After years of debate, the finance chiefs of the G7 countries have agreed on a global minimum corporate tax of 15%, a step that U.S. Treasury Secretary Janet Yellen calls “unprecedented” and the G7 group calls “historic.” What would it mean, and why is it happening now? And does it increase the odds that other changes President Biden wants to make to the way companies are taxed may soon follow? The issues are sometimes complicated, and the effects could be significant. Here’s a guide.
Why is the idea of a global minimum tax suddenly getting so much attention?
The Organization for Economic Cooperation and Development (OECD) has been leading negotiations among 139 nations and jurisdictions to agree on a minimum tax since 2013. U.S. support was lukewarm at best until President Biden proposed substantial changes to the U.S. corporate income tax; the revised rules wouldn’t be very effective unless the U.S. and other countries all had some kind of minimum corporate tax. So the Biden administration is enthusiastically supporting the OECD project, giving it far more momentum than it has had so far.
The G7 agreement is largely symbolic but still significant. If only seven countries agreed on a global minimum tax, the effect would be minor. But the support of the G7 (the U.S., Japan, Germany, the U.K., France, Italy, Canada) increases the chances the finance leaders of the G20 countries will endorse the tax at their meeting next month in Italy, which would further increase the OECD project’s momentum.
Why does President Biden want to change the corporate tax code?
The fundamental issue is that today’s global economy is based increasingly on intangibles—services and intellectual property—but the international tax regime, which began to take shape about a century ago in the League of Nations, hasn’t kept up. As a result, many multinational corporations can easily and legally cut their taxes by shifting revenues, and thus profits, from high-tax countries to low-tax or no-tax countries.
Example: An American company might set up a subsidiary in Jersey, an island in the English Channel, to own the company’s brands. Then the company’s operations in the U.S. and around the world would pay royalties to the Jersey subsidiary for rights to use the brands. Those royalty payments would reduce the company’s taxable income in the countries where it does most of its business. The Jersey subsidiary would have very high profits, but Jersey has no corporate income tax. That’s a simplified example of what companies can do; real-world arrangements are often far more complex.
Developed economies don’t like such arrangements because they reduce tax revenue. In addition, governments dislike these tax maneuvers because they reduce a government’s power over big corporations. Governments use corporate tax policy to shape where companies build facilities, what products they make, how they finance their operations, and much more. When a company shifts profits away from a given country, the company is much less affected by the country’s tax policy.
How is Biden trying to change all this?
He’s proposing a multipart system to make escaping U.S. tax more difficult and to make U.S. corporations pay more tax no matter where their profits are.
The system starts with increasing America’s global minimum tax on U.S. multinationals, requiring them to pay the U.S. government more of the profits they record in other jurisdictions. But raising the tax, by itself, wouldn’t accomplish much. The U.S. is the only country that imposes a global minimum tax, so increasing its burden would incentivize U.S. multinationals to invert—merge with companies in other countries and thus move their tax residence out of the U.S. The corporation could continue operating in the U.S. as a foreign company, avoiding the minimum tax.
In part to prevent that from happening, Biden would punish foreign companies in the U.S. if their home country didn’t have a global minimum tax like America’s (presumably with a tax rate at least as high as the U.S. minimum). If that foreign company’s U.S. subsidiary made payments to another subsidiary in a tax haven, which would reduce its U.S. tax, the Biden proposal would forbid the subsidiary from using the payment as a tax deduction for its U.S. taxes. “It would allow us to recapture some of that taxable income,” says Samantha Jacoby, an analyst at the left-leaning Center on Budget and Policy Priorities. “The other main thing it would do is provide an incentive for other countries to agree to a minimum tax like the one the U.S. has.”
Some analysts believe that if the U.S. adopted such a tax rule unilaterally, the change could violate America’s obligations as a member of the World Trade Organization; a detailed proposal has yet to be released.
Why does Biden care about domestic tax rules in other countries?
He wants to use America’s heft as the world’s largest economy to shape the creation of a minimum global tax that’s truly global. If the OECD’s project succeeds, all 139 nations and jurisdictions would adopt and impose a minimum tax like America’s. If that happened, tax avoidance based on today’s profit shifting would be more difficult. Notably, the most popular tax havens—Bermuda, Cayman Islands, Jersey, Luxembourg, and others—are participating in the OECD project. At least in theory, companies would face little or no incentive to shift profits or move headquarters because they’d always face the same tax on their non-domestic profits.
