The creation of a global minimum tax on the profits of multinational corporations will ensure that, for the first time in history, there is a tax that applies equally in all countries. This is a game changer for international taxation because it will force multinational corporations to pay a minimum level of tax, regardless of where they are headquartered or operate.
In practical terms, the global minimum tax will promote a fairer distribution of taxing rights among countries and prevent multinational corporations from shifting profits to low-tax jurisdictions. This has important implications for tax policies currently applied in countries, forcing governments to re-evaluate current tax rates and incentives to attract foreign investments. Countries will have to weigh the benefits and costs of adhering to the global minimum tax and adapting their current policies.
![With the global minimum tax on global profits, countries will have to adjust their tax policies to this new reality. Learn about the main policy trade-offs,](https://blogs.iadb.org/gestion-fiscal/wp-content/uploads/sites/6/2024/07/Policy-Trade-off-Global-Minimum-Tax-resized.jpg)
These topics were the focus of a three-day Regional Seminar on International Taxation, held in Brasilia on June 11-13, 2024, which marked a significant milestone in the work of the Inter-American Development Bank (IDB) and its partners in helping Latin America and the Caribbean (LAC) address critical tax policy challenges. Senior tax policymakers from across the region attended the event organized by the IDB, the World Bank and the G-20 Brazilian presidency, represented during the event by Ministry of Finance and Receita Federal do Brasil (RFB), the country’s federal tax agency.
In this blog we will discuss some of the main findings of the event, including the policy tradeoffs governments in Latin America and the Caribbean need to consider as they adapt their tax systems to this new reality.
How the Global Minimum Tax Rate Works
Currently all 147 countries that are members of the OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting (BEPS) have agreed on the global minimum tax of 15% applied to the global profits of large multinational corporations.
The minimum global tax[1] seeks to reverse a decades-long “race to the bottom” on corporate taxation by mitigating the incentives for tax competition among jurisdictions[2]. It can do that because it has three enforcement mechanisms that work in tandem, forcing multinational enterprises to pay the 15% tax no matter where they operate or set up their ultimate parent company.
- The Income Inclusion Rule (IIR): It allows countries hosting the ultimate parent entity to tax the income of a foreign branch or controlled entity if that income was subject to a low effective tax rate in the jurisdiction of operation.
- The Undertaxed Profits Rule (UTPR): It forbids the deduction or treaty relief for certain payments unless that payment was subject to a minimum level of tax.
- The Qualified Domestic Minimum Top-up Tax (QDMTT): It allows countries tocreate a minimum top-up tax that may be included in their domestic legislation to ensure that any additional tax on economic activities in a jurisdiction that results from the Pillar Two minimum tax framework remains in the country and is not transferred to another jurisdiction by means of an IIR.
These rules, collectively known as the Global Anti-Base Erosion (GloBE) rules, are crucial in understanding the global minimum tax system.
How the Income Inclusion Rule and the Undertaxed Profits Work Together
The practical impact of the Income Inclusion Rule is that it allows countries that host the ultimate parent company[3] of a multinational organization to include in the calculation of taxable profits of its foreign branches. This mechanismworks across borders to tax large multinationals’ profits up to a 15% effective tax rate.
But if one thinks that the way to avoid the global minimum tax it is to locate the ultimate parent entity in one of these countries, he or she would be wrong, because any subsidiary that is active in countries where the tax does apply would have to obey the Undertaxed Profits Rule, paying the tax that other group entities may have avoided.
Hence, the only way to properly circumvent the tax would be not to do business with any of the where the tax applies (or will apply, as we are in the rather slow process of implementation), something highly unlikely for any multinational enterprise with a turnover higher than 750 million euros.
Important Tax Police Trade-Offs
As a result of this international tax policy aimed at ensuring that multinational corporations pay a minimum level of tax, regardless of a company’s geographical presence, the global minimum tax makes tax incentives and low tax rates less effective as a policy tool for countries to attract investments from multinational companies. These companies will have to pay the 15% minimum tax anyway regardless of where they operate.
Therefore, countries across the globe, including Latin America in the Caribbean, need to decide what to do about it. Those that currently are not members of the Inclusive Framework need to decide whether to continue the outside, or to become members.
Among the members of the Inclusive Framework, those that host large multinationals, like Argentina, Brazil, Chile, Mexico, Panama, and Peru, will need to decide whether to implement the global tax and apply the Income Inclusion Rule and the Undertaxed Profits Rule to tap the undertaxed profits realized by their companies’ subsidiaries in other countries.
