit financially from the new rules. The Federal Ministry of Finance has also always watched out to ensure that Germany, with its export-oriented economy, does not lose out when taxing rights are reallocated. Based on current calculations, Germany’s tax revenue will increase as a result of the minimum tax and the reallocation of taxing rights.
Critics have complained that some tech companies will still be able to use clever accounting methods to circumvent the rules and avoid paying taxes in countries where they make profits. Is that true?
No. Tech companies in particular will not be able to circumvent the new rules. Steps are being taken to ensure that companies can’t use accounting tricks to avoid paying taxes. That’s precisely what the new rules are designed to prevent. Where necessary, tax authorities will look at a corporate group’s various business lines and assess their profitability separately (this is referred to as “segmentation”). For example, authorities can focus on the highly profitable platform businesses of individual groups and treat the profits earned on these platforms as the tax base. It will not be possible to offset these profits against other business lines.
Why is the reallocation of tax revenue a question of fairness?
Tech companies serve as a good example here as well. Recent media reports have highlighted the fact that some highly wealthy tech company owners pay less than one percent in taxes. This shows all the more how important it is for these firms to pay their fair share towards the financing of public goods. It is unacceptable for owners and managers to earn huge profits from dividends, capital gains and bonuses while the general public goes empty-handed.
What happens next?
The outcomes achieved under the auspices of the OECD and G20 will now be implemented, in Europe and around the world. To this end, former Finance Minister Scholz and his European and international partners will work out a joint solution that is consistent with the agreements reached by the OECD and G20.