Digitization has diluted the boundaries and made the world one marketplace. Digital companies are changing the way business is done. Hence, governments are looking at changing the way they tax the digital economy. After years and years of negotiations, 130 countries came together and agreed on a new corporate tax method. These countries represent more than 90% of the global gross domestic product (GDP).
On July 1, Canada and the other 129 countries signed a global pact to change the way large multinationals (MNCs) are taxed. The agreement will address OECD’s (Organization for Economic Cooperation and Development) two-pillar approach to tax the digital economy.
- The first pillar – Align taxation to the location of sales rather than the physical location of a company’s headquarters.
- The second pillar – Establish and implement a minimum tax rate worldwide.
There are two parts to the agreement. First, large companies would pay tax in countries where they do business even if they don’t have a physical presence, reducing the practice of jurisdiction shopping based on beneficial tax policies. Second, the participating countries would implement a minimum corporate tax of 15% on large MNCs. If this global tax comes into effect, participating countries would have to repeal their existing digital services taxes (DST).
The Objective Behind The Global Corporate Tax
For years, MNCs have been avoiding taxes through creative accounting. These MNCs created subsidiaries in tax haven countries like the Cayman Islands and relocated their global profits to these subsidiaries. This tax shift cost national economies across the globe anywhere from $100 billion to $240 billion in lost revenue, according to the OECD.
With the new tax, the OECD wants to remove the incentive for companies to adopt such complex global accounting structures. They want to redistribute taxes to countries where MNCs earn profits and give local companies a level playing field.
French Finance Minister Bruno Le Maire said, “Online giants must pay their fair share of taxes where they have activities.” He added, “There is no reason a small or medium business should pay more taxes than an online giant simply because it’s physically present in the country where it carries out its activities.”
The United States wants to use global tax to encourage countries to remove national DST, which it believes unfairly targets the tech firms. Canada has proposed a 3% DST on some revenue of certain large MNCs. Canada will implement this tax on January 1, 2022, if there is a delay in the global tax. However, Canadian Finance Minister Chrystia Freeland has assured that the government will remove the 3% tax if the global tax rate comes into effect.
What does a global minimum corporate tax mean for multinational corporations?
The governments have proposed the new tax to collect more revenue for infrastructure and green energy spending. But this tax will have a different impact on companies.
Most MNCs shift their profits to foreign subsidiaries with low tax rates. According to data from the Tax Foundation, the worldwide average statutory corporate tax rate stood at 23.85% in 2020. While Canada has a corporate tax rate of 26.47%, Ireland has a rate of 12.5%.
Even if the tax haven countries don’t levy the minimum global corporate tax, the company’s home country can charge up to 15% tax on untaxed foreign earnings.
Let’s take another angle. Many countries have a higher corporate tax. But after adjusting for the various tax breaks and exemptions, the companies often end up paying lower than 15% in corporate tax. Countries offer these exemptions to lure foreign investment, often negatively impacting their own bottom line due to lost tax revenue. The global minimum corporate tax will remove this issue, requiring companies to pay at least 15% tax.
This means a higher tax bill for large MNCs like Facebook and Alphabet. Canadian companies that earn profits in Canada and pay Canadian taxes will benefit from the new tax as it will even out the competition in terms of taxes.
When will the global tax come into effect?
The new tax will take some time to implement. Countries would have to sign a multilateral convention to implement the first proposal of taxing companies at the point of sale. Out of the 139 countries, nine countries, including the low-tax countries like Estonia, Hungary and Ireland, have not signed the deal. The other countries are Barbados, Kenya, Nigeria, Peru, Saint Vincent and the Grenadines, and Sri Lanka. The reluctance can likely be attributed to the fact that the proposal will remove the tax incentive these countries offered to encourage foreign investment. If MNCs relocate their profits to home countries, it will affect the economies and employment of these low-tax countries.
As for the second proposal of global minimum corporate tax, each country can implement it voluntarily through national legislation. Because even if one country doesn’t adopt this tax, the home country holds the right to charge up to 15% tax on untaxed foreign earnings.
Contact Sloan Partners LLP for Corporate Tax Advice and Compliance
So far, the 130 countries have only signed a five-page summary. They will discuss detailed implementation and finalize a plan at the G-20 summit in October. The participating countries expect to implement some elements of the agreement in 2022 and the remaining in 2023. In the meantime, businesses likely to be affected by the changes should begin discussing the implications of these changes with their tax consultants.
At Sloan Partners LLP, our financial professionals will help ensure your company’s compliance while minimizing your tax obligations in Canada and beyond. Contact us online or by telephone at 416-665-7735.