What is global minimum tax? The landmark accord explained

London: Finance Ministers from the Group of Seven (G7) rich nations reached a landmark accord on Saturday backing the creation of a global minimum corporate tax rate of at least 15 per cent, an agreement that could then form the basis of a worldwide deal.

Such a deal aims to end what US Treasury Secretary Janet Yellen has called a “30-year race to the bottom on corporate tax rates” as countries compete to lure multinationals.

Why global minimum tax?

Major economies are aiming to discourage multinationals from shifting profits – and tax revenues – to low-tax countries regardless of where their sales are made.

Increasingly, income from intangible sources such as drug patents, software and royalties on intellectual property has migrated to these jurisdictions, allowing companies to avoid paying higher taxes in their traditional home countries.

Where are the talks at?

The G7 accord feeds into a much broader, existing effort. The Organization for Economic Cooperation and Development has been coordinating tax negotiations among 140 countries for years on rules for taxing cross-border digital services and curbing tax base erosion, including a global corporate minimum tax.

The OECD and G20 countries aim to reach consensus on both by mid-year, but the talks on a global corporate minimum are technically simpler and less contentious. If a broad consensus is reached, it will be extremely hard for any low-tax country to try and block an agreement.

The minimum is expected to make up the bulk of the $50 billion-$80 billion in extra tax that the OECD estimates firms will end up paying globally under deals on both fronts.

How would a global minimum tax work?

The global minimum tax rate would apply to overseas profits.

Governments could still set whatever local corporate tax rate they want, but if companies pay lower rates in a particular country, their home governments could “top-up” their taxes to the minimum rate, eliminating the advantage of shifting profits.

The OECD said last month that governments broadly agreed on the basic design of the minimum tax but not the rate. Tax experts say that is the thorniest issue, although the G7 accord creates strong momentum around the 15%-plus level.

Other items still to be negotiated include whether investment funds and real estate investment trusts should be covered, when to apply the new rate and ensuring it is compatible with U.S. tax reforms aimed at deterring erosion.

What next?

At G20 meeting scheduled for Venice next month will see whether the G7 accord gets broad support from the world’s biggest developing and developing countries.

Much still needs to be ironed out – including the metrics that will determine how and to which multinational companies the tax will be applied.

The G7 communique left open what will happen in the meantime to digital services taxes on big technology companies in various jurisdictions, which the United States wanted to be scrapped as soon as a deal was in place.

It said only that there should be “appropriate coordination between the application of the new international tax rules and the removal of all Digital Services Taxes”.

Any final agreement could have major repercussions for low-tax countries and tax havens.

The Irish economy has boomed with the influx of billions of dollars in investment from multinationals. Dublin, which has resisted European Union attempts to harmonize its tax rules, is unlikely to accept a higher minimum rate without a fight.

However, the battle for low-tax countries is less likely to be about scuppering the overall talks and more about building support for a minimum rate as close as possible to its 12.5% or seeking certain exemptions.

G-7 strikes deal to revamp tax rules for biggest firms

The landmark deal could help countries collect more taxes from big companies and enable governments to impose levies on US tech giants such as Amazon Inc. and Facebook Inc.

The agreement by the G-7 finance ministers in London satisfies a US demand for a minimum corporate tax rate of “at least 15%” on foreign earnings and paves the way for levies on multinationals in countries where they make money, instead of just where they are headquartered.

The deal is aimed at modernizing the century-old international tax code and cools transatlantic tensions that threatened to spill into a trade war under Donald Trump. But key details are still to be nailed down, more nations must sign on, and full implementation could take years.

Decision hailed

US Treasury Secretary Janet Yellen, among the finance chiefs who hailed the announcement as an unprecedented step, said a final accord on which companies could see their profits taxed outside their home countries would include the likes of Amazon and Facebook.

” What you’re seeing is a revival of multilateralism, a willingness of leading nations in the G-7 and G-20, to cooperate to address the most critical challenges facing the global economies,” Yellen said after the meeting.

Focus will now shift to a July meeting of the Group of 20 finance ministers in Italy and long-running talks between about 140 countries at the Organization for Economic Cooperation and Development.

The G-7 pact marks a step to re-write a global system that critics said allowed big companies to save billions of dollars in tax bills by shifting jurisdictions. It’s also help address complaints that major digital companies can make money in multiple countries and pay taxes only at home.

In response to the announcement, some of the world’s biggest tech companies focused on how the deal could help clear up the rules on where to pay taxes.

“Today’s agreement is a significant first step toward certainty for businesses and strengthening public confidence in the global tax system,” Facebook’s Global Affairs Vice President Nick Clegg said on Twitter.

An Amazon spokesperson said the OECD-led process “will help bring stability to the international tax system” and described Saturday’s deal as a “welcome step forward in the effort to achieve this goal.”

Under the Trump administration, the US had also refused to allow foreign governments to tax American digital companies, a key European demand.

The transatlantic division spiraled into a battle of unilateral measures and threats of trade sanctions, which although suspended, are still in place.

According to the communique after the London meeting, countries where big firms operate would get the right to tax “at least 20%” of profits exceeding a 10% margin. That would apply to “the largest and most profitable multinational enterprises,” potentially enabling the G-7 to square the circle so that digital is included without being targeted.

Asked whether that means companies like Facebook and Amazon would be included, Yellen said they would qualify “by almost any definition,” and “most of those firms are likely to be included in this new scheme.”

The ministers of the UK and France both said they were now assured that tech giants would be in the cross-hairs of new rules, even as the final quantitative criteria are still to be determined.

“We’ve been fighting for four years in all European and international forums, here at the G-7 and the G-20 for a fair taxation of digital giants and for a minimum corporate tax,” France’s Finance Minister Bruno Le Maire said.

The antipathy in recent years was greatest between Paris and Washington. France was the first country to bypass the slow-going OECD process on how to tax profits, opting for a controversial levy exclusively on the digital revenues of large firms.

The G-7 said that countries would “provide for appropriate coordination” to remove such digital services taxes. Resolving the exact sequencing of that could prove tricky, with countries unwilling to give up revenues before they have certainty over what they will gain from new global rules.

Italian Finance Minister Daniele Franco said he’ll aim to broaden the discussion when G-20 finance ministers meet in July in Venice. Once the proposal is agreed, Italy will no longer need its digital tax, he said.

Two issues

Highlighting other remaining divisions, the finance minister of Ireland, whose country has attracted some of the world’s big businesses with low taxes, said any deal on a minimum rate must meet the needs of “small and large countries, developed and developing.”

Pushing in the other direction, Le Maire said the 15% is a starting point and France would fight for a higher rate in the coming weeks.

The administration of US, President Joe Biden still needs approval from Congress and will hope the deal hands it leverage for its massive infrastructure program. It is seeking support from lawmakers to raise the domestic corporate tax rate to 28% from 21%. An international deal for 15% could help him because it offers multinationals options.

The OECD has said a final global deal may not come until October, with delivery requiring nations to pass the plan through national legislatures.

“There is important work left to do,” said OECD Secretary-General Mathias Cormann. “But this decision adds important momentum to the coming discussions.”