Joe Biden’s first big clash with the largest businesses in the US came as a result of his proposal to increase corporate tax and raised quite a few eyebrows. Although Corporate America initially welcomed the massive government spending plan, it later expressed genuine concerns on the topic. International corporate taxation has long presented a challenge for tax authorities worldwide, causing them losses in billions of tax dollars. The US has been one of the largest backers of negotiations on a large-scale reform of international corporate taxation that have been going on for quite some time. However, an agreement is yet to be reached within the G20 and the Organization for Economic Cooperation and Development (“OECD”).
US multinationals use so-called tax havens more than anyone else. No other non–haven OECD country records such a high share of foreign profits booked in tax havens like the US. [1] Almost by default, they choose to conduct their business in countries that offer the most beneficial interpretation of tax laws. In developing countries, tax administrations often lack the capacity to tackle complex issues such as international profit shifting. They also tend to interpret regulations in favor of multinational corporations, to attract investments. But is it as simple as it seems?
Some would identify the US tax system as the main culprit for nearly 37,000 Americans renouncing citizenship over the past decade. Namely, the US taxation of foreign income differs from the international tax system in most countries. While the foreign income of US multinational enterprises (MNEs) is also subject to US corporate income taxes, all other countries except Eritrea, apply an exemption system to foreign business income. Most countries exempt foreign-sourced income, to avoid double taxation of employment income. In other words, the country of residence limits its taxation rights to tax foreign-source income. Consequently, said income is taxable exclusively by the source country.
Recently, global taxation talks reached a significant milestone. Namely, the Biden administration released an outline of its proposed changes to US corporate tax policies called the “Made in America” tax plan. It includes a proposal to establish a global minimum tax rate on businesses, a solution that has already been discussed by the OECD and the G20. A global minimum tax rate would mean that that no foreign affiliate can escape the minimum tax rate by declaring its operations in a so-called tax haven. Should its effective tax rate fall below the minimum rate, the countries where the actual economic activity takes place would have the right to tax the difference. For example, if a company is incorporated in a country implementing the global minimum rate of 20% and it earned profits overseas taxed at 5%, the country of incorporation would be entitled to charge the company with an additional 15%. Tax regulators say that it seems realistic for the proposed agreement to be reached this year. But it is the implementation that counts. As many agree, we are facing historical changes.
What are the benefits? Minimum taxation eliminates the incentive for multinational corporations to conduct aggressive tax planning. Therefore, multinationals would be less likely to move their assets to countries offering low or even no-tax treatment. also contributing to tax base erosion. Minimum global taxation also contributes to stable and sustainable tax systems that can support public expenditure and respond to crises such as COVID-19. Last but not the least, the US Treasury Secretary, Janet Yellen, advocated that this type of taxation would also ensure “that all citizens fairly share the burden of financing government”. This would eventually lead to more equitable economic growth around the world.
On the other hand, for this new regime of taxation to work, a lot of issues need to be solved. Will countries agree to it, and can they enforce it? How will reporting work? What counts as taxable income and which deductions should be included? Should profits be taxed in the jurisdiction where economic activities occur, or where these entities are technically headquartered? How should corporate subsidiaries and difficult-to-value assets be handled? And finally, how high could a minimum rate be? In OECD talks, the figure of 12.5% was discussed. However, the US goes much further by suggesting a minimum tax rate of 21%. The latest news, however, is that US is willing to accept 15% minimum rate. That move could make it easier to reach this highly important multilateral agreement.
Janet Yellen has called on countries to join Washington in setting the global minimum corporate tax rate. “Together we can use a global minimum tax to make sure the global economy thrives based on a more level playing field in the taxation of multinational corporations, and spurs innovation, growth and prosperity”, she said. In the EU, Germany and France already backed Washington, welcoming Yellen’s pledge, while low-tax Ireland voiced concerns.
This proposal is only part of the broader picture, including the strong campaign, led by the EU’s “Tax Lady”, Margrethe Vestager, to crack down on corporate tax avoidance and stop countries from offering sweetheart deals to multinationals. Some multinationals have already faced actions from the EU as a result of the campaign. Amid the landmark Apple tax case (more details available here), Vestager pointed out that if EU Member States give certain multinational companies tax advantages not available to their rivals, it harms fair competition in the EU. The European Commission further emphasized that, while Member States enjoy fiscal sovereignty, any tax measure adopted by a Member State must comply with EU state aid rules.
To sum up, tax reforms are almost always controversial. Hence any such legislative change needs to consider the interests of all stakeholders. For example, the US Chamber of Commerce called the plan to fund Biden’s infrastructure proposals with higher corporate taxes “dangerously misguided”. Meanwhile, Cathy Schultz, the Vice President for Tax Policy at the National Foreign Trade Council, a lobby group for the US multinationals said: “They have no idea how difficult it’s going to be for US companies to compete against foreign competitors who are not subject to these high minimum taxes”.
But beyond all the controversial wrangling, the crucial question is whether the US can force other countries to surrender their tax sovereignty and adjust their tax systems. Tax policy is ultimately a matter of national sovereignty and each country is free to devise its tax system in the way it considers most appropriate.[2] But the essence of the problem is that global superpowers, rather than the individual sovereign countries, too often shape tax policies.
Authors: Teodora Ristić, Jovana Trivunović
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[1] Gabriel Zucman, Thomas Wright, “The Exorbitant Tax Privilege”, NBER Working Paper No. 24983, September 2018. Available at: https://ssrn.com/abstract=3246780.
[2] Addressing Base Erosion and Profit Shifting, OECD publishing. Available at: https://read.oecd-ilibrary.org/taxation/addressing-base-erosion-and-profit-shifting_9789264192744-en#page30.
