A significant step towards the goal of tax fairness
With the new year, the EU directive imposing a minimum effective tax rate of 15% for multinational corporations operating within the Union has come into effect. After lengthy negotiations, all 27 members unanimously voted in favour in December 2022, as is customary for tax matters.
Based on the principles and regulations developed within the framework of the OECD and adopted through the Council Directive of the European Union 2022/2523, Italy has incorporated provisions regarding the global minimum tax (through Legislative Decree no. 209 of December 27, 2023).
This tax, known as “Global Minimum Tax,” took effect on January 1, 2024, and applies to all multinational companies with a total turnover of at least 750 million euros. The rate of the global minimum tax corresponds to 15% of the profit and is applied to the parent company if it is based in a country adopting this type of tax, or alternatively, to subsidiaries.
How it works
The Global Minimum Tax applies when companies in a jurisdiction – for example, Italy – pay income tax less than 15%. For these purposes, the nominal rate (24% in Italy) is not considered, but only the effective one.
After a prolonged phase of discussions lasting years, 140 countries, members of the OECD and G20, have agreed on the need to adopt a global tax reform based on two fundamental principles:
1. New Tax Setting System for Large Multinational Enterprises:
It is envisaged that large enterprises, with a turnover exceeding 20 billion euros and a profitability exceeding 10% before the application of taxes, must pay taxes in the countries where they generate profits, not limited to the location of their legal headquarters.
Effective Minimum Tax of 15% for Large Multinational Groups:
An agreement has been reached to establish an effective minimum tax rate of 15% for large multinational groups with a global turnover exceeding 750 million euros. This measure aims to limit opportunities for tax base erosion and profit shifting.
For years, the EU has tried to flex its muscles against corporate tax evasion, introducing a series of new laws and pursuing high-profile legal cases against multinational companies.
However, some of its member states – such as Ireland, Luxembourg, and Cyprus – have continued to allow high-profit companies to evade both taxes and controls. Global profit shifting (1) has also remained high, causing billions of euros in losses to the continent, while economic inequality worsened.
European Commissioner for Economic Affairs, Paolo Gentiloni, has described the new rules as “a new dawn for the taxation of large multinational corporations.“
Globally, 139 countries, representing over 90% of the world’s GDP, including the United States, China, India, and Russia, have approved this tax reform developed within the EU by the Organisation for Economic Co-operation and Development (OECD). The minimum taxation for large enterprises is the implementation of the “second pillar” of the OECD reform, while the first focuses on the reallocation of taxable profits.
The aim of this long-awaited reform is to put an end to the so-called “race to the bottom” or tax dumping: the gradual reduction of income tax rates to attract multinational investments in national economies. With the EU at 27, the first to implement the reform were the United Kingdom, Norway, Australia, South Korea, Japan, and Canada. Many are still in the process.
Specifically, the directive establishes a set of common rules for calculating and applying a “top-up tax” in a specific country if the effective tax rate is below 15%. If a controlled company is not subject to the minimum effective rate in the foreign country where it is based, the member state of the parent company will apply an additional tax to it. Furthermore, the directive ensures effective taxation in cases where the parent company is located outside the EU, in a low-tax country that does not apply equivalent rules.
According to OECD estimates, the global tax reform could generate $220 billion worldwide, provided that all signatories keep their promises and implement the planned reform.
A “revolution” in tax justice
The OECD agreement, as mentioned, consists of two pillars, the first of which aims to ensure that companies pay taxes where they conduct their activities. The second pillar establishes a global minimum tax rate of 15%.
This does not necessarily mean that EU countries will adjust their corporate tax rates to the 15% baseline, as other countries may intervene to collect taxes from multinational corporations paying their taxes in low-tax jurisdictions.
This means that, in a hypothetical scenario, for example, that an Italian multinational operating in Eritrea and transferring its profits to Ireland could face an additional tax from Italy or even Eritrea if it does not pay the minimum 15% rate in Ireland.
Most EU countries have already incorporated the EU directive into law, making the new rules a reality. Five countries – Estonia, Latvia, Lithuania, Malta, and Slovakia – have informed the European Commission that they will delay implementation as the affected multinational companies operating within their borders are fewer than twelve.
What do we talk about when we talk about international taxation of multinational corporations?
Improving tax information on multinational corporations helps better understand the dynamics used by these corporate giants to reduce their tax burden. Corporate tax statistics published by the OECD on November 21 show that this represents a significant share of national tax revenues, averaging 15.1% across all 116 jurisdictions for which data is available.
Corporate taxation remains well below its historical average, even though tax rates have stabilized between 2021 and 2023, interrupting the downward trend of the last two decades. Information for 2019 and 2020 indicates a discrepancy between where profits are declared and where economic activities generating them take place. The data reveals the existence of base erosion and profit-shifting practices, emphasizing the need for international agreement.