Biden needs the OECD project to succeed. If it doesn’t, and if he’s able to raise the U.S. minimum tax (from 10.5% to 15%) and the basic corporate tax (from 21% to 28%) as he has proposed, while other countries change nothing, he’d significantly disadvantage U.S. corporations in global competition.
The details of the OECD effort can be mind-numbing, but the big picture is indeed historic. For the past hundred years, international tax diplomacy has focused on coordinating national policies, largely to avoid double-taxation. But now the OECD project envisions 139 countries and jurisdictions all changing their own laws to conform to a global standard. It’s “creating domestic law standards, which is typically what hasn’t happened,” says Manal Corwin, who leads KPMG’s Washington National Tax practice. “What we’re shifting into is this,” she says. “Let’s set standards for domestic taxation in order to prevent a race to the bottom. It’s really about the competition between countries and not just coordination between countries.”
How leak-proof would this new international regime be?
Hard to say, for two reasons.
Even if the OECD group agrees on a tax rate of 15%, the rate is only half the story. The other half is the welter of rules for determining what income gets taxed and what does not. The OECD is working on that problem also, but ultimately each country will set its own rules. A worldwide agreement to maintain a minimum corporate tax sounds a lot like a cartel, and cartel members are always incentivized to undercut the agreement that ties them together. Some countries could do that through the rules they impose.
The other reason an agreement’s success would be hard to predict is that the new system would inevitably be complex, and there’s no telling what a large industry of tax lawyers and accountants could do with it. Maarten de Wilde, a professor at the Netherlands’ Erasmus School of Law, thinks he has already found a complicated way to game the current version of the new framework, in which case, he writes, “a new world of tax planning opportunities would likely emerge.”
Besides changing international taxation, how else does Biden want to change corporate tax?
As noted, he proposes raising the overall corporate tax rate for all corporations from 21% to 28%.
In addition, he’s proposing an unprecedented new type of tax on corporations with profits of at least $2 billion. By law, U.S. corporations must keep two sets of books. Mandatory filings with the Securities and Exchange Commission use Generally Accepted Accounting Principles (GAAP). But tax filings with the Internal Revenue Service must use a completely different set of accounting rules. That’s one reason a profitable corporation may pay no income tax in a given year; the company was profitable according to publicly available SEC filings using GAAP rules but was not profitable under IRS rules for determining tax.
Biden would require U.S. corporations with profits above the $2-billion threshold to compute a 15% tax on profits as reported under GAAP rules and compare that amount with taxes as computed under IRS rules. The company would then pay whichever is higher—an Alternative Minimum Tax for companies.
No country in the world has imposed such a tax. Details of Biden’s proposal have yet to be worked out.
What are the odds that any of this will happen?
Biden included his tax changes in his infrastructure plan as a way to pay for its $2.2-trillion cost. Senate Republicans have said they oppose any increase in the corporate tax, and they and the White House have traded counteroffers on the amount of spending in the plan; Biden has reportedly floated the idea of leaving the basic corporate rate at 21% in exchange for Republican concessions on spending, but an overall agreement seems distant. Brian Riedl, a longtime Republican Senate staffer and adviser, now with the right-leaning Manhattan Institute, says, “At most I think they raise the corporate tax rate from 21% to 25% and make some modest international tweaks.” A former House Ways and Means Committee staffer agrees, saying, “Even some Democrats think 28% is too high. I think 25% is where they settle.”
Even if that happens, “it will probably be seen as a very temporary change, given the trend around the world,” says William McBride, vice president of federal tax and economic policy at the nonpartisan Tax Foundation. “Every year several major countries reduce their corporate tax rate. We can’t sustainably increase the corporate tax rate in the U.S.”
The OECD project to create a truly global minimum corporate tax has set a mid-July deadline for reaching some kind of consensus. The project faces “a lot of political pressure to achieve a form of consensus,” says KPMG’s Corwin, “but my experience with the OECD is that consensus can be defined in lots of different ways.” Her outlook for the mid-July deadline: “Achieving enough of a consensus to convince policymakers that something will happen should be enough to move things forward.” But getting 139 countries and jurisdictions to agree on a specific tax rate? “There’s no precedent for anything like that happening,” says McBride. “I don’t put a lot of stock in something like that happening this year.”
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