A Global Minimum Tax: Is This the End of the Race to the Bottom?
Supply chain disruptions have led companies to rethink their global supply chain strategies and their global business models. International trade in goods has plateaued over the years and globalization is evolving to a “think global, make local” model—a shift from the current model of manufacturing items in low-cost countries and then shipping them elsewhere. At the same time, companies are also operating in an increasingly digitalized world—whether that manifests in their internal business processes or value provided to customers.
In step with these changes, the global tax framework is also undergoing a fundamental change from tax competition to tax cooperation. Over the past decades, countries including the United States have reduced tax rates to attract corporate investment. Multinational companies have been able to legitimately reduce their global tax bills by taking advantage of these differences in tax rates and rules. In order to stop a race to the bottom, countries are now planning to come together.
“After decades of undermining one another, 139 rich and poor nations are closing in on a framework for taxing multinational corporations that would be the biggest change in the system since 1923,” according to a Bloomberg Tax article. “The goal is to create a united front to prevent corporations from playing one country off against another, recognizing that a race to the bottom in taxation has no winner, only a bunch of revenue-deprived losers.”
One potential avenue global leaders are exploring is a global minimum tax that envisages companies paying a minimum tax on their global revenues. Here’s an example of how such a system might work, as explained in a paper for the Atlantic Council by Jeff Goldstein, a former special assistant to the chairman of the White House Council of Economic Advisers:
[A]ssume Country A has a corporate tax rate of 20% and Country B has a corporate tax rate of 11%. The global minimum tax rate is 15%, and Company X is headquartered in Country A but reports income in Country B. Country A would ‘top-up’ the taxes paid on profits earned by Company X in Country B in a manner equal to the percentage-point difference between Country B’s rate of 11% and the global minimum of 15% (e.g., Company X would pay in taxes an additional 4% of profits reported in Country B). This approach would set a floor on the collection of global tax revenue and help alter corporate incentives because companies would know that profits shifted to tax havens would face incremental taxation.
The idea for a global minimum tax was originally proposed in 2019 by the Organisation for Economic Co-operation and Development (a group of 35 mostly developed countries) alongside a digital tax. While the U.S. tax rules already include a version of a minimum tax on global profits, President Biden is proposing to increase this minimum tax rate from 10.5% to 21% on U.S. companies’ foreign income to counter international tax planning strategies that take advantage of tax rate arbitrage. In line with this, Treasury Secretary Janet Yellen is working with other countries to forge an agreement on a global minimum tax. France and Germany have pledged their support, while others including countries that use low tax rates to attract foreign investment are still in discussions.
The possibility of a digital tax—another measure to tax companies based on the location of their customers— would be relevant mostly to technology companies and businesses in digitally focused sectors such as ecommerce and online advertising. The notion of a digital tax has been contentious in the past because of perceptions that such a tax unfairly targets U.S. technology companies; that perception led the Trump administration to disengage from these discussions.
These international discussions on both a global minimum tax and a digital tax have now received a boost thanks to Biden’s tax proposals to fund infrastructure investments and also his willingness to re-engage in exploring alternative approaches to how a digital tax might work.
Anticipating the Impact
International tax rules are complicated. Evolving globalization and digital business models entail rethinking sourcing strategies, operating locations, supply and delivery channels, the extent of centralized versus decentralized operations, sharing of technology and intellectual property, talent management and related investments – and corporate taxes impact each of these decisions. Multinational companies are no doubt concerned about any increase in taxes, but they also want certainty and simplicity. U.S.-based companies will need to consider the interplay between a potential global minimum tax and evolving U.S. tax policy, which is set to encourage reshoring of manufacturing operations and also ensure that global profits are adequately taxed.
These domestic and global tax policies, if appropriately designed, have the potential to simplify the tax framework by eliminating certain redundancies. A global minimum tax may reduce or eliminate compliance with other global tax rules that become redundant in a system where there is no tax arbitrage. At the same time, such a tax may increase compliance challenges and the possibility that companies get caught in disputes between governments trying to garner a greater share of taxes under the new framework.
There are a lot of negotiations that need to conclude for a global minimum tax to come to fruition, and there are a lot of practical questions that need to be resolved before it becomes an effective reality. In a post-pandemic world where countries have to finance fiscal stimulus spending, rebuild supply chain and infrastructure and respond to growing calls for tax fairness, we can be sure that tax policy will be front and center. Multinational companies may assert that an increase in global tax rates could reduce their competitiveness and ability to create more jobs. Research indicates that most of the benefit from tax rate reductions during the 2017 U.S. tax reforms accrued to the shareholders, and not workers. What nations need to agree on is a tax framework that encourages job creation, competitiveness and a fair playing field. As multinational companies adapt to new supply chain models, the ability to adapt to evolving tax laws is also critical.
Shruti Gupta has more than 15 years of experience advising multinational clients on their transfer pricing planning, supply chain structuring, global compliance and controversy management strategies. She is a senior analyst in RSM’s Industry Eminence Program, which positions its analysts to understand, forecast and communicate economic, business and technology trends shaping the industries RSM serves.
