Global Minimum Tax: Developing Countries Could Lose Out on Tax Revenues, says UNCTAD

The proposed reforms, planned for 2023 or 2024, aim to discourage multinationals from shifting profits to low-tax countries. According to UNCTAD, the key implications include:

• Increased tax revenues from multinationals for most countries.
• Higher taxes on foreign profits of multinationals.
• Potential downward pressure on new investment by multinationals.
• Reduced effectiveness of low tax rates and fiscal incentives to attract investment.
• Urgent need for investment promotion agencies (IPAs) and special economic zones (SEZs) to review investment attraction strategies.

These can broadly be seen as:

• Tax rates on the foreign profits of multinationals will increase. Foreign affiliates that pay tax rates below the minimum on profits reported in host countries will be subject to a top-up. Also, multinationals will reduce profit shifting and pay host-country rates on a larger profit base.
• The estimated rise in the effective tax rates faced by multinationals is conservatively estimated at 2 percentage points. This corresponds to an increase in tax revenues paid by multinationals to host countries of about 15% – closer to 20% for large firms that are directly affected by the reforms.
• Both developed economies and developing economies are expected to benefit substantially from increased revenue collection. Offshore financial centres stand to lose a substantial part of revenues collected from foreign affiliates.
• For smaller developing countries – which generally have lower rates – the application of the top-up tax could make a major difference in revenue collection.

The global minimum tax was agreed in October 2021 between 136 (now 137) of the 141 countries who are members of the Organisation for Economic Co-operation and Development (OECD)/G20 inclusive framework on tax base erosion and profit shifting (BEPS), capping years of negotiations.

The global minimum tax rate will apply to overseas profits of multinational firms with 750 million euros ($868 million) in sales globally. Governments can still set whatever local corporate tax rate they want, but if companies pay lower rates in a particular country, their home governments could "top up" their taxes to the 15% minimum, eliminating the advantage of shifting profits.

In December 2021, the OECD published detailed rules to assist in the implementation of the landmark reform. The Pillar Two model rules provide governments a precise template for taking forward the two-pillar solution to address the tax challenges arising from digitalisation and globalisation of the economy agreed in October 2021 by 137 countries and jurisdictions under the OECD/G20 Inclusive Framework on BEPS.

The rules define the scope and set out the mechanism for the Global Anti-Base Erosion (GloBE) rules under Pillar Two, which will introduce a global minimum corporate tax rate set at 15%. The minimum tax will apply to MNEs with revenue above EUR 750 million and is estimated to generate around USD 150 billion in additional global tax revenues annually.

The GloBE rules provide for a co-ordinated system of taxation intended to ensure large MNE groups pay this minimum level of tax on income arising in each of the jurisdictions in which they operate. The rules create a “top-up tax” to be applied on profits in any jurisdiction whenever the effective tax rate, determined on a jurisdictional basis, is below the minimum 15% rate.

The flipside of increased tax revenues is the potential downward pressure on the volume of investment that the increase in tax on foreign direct investment activities will exert. UNCTAD estimates that cross-border investment in productive assets could decline by 2%.

International investment policymakers and negotiators of international investment agreements (IIAs) need to consider the potential constraints that IIA commitments may place on the implementation of key provisions of the reforms.

If (often developing) host countries are prevented by IIAs provisions from applying top-up taxes or removing incentives, the tax increase to the minimum will accrue to (mostly developed) home countries. Host countries would lose out on tax revenues without providing any benefit to investors.

"The tax revenue implications for developing countries of constraints posed by international investment agreements are a major cause for concern," the report noted, adding that the international community, in parallel with or as part of the negotiations of the tax reforms, should alleviate the constraints that are placing developing countries at a disadvantage.

"We need to vastly scale up technical assistance to support implementation of the reforms, and we need a multilateral solution to remove implementation constraints posed by IIAs. As a stop-gap measure, we need a mechanism to return top-up revenues raised by developed home countries that should have accrued to developing host countries," the report said.

The flipside of increased tax revenues is the potential downward pressure on the volume of investment that the increase in tax on foreign direct investment activities will exert. UNCTAD estimates that cross-border investment in productive assets could decline by 2%.

International investment policymakers and negotiators of international investment agreements (IIAs) need to consider the potential constraints that IIA commitments may place on the implementation of key provisions of the reforms.

If (often developing) host countries are prevented by IIAs provisions from applying top-up taxes or removing incentives, the tax increase to the minimum will accrue to (mostly developed) home countries. Host countries would lose out on tax revenues without providing any benefit to investors.

"The tax revenue implications for developing countries of constraints posed by international investment agreements are a major cause for concern," the report noted, adding that the international community, in parallel with or as part of the negotiations of the tax reforms, should alleviate the constraints that are placing developing countries at a disadvantage.

"We need to vastly scale up technical assistance to support implementation of the reforms, and we need a multilateral solution to remove implementation constraints posed by IIAs. As a stop-gap measure, we need a mechanism to return top-up revenues raised by developed home countries that should have accrued to developing host countries," the report said.

Loopholes in the GMT have alreadty been pointed out. In February, the International Institute of Sustainable Development (IISD) had outlined:

• Firstly, offshore investment centres such as the Cayman Islands, Bermuda, or the British Virgin Islands will have no reason to continue to offer reduced or zero income tax rates to multinational companies. Some countries are already planning to change their headline corporate tax rate. This could make them less attractive for MNEs, possibly leading to a “reshoring” of taxable profit to other countries.
• Secondly, developing countries may find that the global minimum tax could actually lead to tax revenue being lost to other jurisdictions. Developing countries are typically not considered tax havens, given that they often have relatively high headline corporate income tax rates. But after decades of giving tax exemptions to specific sectors, investors, or regions, the effective tax rate paid by many large companies can be quite low. Under global minimum tax rules, which set a 15% minimum benchmark, developing countries whose tax incentives lead to an effective tax rate below 15% may find themselves in effect giving up tax revenues to the jurisdiction where the MNE is based. Because the jurisdiction where the MNE is based will be collecting the minimum tax itself, developing country governments might not even be aware that this is happening.

In December last year, the World Inequality Report published by the World Inequality Lab had called for raising the threshold to 25 per cent.