Countries representing 90% of global economic output have finalised an agreement to reform the international tax system and impose a 15% tax rate on multinational enterprises from 2023.

The minimum tax is aimed specifically at corporations that generate profits in low-tax and zero-tax jurisdictions, including the Cayman Islands.

The landmark deal will also reallocate more than US$125 billion of profits from about 100 of the world’s largest and most profitable corporations to countries worldwide, to better align where these companies operate and generate profits with where they pay tax.

After years of negotiations, trying to adapt international tax rules to the digital age, 136 of the 140 members of the OECD/G20 Inclusive Framework on BEPS joined the so-called two-pillar solution.

It updates and finalises a July political agreement by members of the Inclusive Framework to fundamentally reform international tax rules and now includes three EU member countries – Ireland, Hungary and Estonia – that were formally opposed to a global minimum tax rate for companies.

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Compared to the July deal, countries have now agreed the minimum tax rate, how much residual profit can be re-allocated, and an implementation plan.

The two-pillar solution will be delivered to the G20 Finance Ministers meeting in Washington DC on 13 Oct and then to the G20 Leaders Summit in Rome at the end of the month.

Four countries – Kenya, Nigeria, Pakistan and Sri Lanka – have not yet joined the agreement.

The OECD, which led the negotiations on behalf of the G20, said in a statement that the global minimum tax agreement does not seek to eliminate tax competition, but puts multilaterally-agreed limitations on it.

The organisation believes countries will collect around US$150 billion in new revenues annually as a result of the reform.

Re-allocating taxing rights

Pillar One will re-allocate some taxing rights over the largest and most profitable corporations from their home countries to the markets where they have business activities and earn profits, regardless of whether firms have a physical presence there.

This aims to achieve a fairer distribution of profits and taxing rights over tech companies that can effectively sidestep traditional tax rules, based on physical presence, by delivering their products and services digitally.

Under the agreement, multinational enterprises with global sales of more than EUR20 billion and a profitability higher than 10%, will see a quarter of their profit above a 10%-threshold taxed by market jurisdictions, rather than countries where they were traditionally tax-resident.

The OECD estimates that taxing rights on more than $125 billion of profit are expected to be reallocated to market jurisdictions each year. Developing countries stand to gain proportionally more revenue than more advanced economies, the organisation said.

While the new rules only apply to the approximately 100 most profitable companies, expanding the scope to more companies would have increased the amount of complexity but not necessarily the amount of re-allocated profits, the OECD said. But there is a provision that would allow for bringing more companies under the new rules after seven years.

Minimum global corporation tax rate

Pillar Two introduces a global minimum corporate tax rate set at 15%. This new minimum tax rate will apply to companies with revenues of more than EUR750 million. It is expected to generate almost all of the US$150 billion in expected additional global tax revenues annually.

The minimum tax is targeting corporations that generate profits in low- and zero-tax jurisdictions, like the Cayman Islands.

To curb tax evasion and aggressive tax avoidance, the G20 and the OECD-hosted Global Forum on Transparency and Exchange of Information for Tax Purposes initially focused on introducing the automatic exchange of information of bank and taxpayer information.

The OECD Base Erosion and Profit Shifting (BEPS) project then required companies to have a minimum level of substance, as opposed to just shell companies, in low-tax jurisdictions.

Pillar Two now means that those companies pay a minimum effective tax rate of 15% on their profits booked in low-tax and zero-tax jurisdictions with carve-outs for real, substantial activities.

In practice, the global minimum tax rate applies to overseas profits. Governments are still able to set local corporate tax rates but if a company’s subsidiaries pay a lower tax rate than 15% in a specific country, the group’s home government can “top-up” the taxes that are due to the minimum rate.

“The cumulative impact of these initiatives means that ‘tax havens’ as people think of them would no longer exist,” the OECD said. “Those jurisdictions that offer international financial services may continue to find a market for their services, but on the basis that they add real economic value for their customers and support for commercial transactions that are not tax-driven.”

Model rules that give effect to the minimum corporate tax are planned to be developed by November 2021. A multilateral instrument will then be released by mid-2022 to implement the rules in bilateral treaties and take effect in 2023.

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