More than a third of profits from major global groups are taxed at an effective rate below 15%. The statistics analyze, for the first time on a global scale, low-taxed profits, taxed at an effective rate below 15%. This is observed in both low-tax and higher-tax jurisdictions.
Over half (53.2%) of profits taxed at a rate below 15% are generated in countries considered “high-tax“, which paradoxically grant generous tax benefits to these large companies. In these countries, 10% of multinational profits are generated but taxed at a rate below 5%. This data is highlighted in the study complementing the statistics on the effective tax rates of multinational corporations (2).
Too many loopholes
Despite promises, experts fear that the reform alone may not eliminate tax havens or prevent the so-called “race to the bottom” of harmful tax competition between governments. States can still meet the new minimum rate by offering generous tax credits and other deductions that effectively reduce the tax rate below 15%. Many states are already introducing transferable credits, grants, and subsidies to compete for investments.
Another loophole in the agreement allows companies to exclude certain amounts of profits from the tax base – equal to 8% of the value of tangible assets and 10% of salaries in the first year.
The world should move in unison
The system designed by the OECD is unique in that it encourages all nations worldwide to move in unison. Among the signatories are also countries famous for attracting giant companies with attractive tax incentives, such as Barbados and Panama. The overwhelming majority of Swiss voters (78.5%) also supported the new rules in a consultation last June, putting pressure on the government to adopt them quickly.
It is worth noting that most countries globally have an effective tax rate higher than 15%. This could lead some countries to lower their tax rates, engaging in a race to the minimum rather than a race to the bottom.
The issue of developing countries
The promotion of the Global Minimum Tax has been primarily led by the OECD, an international organization whose members are mainly developed countries, in contrast to the United Nations (UN), which has a much broader base, including various developing countries. In this context, only developed countries have so far implemented the Global Minimum Tax, including major economies of the European Union such as Italy, Germany, France, the Netherlands, Belgium, Ireland, Austria, and Luxembourg, among others.
On the other hand, developing countries have been excluded from the Global Minimum Tax discussion and have not had significant participation.
Now, is this apparent dichotomy between developed and developing countries regarding the Global Minimum Tax relevant, or is it just a coincidence? It would not be surprising if developed countries were more inclined towards the Global Minimum Tax. Part of the criticism suggests that the implementation of the Global Minimum Tax could pose a serious risk to the fiscal sovereignty of developing countries, which are precisely those excluded from the discussion.
A first approach reveals that a common denominator among the states most interested in implementing the Global Minimum Tax, even within the European Union, is that they are developed countries where the headquarters of multinational groups are usually located.
From the perspective of jurisdictions, the state where the holding company of the multinational group resides will tax the income of entities within the multinational group residing in other jurisdictions with a low level of taxation, and will also collect the supplementary tax for these entities. The fact that a state taxes income generated in other jurisdictions by entities residing there is what can be defined as the extraterritorial effect of the Global Minimum Tax.
The structure of the Global Minimum Tax reveals its convenience for developed countries since it is well known that multinational groups tend to place their headquarters in developed countries (such as the Netherlands, Luxembourg, etc.).
On the other hand, it is also well known that often countries with low levels of taxation are developing countries, which, due to a lack of technology, infrastructure, public services, economic, political, or social stability, etc., use their tax system as a strategy to attract foreign investments that would otherwise be challenging to attract.
Therefore, returning to the question of whether the dichotomy between developed and developing countries is relevant, we can affirm that, given the structure of the Global Minimum Tax, this differentiation is extremely relevant considering that the headquarters of multinational groups are typically in developed countries, which are the ones that would apply the Global Minimum Tax as a priority rule.
All of this leads us to question the legitimacy of this Global Minimum Tax. How does the extraterritorial effect of the Global Minimum Tax reconcile with the principle of fiscal sovereignty in international tax law?
Fiscal Sovereignty
From the principle of fiscal sovereignty, the principles of source and benefit derive, guiding the legitimate use of fiscal power by a state.
The principle of source establishes that a state has the right to tax at its discretion the wealth generated within its territory, while the principle of benefit establishes that the state has the right to tax the wealth generated thanks to the governmental structures that contributed to its generation (e.g., public services, infrastructure, legal system, technology, etc.). Although both principles may seem identical and in many cases may coincide, it is true that each can be applied separately and independently.
In light of the above, the principles of source and benefit serve as principles to justify tax imposition by a state (“justification-tax-principles“). However, in their negative version, the principles of source and benefit also serve as legitimate limits for a state in the exercise of its fiscal power (“limitation-tax-principles“). In fact, based on the negative versions of the principles of source and benefit, a state should not subject to tax the wealth generated outside its territory, and whose generation did not require the use of the governmental structures of that state.
