Two weeks ago, the finance ministers of the G7 countries agreed on a minimum corporate tax rate of 15% for their largest multinationals. Tax advocates say this will be a major and lasting blow to jurisdictions that have no corporate income tax, like the Cayman Islands, and countries with low tax rates. Others believe the effects will be benign.
Here we answer some of the main questions about the global minimum tax.
Why is this happening?
International groups, like the G20 and the Organisation for Economic Cooperation and Development, have been working on new rules that reform how the profits of large corporations are taxed.
Multinational companies have over the years devised many ways to pay less tax.
They can do this, for example, by shifting profits to where tax rates are very low or where they do not have to pay any tax at all – such as in places like the Cayman Islands.
Even if most practices are legal, there is a growing feeling that this is not only unfair to smaller domestic companies who cannot use the same tax-avoidance techniques, but also quite simply that corporations are no longer paying their ‘fair share’ of tax.
Is that true?
It is certainly true that governments receive less tax revenue from corporations than they used to.
This is because most countries have lowered their corporate tax rates to make their homegrown companies more competitive internationally and to attract businesses and jobs from overseas.
The result was a consistent decline in corporate income tax rates and revenue worldwide. But it supported job creation and economic activity.
What has changed recently is that more countries, especially the United States, are planning to reverse their tax policies and set new priorities.
More governments now believe the trade-off between more economic growth and jobs on the one hand and tax losses on the other is no longer favourable (to the extent that it ever has been) and, following the COVID pandemic, that they need the money.
Rather than lower the tax rates for businesses, the new Biden administration, for instance, wants to increase business tax rates to 28% in the US to raise funds for investments into America’s ageing infrastructure.
What is the US planning to do?
Because US companies could attempt to sidestep tax increases at home by shifting profits to low-tax countries abroad, just as they have done in the past, the US government wants other countries to agree to a minimum corporate tax worldwide, ideally at the 21% rate that the US plans to levy on US corporates’ overseas profits.
This would end what US Treasury Secretary Janet Yellen called a ‘race to the bottom’ on tax rates and revenue.
The G7 finance ministers have agreed a rate of at least 15% on the worldwide profits of multinational companies. The rate is lower than the 21% demanded by the US to get more countries to accept the proposal.
The G7 countries also agreed a deal that will allow governments to tax some corporate profits based on the location of sales.
What does that mean?
This changes who has the right to tax corporate profits. The rule has been until now that countries can tax businesses that have a physical presence – offices, manufacturing plants, distribution centres and shops – within their borders.
In recent years more corporations, in particular US tech companies, were able to generate massive profits by selling to customers in countries where they have no presence, for example by selling services online.
Under the traditional tax approach, it has become much more difficult to tax them. The G7 agreement will allow countries to tax a fraction of corporate profits (20%) that exceed a 10% profit margin.
So, an US multinational’s profits that would have gone untaxed to a subsidiary in Cayman, for example, will now be subject to some tax in countries where the profits were generated from sales.
In addition, the same offshore subsidiary will face a minimum 15% rate on profits, regardless of where they were earned.
How does the minimum tax work?
Under the proposed new rules, governments would impose a minimum tax on companies that are tax resident in their country.
For example, if the Cayman subsidiary of a US corporation pays less than the 15% minimum – which is likely because the rate in Cayman is 0% – then the US can tax the offshore profits to bring the corporation’s overall tax rate, including US and foreign taxes, to 15%.
Is this a big deal for corporations?
If the reaction of the stock market is anything to go by, no, it is not. After the G7 tax deal was announced, the share price of computer chipmaker Nvidia, which reportedly only pays an effective corporate income tax rate of 2% on its worldwide profits, actually increased, as did the share prices of many other multinationals that would be subject to the tax.
This reflects the belief of stock market analysts and investors that either the deal will not happen after all – there are still question marks whether US lawmakers will ratify it – or that if it is adopted the effect will not be as great as expected.
The OECD estimates the minimum tax would raise about 4% more in corporate income tax worldwide or about US$100 billion. That sounds like a large amount but is comparatively small compared to overall profits.
The companies most affected will be the ones that license their intellectual property through low-tax jurisdictions to accrue profits where they are subject to less tax.
However, some companies like Google or Microsoft have already dismantled many of those structures after the 2017 US tax reform and made the profits subject to US tax.
Does it matter to the Cayman Islands?
Economist Paul Byles, director at FTS Consulting, says ultimately the impact of the proposed global tax initiative will depend on how much the industry relies on multinationals, particularly US-based ones that seem to be the target of the programme.
Byles believes that Cayman’s tax transparency is so high, after it signed many tax information exchange treaties over the past decade, that it is unlikely that much of the business the minimum tax is targeting is still operating from the Cayman Islands.
One aspect of the new tax transparency is the so-called country-by-country reporting by multinationals with more than $850 million in revenues, which reveals how much profit they make in each jurisdiction.
In 2017, a total of 404 US-based multinationals reported that their more than 2,100 Cayman offshore entities earned net profits of $58.5 billion.
The US Congress Joint Committee on Taxation calculated that this represented 1.3% of all reporting US subsidiaries’ worldwide profits. The effective tax rate paid on this profit was 0.3%, based on taxes paid by these entities to other foreign countries.
In 2018, Cayman-based profits of US multinationals dropped to $50.2 billion based on total revenue of $75.2 billion.
The US companies also reported that their 2,144 offshore subsidiaries in Cayman employed 1,567 staff in 2017 and 5,498 staff in 2018. How many of these are supposed to be based in Cayman is not clear.
Although Cayman-based profit figures of US corporates are enormous, losing this type of business would not impact local tax revenues because Cayman does not impose any tax on offshore entities.
Instead, government levies annual registration fees. Both government revenue from fees and stamp duties and service provider fees related to US offshore subsidiaries are likely in the millions to low tens-of-millions range.
Comparable profit data for other countries is only available for 2016, and it shows that more than 90% of Cayman-based subsidiary profits were related to the US companies.
This confirms that for the Cayman Islands only the subsidiaries of US multinationals are relevant in the context of the global minimum tax and corporate tax reform.
It is also important to note that US offshore profits were already subject to some tax.
Until 2017, US companies’ foreign profits were taxed at the domestic tax rate upon repatriation to the domestic parent firm. This created a big incentive for large companies to keep profits offshore to avoid US tax entirely.
Since the 2017 tax reform, US firms have been subject to a minimum tax on their global intangible low-taxed income (GILTI). This tax on easily movable intangibles assets, such as intellectual property rights, generally ranges from 10.5% to 13.125%, well below the regular US corporate tax rate.
Even if the global minimum tax is not adopted, the Biden administration has submitted a proposal to Congress that would replace the GILTI regime and tax overseas profits, including those in Cayman, at a rate of 21%.