When you heard Big Ben strike midnight on 31st December, was your first thought that “this marks the moment when international tax laws change to make it harder for multinationals to avoid tax”? If, inexplicably, you had other priorities at New Year, it is worth taking time now to celebrate.
The Churches have for years added their voices to calls for a more just global tax system. A global minimum corporation tax rate was introduced at New Year, which is a major step forward in ensuring multinational corporations pay their fair share.
Why is a Global Minimum Corporation Tax important?
Companies pay taxes on their profits. These tax revenues provide governments with vital funds to provide public services, invest in infrastructure and tackle issues such as climate change and poverty. If a company wants to avoid tax, a common strategy is to set up a subsidiary in a place that charges low or no effective tax. These place are often referred to as “Corporate Tax Havens”, or “secrecy jurisdictions”. The company then creates an accounting fiction that the profits of the whole multinational are made by this new subsidiary, which then pays low or no tax on the profits.
The secrecy jurisdictions are often home to financial services industries which offer creative ways of moving profits to the low tax subsidiary, some legal, some not.
This can include moving intellectual property to the subsidiary and then charging the rest of company to use it. For instance, a drinks manufacturer might move the ownership of a soft drink recipe to Ireland, then ensure that the rest of the multinational’s companies across the world pay high licencing fees to use the recipe. Suddenly profits in higher tax areas are wiped out by these fees, while the company in low tax Ireland becomes hugely profitable.
Using the interest on intra-company loans is another common mechanism to move profits. This is where a subsidiary in a low tax area “lends” money at high interest to the multinational’s subsidiaries in high tax areas. The interest on the loan eats away at the profits in high tax areas while inflating profits for the low-taxed subsidiary.
The problem is that sometimes there are genuine reasons for intellectual property licence fees and for intracompany loans. Therefore, for just these two examples a series of increasingly complex and erratically enforced rules has evolved to distinguish ‘genuine’ from ‘abusive’ transactions. The result has been an endless game of ‘whack-a-mole’ where an abusive practice arises, and once it comes to light[1], the tax authorities try to find a way of knocking it down.
The result is that multinationals can have the benefits of operating in societies where governments provide high quality public services, infrastructure and social welfare systems, while contributing next to nothing to the costs of such public goods. Alongside this, corporations can be making significant profits from exploiting the natural resources and human capital of less developed countries where governments have very little tax revenue to invest in social improvement. Both situations are simply unjust, as well as being a substantial bar to progress for less developed nations.
Ending ’whack-a-mole’: a Global Minimum Corporation Tax
Rather than painstakingly finding and closing down each abusive practice, the minimum tax model takes a different approach. It is an international agreement that no matter where a company is based, or what accountancy games are played, its tax bill should be at least 15% of its global profits. If not, an additional top-up tax will be levied.
The beauty of the new system’s design is that if you are a large multinational operating in any of the 140 signatory countries then no matter where you choose to base yourself, the 15% minimum rate still applies to you.
The new rules are expected to bring in £175Bn extra tax worldwide each year. To put that figure in context, last year total global aid spending was £155Bn, a record high[2]. This is an enormous amount of extra money that offers many governments genuinely new opportunities.
It’s not perfect, but it is a big move forward
The new international agreement evolved from a 1992 EU proposal for a 30% minimum tax rate with strong provisions to ensure that a greater proportion of the taxes paid by multinational corporations were directed towards developing countries. In the intervening three decades, the rate has dropped from 30% to 15% and the focus on developing nations has withered away.
Many of those who lobbied on this issue are – rightly – disappointed, because they saw the opportunity for something better. However, this New Year did bring in a global tax system that was more just than the year before, where those who work hard to shirk their responsibilities will find it harder, and where governments across the world will have more resources to serve their people if they choose to.
Happy New Year.
[1] This can take a while as low-tax and low-transparency tend to go hand in hand.
[2] It is worth noting that this record spend was driven by a) Western countries spending more on hosting refugees which although spent in Western countries is counted as international aid and b) aid given to Ukraine (excluding any costs that directly assist the Ukrainian military).
