As the business environment increasingly globalised, creating a standardised structure for corporate taxation becomes exceptionally necessary. A noteworthy change in this domain is the suggested Global Minimum Corporate Tax Rate. While this regulation is yet to be put into action, it is anticipated to trigger noteworthy transformations for numerous companies.
What is the Global Minimum Corporate Tax Rate?
The Global Minimum Corporate Tax Rate taxation initiative is taken by the Organisation for Economic Cooperation and Development (OECD). The law aims to set a baseline for corporate income tax across the globe.
In a significant overhaul of cross-border tax rules, 136 countries agreed in 2021 to implement this minimum tax. The new law is supposed to come into effect in 2023, marking a key shift in global tax policy.
What is the aim of the Global Minimum Corporate Tax Rate?
This minimum taxation is part of the OECD's two-pillar plan to address tax challenges arising from digitalisation and globalisation. The second pillar of the plan, which includes the Global Minimum Corporate Tax, is designed to ensure multinational enterprises (MNEs) cannot exploit gaps in tax rules to avoid paying.
This landmark agreement signifies a broad consensus on the need for a more equitable international tax system. The Global Minimum Corporate Tax is expected to have far-reaching implications for MNEs and the global economy, reshaping investment decisions and tax strategies.
By setting a minimum corporate tax rate, the OECD aims to end the competitive lowering of tax rates by different countries to attract corporations, a phenomenon known as the 'race to the bottom’.
Global Minimum Corporate Tax Rate: Pillar one
Pillar One is a crucial component of the two-pillar plan proposed by the OECD. Traditionally, companies have been required to have a physical presence in a country before they are subject to tax there. Yet, due to digital advancements and the progress of technology in finance, numerous multinational enterprises (MNEs) can now amass substantial profits in locations where they lack any physical establishment. This scenario has prompted discussions regarding the justness and efficacy of the existing global tax structure.
Pillar One seeks to address these concerns by introducing new [1] rules. These rules would allow countries to tax an MNE based on sales or other economic activity within that jurisdiction. Specifically, pillar one [2] focuses on the largest and most profitable MNEs, ensuring they pay taxes where they conduct sustained and significant business, even if they do not have a physical presence there.
Under pillar one, a portion of the residual profit (profit that remains after routine activities are accounted for) of these MNEs would be reallocated and subjected to tax in the market jurisdictions. This approach aims to achieve a more equitable distribution of taxing rights among countries.
Global Minimum Corporate Tax Rate: Pillar two
Pillar two, the second component of the OECD’s plan, is an innovative approach designed to address the tax challenges arising from digitalisation.
This pillar mandates a minimum effective corporate tax rate of 15% on multinational enterprises (MNEs). This measure aims to ensure MNEs cannot exploit mismatches in tax rules to shift profits to low-tax jurisdictions and avoid paying their fair share.
The Pillar 2 rules come into effect when in a particular jurisdiction when the effective tax rate for entities falls below the 15% minimum. This requires the group to pay additional taxes to meet the minimum rate.
The income inclusion and undertaxed payments rules operate as a form of 'top-up' tax, ensuring MNEs pay at least the minimum level. In contrast, the subject-to-tax and switchover rules within this pillar are designed to deny benefits or deductions for transactions that are not sufficiently taxed.
The introduction of Pillar Two represents a significant shift, aiming to create a more level playing field, reduce harmful tax competition, and promote fairness and equity in the global tax system.
What are the likely outcomes of the Global Minimum Corporate Tax Rate?
1. Increased corporation tax revenue
Countries can anticipate an increase in their corporation tax revenue. The new measure would prevent profit-shifting to low-tax jurisdictions, thereby ensuring a more equitable distribution of tax revenues.
2. Reduced ‘race to the bottom’ of corporation tax rates
The proposal could effectively put an end to the ‘race to the bottom’ among countries who lower their tax rates to attract corporations. This competition has been a significant factor contributing to declining corporate tax rates worldwide. Countries have been vying with each other to draw inward flows of capital by offering increasingly lower corporate tax rates. However, this strategy often proves detrimental in the long run as it can erode the domestic tax base and lead to a loss of crucial revenue for public services.
3. Implications for countries below the proposed rate
Countries with a corporate tax rate below the proposed minimum may need to adjust their tax policies to conform to the new rules. While this could lead to increased tax revenues, it may also affect their ability to attract foreign investment.
How will the Global Minimum Corporate Tax Rate affect countries below the proposed rate?
Some nations use low corporate tax rates as an incentive for foreign investment, fostering economic expansion. Therefore, the implementation of a global minimum tax could weaken this strategy. If multinational enterprises (MNEs) are mandated to pay a minimum of 15% in taxes, irrespective of their operational location, the appeal of low-tax jurisdictions will wane.