The choice seems easy to make, as it tends to increase domestic resource mobilization, but the revenue expected needs to be balanced with the cost of administering the complexity and increasing data processing demand of a global tax, requiring investments in technology and capacity building inside their tax administrations.
Rethinking Tax Rates and Incentives
Another important policy consideration is how the region should rethink their tax rates and incentives, since now they risk losing tax revenue without reaping much foreign investment benefit. Worse, if they keep their effective tax rate too low, they could be boosting profits of the parent entity, allowing the country that hosts that entity to tax more.
Most Latin-American countries (including the six abovementioned) host subsidiaries of in-scope companies that are already subject to the global minimum tax since it is has been already implemented in Europe and other countries.
Countries in this situation may decide to implement a Qualified Domestic Minimum Tax to protect their taxing rights. The policy response seems simple, but two objections may arise.
One, countries will be adding another layer of complexity to their domestic legislation because they would be creating a new tax, which could increase compliance costs for both the government and the companies.
Second, government may face domestic political opposition against heavier taxation. Influenced by legacy foreign direct investment policy practices, governments often prioritize lower taxes to stimulate economic growth and attract investment. QDMTT may face resistance from public perception and lobbying against heavier taxation.
Tax Revenue Leakage to Advanced Economies
One of the key takeaways from the seminar was the recognition that these comprehensive international tax initiatives can have important impact on domestic resource mobilization and the capacity of countries to advance on their efforts to achieve their sustainable development goals.
Of concern to developing countries is that the global minimum tax may lead to tax revenue being lost to other jurisdictions, specially advanced economies. Aside from LAC countries whose statutory tax rate is inferior to 15%, most countries are expected to be affected.
Many countries in LAC with high statutory tax rates have instead very low effective tax rates after decades of giving away tax exemptions to specific sectors, investors, or regions. As explained above, countries whose tax incentives lead to an effective tax rate below 15% may find themselves in effect giving away tax revenues to the jurisdiction where the multinational company is based.
Short-Term Policy Response
In the short term, there is a certain level of consensus that jurisdictions should consider the introduction of the previously mentioned qualified domestic minimum top-up tax. The introduction of such tax will ensure that jurisdictions effectively tax low-taxed income arising domestically before that income is subject to top-up taxes imposed by a foreign jurisdiction.
In theory, the impact of such tax on foreign investment decisions should be limited, as the income would otherwise be taxed by other jurisdictions under the GloBE Rules. Even where a QDMT has been implemented, there will still be a case for tax incentive reform as certain types of incentives may become ineffective.
Long-Term Policy Response
As attracting foreign direct investment (FDI) is crucial for developing countries seeking economic growth and global competitiveness, based on OECD recommendations, countries should emphasize other strategies than tax breaks, such as:
- Promoting greater integration with regional and global markets and reducing restrictions on FDI inflows.
- Ensuring ease of doing business by simplifying bureaucracy and regulations, combating corruption, and advancing research and development.
- Strengthening institutions, rule of Law, and protecting property rights.
- Fostering political stability, transparency, security, and a stable legal and regulatory environment.
- Building strong business and innovation ecosystems and foster local linkages.
The adaptation to the new international taxation landscape will take time and exchanging experiences and lessons learned will be a key instrument to help governments in the region to devise more effective policy responses. It will also be of vital importance that governments incorporate business perspectives in their decision.
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Our three-day seminar was a crucial step to promote this knowledge exchange. For governments, it helped them understand the current landscape and the policy tradeoffs. For companies, the seminar highlighted the potential decisions to restructure, re-evaluate their tax planning, compliance strategies, and investment decisions considering the forthcoming new frameworks.
To learn more about how the IDB can support governments in implementing tax policy reforms under the new international taxation scenario and participate in future events related to this topic, please contact us at ubaldog@iadb.org.
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[1] The global minimum tax is a key component of the Global Anti-Base Erosion (GloBE) proposal.
[2] Some critics say that GMT may result in changes in investment behavior, especially in low taxation countries incapable to offer an alternative attractive package, resulting in both foreign and domestic reductions in operations and employment, and impact on the local economy: a decrease in corporate presence could lead to job losses and reduced economic activity, impacting the local economy and potentially leading to lower tax revenues.
[3] It is the ultimate parent company or entity is an entity that is not controlled by any other entity but that controls directly or indirectly other entities.
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