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

Plans for a minimum tax on profits of multinationals will have major implications for investment policy, the UNCTAD’s World Investment Report 2022 has warned. Developing countries could lose out on tax revenues due to capacity and legal constraints on the implementation of needed reforms.

Long Story, Cut Short
  • The global minimum tax was agreed in October 2021 between 136 (now 137) of the 141 countries who are members of the OECD /G20 inclusive framework on tax base erosion and profit shifting, capping years of negotiations.
  • The proposed reforms, planned for 2023 or 2024, aim to discourage multinationals from shifting profits to low-tax countries.
  • The global minimum tax rate will apply to overseas profits of multinational firms with 750 million euros ($868 million) in sales globally.
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.
Tax Implications 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. Christine Roy / Unsplash

The proposed global minimum tax may be a great idea that has found widespread currency, but is likely to come at a cost. The proposed introduction of a minimum tax of 15% on the foreign profits of the largest multinational enterprises (MNEs) has major implications for international investment and investment policy, UNCTAD has said in a report.

The 2022 edition of UNCTAD's annual World Investment Report, published on 9 June, is subtitled 'International tax reforms and sustainable investment', and provides a guide for policymakers to navigate the complex new tax rules and to adjust their investment strategies. Chapter II of report, titled ' The Impact of a Global Minumum Tax on FDI, serves as a warning on the collateral damage such a tax can cause.

If and when enforced, the global minimum tax will work well in many countries, and won't in many others. The word of caution was underlined in the press release that accompanied the release of the report. UNCTAD Secretary-General Rebeca Grynspan was quoted as saying: "Developing countries face constraints in their responses to the reforms, because of a lack of technical capacity to deal with the complexity of the tax changes, and because of investment treaty commitments that could hinder effective fiscal policy action. The international community has the obligation to help."

  The OECD, which has steered the negotiations, estimates the minimum tax will generate $150 billion in additional global tax revenues annually.
Additional Revenues The OECD, which has steered the negotiations, estimates the minimum tax will generate $150 billion in additional global tax revenues annually. Jason Leung / Unsplash

How the GMT will affect countries

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.

Developing countries face constraints in their responses to the reforms, because of a lack of technical capacity to deal with the complexity of the tax changes, and because of investment treaty commitments that could hinder effective fiscal policy action. The international community has the obligation to help.

Rebeca Grynspan
Secretary-General
UNCTAD
Rebeca Grynspan

The agreemment on GMT

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.

  Taxing rights on more than $125 billion of profit will be additionally shifted to the countries were they are earned from the low tax countries where they are currently booked.
Looking for Profits Taxing rights on more than $125 billion of profit will be additionally shifted to the countries were they are earned from the low tax countries where they are currently booked. Wilfried Pohnke / Pixabay

Policy emplications of the GMT

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 tax revenue implications for developing countries of constraints posed by international investment agreements are a major cause for concern," the report notes, 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.

Policy emplications of the GMT

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.

Tax abuse by multinationals and avoidance by rich individuals costs countries around the world $427bn a year in lost revenues, according to research by the Tax Justice Network campaign group.
Pay up Now Tax abuse by multinationals and avoidance by rich individuals costs countries around the world $427bn a year in lost revenues, according to research by the Tax Justice Network campaign group. The New York Public Library / Unsplash

The earlier warnings

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.

 
 
  • Dated posted: 11 June 2022
  • Last modified: 11 June 2022