Moreover, if the effective corporate income tax (CIT) rate in a particular jurisdiction falls below the 15% threshold, the Pillar Two rules come into effect. These rules may require the group to pay additional taxes to meet the minimum rate. Consequently, countries might need to consider introducing domestic top-up taxes to expand their tax base and ensure compliance with the new global tax regime.
On the other hand, the global minimum tax could also bring benefits for countries with rates below the proposed minimum. For instance, it could help level the playing field by reducing harmful tax competition among countries. Also, it could result in increased tax revenues for many countries, as their MNEs would no longer be able to shift profits to low-tax jurisdictions to avoid taxation.
Challenges the Global Minimum Corporate Tax Rate may face
1. Political resistance
The proposition of a Global Minimum Corporate Tax Rate has been met with mixed reactions on the global stage, and it's clear that political resistance could emerge as a significant roadblock. This resistance primarily stems from concerns over sovereignty in tax matters.
Countries traditionally hold the prerogative to set their own tax rates to stimulate economic growth. The introduction of a global minimum tax rate could be perceived as an infringement on this autonomy. Moreover, countries with lower tax rates might worry about the potential economic implications, fearing the loss of a crucial competitive advantage.
Therefore, it holds significance for policymakers and international institutions to promote discussions and establish agreement. Their emphasis should be on the collective advantages of this tax restructuring, encompassing the reduction of tax avoidance and the establishment of a more equitable sharing of tax incomes. Nevertheless, finding a harmony between worldwide economic interests and national autonomy will assuredly require careful handling.
2. Compliance and enforcement
The compliance and enforcement of the Global Minimum Corporate Tax Rate across different jurisdictions represents another significant challenge. Given the complexity of international tax laws and the diversity of corporate structures, ensuring that all multinational companies comply with the new rules is no small feat.
Firstly, there's the matter of transparency. Companies must disclose accurate and comprehensive financial information so that tax authorities can determine whether they're meeting their obligations. Secondly, tax authorities themselves must have the resources and capabilities to assess this information effectively.
Enforcing the rules is another hurdle. It requires unprecedented cooperation and information sharing between tax authorities worldwide. While international agreements and treaties can facilitate this process, the practicalities of enforcement (such as resolving disputes and imposing penalties) could prove complex.
What will the Global Minimum Corporate Tax rate mean for businesses?
While some specifics are still being ironed out, it's clear that this new policy will alter the landscape of corporate taxation in some of the following ways:
Increased tax burden
One of the primary outcomes of the Global Minimum Corporate Tax Rate will be an increased tax burden for many organisations. Particularly, those that have actively attempted to reduce their tax liability in previous times.
This could lead to decreased post-tax profits and potentially affect shareholder returns. Businesses would need to build forward facing finance teams that can strategically support the company’s growth to offset this.
Reduced tax incentives
The new policy is designed to curb the practice of profit-shifting to low-tax jurisdictions. As such, the tax incentives associated with establishing subsidiaries or operations in these regions will be markedly reduced. This could prompt a re-evaluation of corporate structures and operational strategies. Businesses might need to consider factors beyond tax efficiency when deciding on locations for their operations, such as market access, labour costs, and supply chain logistics.
Greater compliance complexity
Implementing the Global Minimum Corporate Tax Rate will undoubtedly increase the complexity of tax compliance for multinational corporations. They will need to navigate the intricacies of this new legislation, which may vary across different locations.
This could necessitate significant investments in legal and financial expertise, as well as more sophisticated tax reporting systems. The cost and effort associated with ensuring compliance could be considerable, particularly for businesses operating in many places.
Advanced Financials: Preparing your business for the Global Minimum Corporate Tax Rate
Financial regulations are continuously evolving, and new regulations are coming into place all the time. Understanding and complying with the likes of tax laws can be a daunting task for businesses. The complexity involved often requires a deep understanding of international tax law, intricate financial calculations, and extensive documentation.
Moreover, non-compliance will likely carry severe penalties, including financial fines and reputational damage. This is why it’s an absolute necessity to leverage the help of technology if organisations are to effectively navigate the complexities of financial legislations like the Global Minimum Corporate Tax Rate (and other regulatory frameworks).
Our Cloud based accounting software, Advanced Financials, provides robust reporting capabilities, simplifying regulatory reporting by offering tools to swiftly compile and analyse financial data. This aids businesses in meeting diverse regulatory requirements, thus reinforcing their reputability in the marketplace.
Advanced Financials is updated regularly, so that it not only keeps finance teams compliant with the latest laws, but it also keeps their capabilities up to date with the latest market/competitor trends. As it’s a Cloud-based system, nothing is installed locally, and these updates can be applied instantly and remotely.