Conflict between the Global Minimum Tax and Fiscal Sovereignty
The OECD argues that the Global Minimum Tax aims to protect the sovereignty of states by establishing a minimum effective taxation of 15% worldwide, thereby curbing the intense competition among states to minimize their tax rates (“race-to-the-bottom“) and the resulting loss of tax revenue.
Developed countries perceive tax competition as harmful and/or unjust competition that jeopardizes their fiscal sovereignty, forcing them to adapt their tax system to increasingly unsustainable levels (i.e., with ever lower effective tax rates and lower tax collection levels) to try to remain physically attractive compared to other states with low or zero tax rates. Developed countries view the low or zero taxation of developing countries as “beggar-thy-neighbor strategies” that threaten their fiscal sovereignty.
In this regard, from the perspective of developed countries, the implementation of a Global Minimum Tax would restore existing tax competition to acceptable and/or fair levels (as would be, according to them, a minimum of 15% effective taxation), so that the fiscal sovereignty of developed countries would no longer be threatened.
Regarding developing countries, the OECD explains that in recent decades, these countries have implemented various tax incentives in their effort to attract and retain foreign investments, many of which have proven inefficient or irrelevant for attracting investments. Therefore, the loss of tax revenue by these states in the creation of these tax incentives ends up reducing their public budget and influencing investment opportunities in sectors that need it, such as infrastructure, public services, or social assistance.
Based on this understanding, the OECD argues that the Global Minimum Tax could effectively protect developing countries from the pressure to offer tax incentives (often ineffective) to attract investments, and therefore, the Global Minimum Tax would allow them to tax investments made in their country and collect the corresponding tax.
Recently, on January 9, 2024, the OECD published the work carried out by authors Felix Hugger, Ana Cinta González Cabral, Massimo Bucci, Maria Gesualdo, and Pierce O’Reilly in the document titled “Economic Impact Assessment of the Global Minimum Tax” (3). In this document, the authors examine the impact of the Global Minimum Tax on multinational groups, considering, among other aspects, the final design of the rules on the Global Minimum Tax and updated data from 2017 to 2020.
The authors estimate that with the Global Minimum Tax, revenues subject to low taxation would decrease by 80%, and the transfer of benefits between jurisdictions would decrease by about half.
Finally, an important discovery by the authors is that, as differences between the tax systems of jurisdictions would decrease due to the Global Minimum Tax, other non-tax factors would become more important in investment decisions and capital positioning.
Despite the previous exposition, it is true that in this initial phase of implementing the Global Minimum Tax, it is extremely complex to anticipate its convenience or lack thereof, both for developed and developing countries.
One of the main criticisms of the Global Minimum Tax lies in its effect of eliminating the fiscal attractiveness of low or zero-tax developing countries, forcing them to compete under fiscal conditions similar to those of developed countries.
The problem is that even if the effective taxation of a developed country and that of a developing country were similar or identical, developed countries would still be in a better position to attract investments than developing countries. This is because developing countries lack infrastructure, public services, technology, economic, political, or social conditions similar to those of developed countries.
Therefore, “equalizing” developed and developing countries merely puts developing countries in a worse position than they were before.
The extraterritorial effect of the Global Minimum Tax implies that the state in which the parent company of a multinational group resides will tax the income generated by group entities residing in other states, without necessarily being generated in the territory of the first state and/or through the use of facilities provided by it.
In the same vein, author Miguel Mur argues that “(…) the new global system could grant collection rights to a country that does not participate in the origin of the income, without necessarily the collection going to the country that needs it most” (4).
In the absence of a connection with the income generated by entities in other states, in accordance with the negative versions of the principles of source and benefit, the state applying the Global Minimum Tax would lack justification for taxation and, moreover, should avoid taxing them to avoid compromising another state’s fiscal sovereignty with its tax policy.
Therefore, the indicated extraterritorial effect of the Global Minimum Tax represents a risk to the fiscal sovereignty of countries with low or zero taxation and is not in line with the principle of fiscal sovereignty that should govern international tax law.
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(1) Base Erosion and Profit Shifting (BEPS) refers to the set of tax-related strategies that some companies employ to erode the tax base (erosion of the base) and thereby avoid taxation.
(2) You can read more about how multinational companies pay fewer taxes on https://www.openpolis.it/come-le-multinazionali-pagano-meno-tasse/.
(3) For insights into the Global Minimum Tax and the taxation of multinational enterprise profits, you can refer to the document by Felix Hugger, Ana Cinta González Cabral, Massimo Bucci, Maria Gesualdo, and Pierce O’Reilly at https://www.oecd.org/publications/the-global-minimum-tax-and-the-taxation-of-mne-profit-9a815d6b-en.htm.
(4) For a perspective on the new Global Minimum Tax and its impact on Peru and the world, you can read Miguel Mur’s article at https://gestion.pe/opinion/miguel-mur-el-nuevo-impuesto-minino-a-la-renta-y-su-impacto-en-el-peru-y-en-el-mundo-noticia/.