Global minimum corporate tax and reform of taxing rights between countries
The G7 countries reached preliminary agreement in June on a minimum corporate income tax and on a reform of how the taxing rights are distributed among countries. The G20 meeting in July will be more challenging. In the long term the change is unlikely to solve the problems of international corporate taxation. In the research blog we are examining some of the background and effects of the reform.
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Pillars prepared by the OECD are behind the G7 agreement
It was no surprise that the G7 countries reached a common understanding, as all these countries can be seen to benefit from the reform. The agreement that has now been achieved should be understood primarily as a signal that the G7 countries are ready to introduce some kind of version of the OECD proposal for reform.
The proposal prepared by the OECD contains two regulatory wholes that are referred to as pillars. Pillar 1 would allow states to tax the profits of large digital enterprises operating in those countries. Pillar 2 would set an international minimum tax. At the OECD level there are still many open questions concerning the implementation of the pillars, which the 139 member states of the project need to agree on. The reform is far from finished now.
No upheaval in international corporate tax system
The reform cannot be considered especially “revolutionary”, because the new regulations will come in addition to the present system and apply only to the largest enterprises. The greatest problems with international corporate taxation stem from the source country principle, under which a company's profit is taxed in the country where the profit in question originates. This serves as an incentive for companies to move their income to countries of low taxation.
The reform now under discussion does not change the source country principle - it merely seeks to minimise its negative effects, such as moving profits to tax havens. Consequently, the incentives for shifting profits remain largely unchanged, even though individual companies might face higher costs and lower benefits because of the reform. Eliminating the possibility for shifting profits would require changes of the principles of corporate taxation, which is not the aim of the reform.
Minimum tax rate aimed at reducing tax competition
One of the goals of the reform is to reduce tax competition between countries. The reform aims to encourage countries falling below a minimum level to raise their own tax rates, as they will not be allowed to enjoy a competitive advantage from their low tax rates. A tax rate that falls below a minimum level would only mean that the profit in question would be taxed somewhere else. However, the OECD's pillar 2 would not force all countries to set a specific minimum tax rate. In practice, if the tax rate implemented in the country where a subsidiary or branch of a company is located falls below the minimum, the profits of a subsidiary or fixed branch of a multinational company would be taxed as income for the parent company up to the minimum tax level. The aim is to implement the minimum tax rate largely with the help of existing tools, and to use these more extensively on an international level.
What the reform means for Finland
With respect to Finland's tax revenue, it is best to view the reform as a whole. The taxing rights reform in Pillar 1 would move some of the profits of large digital companies to be taxed in the market countries where their customers and users of their services live. Many international digital companies operate in Finland, and part of their profits would be taxed in Finland under Pillar 1. However, it is worth keeping in mind that the portion of the profits that would shift to the market countries would be small – most of the profits of large Finnish companies would continue to be taxed in Finland. If, in spite of everything, the effect of Pillar 1 were negative, the positive effect of the minimum tax in Pillar 2 would compensate for this in Finland's tax revenue.
A significant factor in the ultimate success of the reform also depends on whether all countries participate in the reform. Individual countries are believed to have incentives to stay outside the reform and to keep their tax levels low in order to encourage international companies to set up their head offices in those countries.
The G20 meeting in July is expected to be more difficult than the G7 meeting. Agreeing on details, such a minimum tax rate, will be more difficult, the more countries join the discussions, and how different they are. A solution that all can agree on will inevitably be a compromise. In the long term it is unlikely to solve the problems of international corporate taxation.
Ministry of Finance (2021). Report by the Ministry of Finance to the Finance Committee of the Finnish Parliament on the OECD's project to reform international taxation of income.
Chief Researcher Seppo Kari, VATT Institute for Economic Research, [email protected], +358 295 519 419
Assistant Researcher Marika Viertola, VATT Institute for Economic Research, [email protected]