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Global minimum tax rate: Legislating tax transparency is a step toward global tax equity

A corporate tax agreement with a minimum global corporate tax rate of 15 percent is set to standardize international tax legislation.

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Quantumrun Foresight
December 5, 2022

Insight summary

The G-7 nations (a group of wealthy countries) have gained the approval of 140 nations to implement a global minimum tax rate (GMT) on corporate revenues by 2023. Some experts believe this legislation will result in tax transparency, while others think it may only reshuffle tax havens. Other long-term implications of a global minimum tax rate could include low-income countries opposing this legislation and tax professionals upskilling to accommodate complexities within this policy.

Global minimum tax rate context

Nations established the basis for the global corporate tax system in the 1920s to prevent trade and growth from being double taxed on the same profits. However, multinational companies (MNCs) have avoided taxes for decades by moving their profits into low-tax havens. Meanwhile, in 2015, the Organization for Economic Co-operation and Development (OECD) estimated that this tax avoidance costs USD $100 to $240 billion annually, which equates to up to 10 percent of global corporate tax revenue.

However, in 2020, the COVID-19 pandemic initiated an economic downturn that pressured governments to reassess their economic policies, including how to address tax avoidance. In particular, the US, under the Biden Administration, spearheaded the standardization of a global tax system to promote transparency and avoid corruption.

Generally, governments allot the right to tax profits wherever goods are produced, i.e., the “source.” If a parent company is headquartered in another country, that’s where the taxes go next, i.e., the “resident.” In this system, it doesn’t matter where sales are made. Companies keep records of payments between affiliates using the “arm’s-length” principle, which should be equivalent to those found on the open marketplace.

This setup has resulted in bilateral tax treaties with two significant consequences. First, governments compete for investment and revenue by offering meager tax rates. Secondly, businesses are incentivized to move their reported profits to countries with lower taxes. For example, the Cayman Islands, Ireland, and Singapore have a 5 percent tax rate on foreign companies. As a result, there’s a mismatch between economic activity and where the tax is remitted.

Disruptive impact

Some countries have strong stances on the global corporate tax rate. President Biden said (2021) multinational businesses would no longer be able to pit nations against one another to lower tax rates or avoid paying taxes by hiding profits generated in the US in lower-tax jurisdictions. Meanwhile, several European Union (EU) members were hesitant to agree to the deal because it would hinder them from establishing their respective local tax rates, especially those over 15 percent.

In contrast, in 2022, China stated that it welcomes a GMT as it has no significant effect on the country. China’s corporate tax is at 25 percent, offering a 15 percent rate for some technology companies. While some developed nations argue that China will probably use the legislation to seek exemptions, the country emphasizes that there is no need for this measure as China continuously receives foreign investments.

However, Hong Kong is not so enthused. The government is the seventh-largest tax haven globally and the biggest in Asia. The Hong Kong finance department is concerned that the GMT would weaken incentives that support its various economic sectors. Such examples are cited by some experts as one of the potential side effects of a global tax rehaul, wherein MNCs would look for other potential tax havens instead of avoiding them.