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The case for a global minimum tax

Ng Qi Siang
Ng Qi Siang  • 10 min read
The case for a global minimum tax
So far, 130 countries - including Singapore - have endorsed BEPS 2.0, with just nine abstaining.
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For the past four decades, the international community has been in a “race to the bottom”. Different jurisdictions compete to cut corporate taxes in a bid to attract capital and foreign direct investment (FDI), given how globalisation makes it easier for multinational enterprises (MNE) to locate from one country to another. In the early 1980s, the worldwide average statutory corporate income tax rate was slightly above 40%; today it is slightly less than 25%. In the US, corporate tax revenue as a share of GDP has fallen from approximately 7% in 1944 to just 1.1% as of 2019.

But governments have had enough. On June 5, Group of Seven (G7) finance ministers agreed to commit towards implementing a global minimum tax of 15%. Group of 20 (G20) finance ministers and central bank governors — who preside over 90% of global GDP and 80% of international trade — are expected to sign off on the proposal in Venice from July 9–10. So far, 130 countries — including Singapore — have endorsed the proposal in principle, with implementation possibly as early as 2030.

The Base Erosion and Profit Shifting (BEPS) 2.0 proposal comprises two major pillars. Pillar One grants jurisdictions where a firm’s customer base is located greater taxing rights than those where its underlying economic activity is conducted. This rule applies to only a small group of very large multinationals. Pillar One’s threshold applies to MNEs with more than EUR20 billion ($31.9 billion) of global turnover potentially reducing to EUR10 billion after seven years.

Pillar Two requires MNEs to pay a minimum tax rate in their home jurisdiction. Regardless of how they manage their tax affairs and operational model, governments are allowed to charge “top-up taxes” if firms are paying an effective tax rate below the proposed 15%. The revenue threshold for Pillar Two is EUR750 million ($1.2 billion) and will affect 1,800 MNE groups in Singapore.

“Our collaboration will create a stronger level playing field and it will help raise more tax revenue to support investment and it will crack down on tax avoidance,” declared the G7 summit communique issued on June 13.

Singapore, ever eager to maintain a business-friendly environment, will ensure that the country’s tax system remains compatible with international norms. However, “the new rules should not inadvertently weaken the incentives for businesses to invest and innovate, otherwise, countries will all be worse off, fighting over our share of a shrinking revenue pie”, said Finance Minister Lawrence Wong on June 8.

In parliament on July 5, the finance minister committed to minimising the compliance burden for affected companies in Singapore. Wong also vowed to safeguard Singapore’s “sovereign rights on taxes” even as Singapore actively participates in BEPS 2.0 discussions to shape international consensus in line with its national interests and create a level playing field for all.

Payback time

Now, having implemented unprecedented fiscal stimulus to counter the economic fallout of the pandemic, governments see BEPS 2.0 as a way to replenish their coffers. “There’s now an expectation that companies pay back for those kinds of benefits and there’s been a mood that companies should pay more tax for a long time,” says Simon Baptist, global chief economist at the Economist Intelligence Unit (EIU).

Some coffers, if left empty, could trigger a downward spiral. “With a vigorous post-Covid-19 rebound and higher interest rates, the most heavily indebted countries could find themselves in difficulties,” warns John Driffill, Yale-NUS economics professor, in a CNA op-ed, arguing that rates should be at least 25% in order to be meaningful.

Still, Jamus Lim, associate professor of economics at ESSEC Business School, is sceptical that higher corporate taxes would straightaway translate into lower financial burden for states. The sheer size of debt incurred following the pandemic stimulus is on top of the spending incurred just over a decade ago countering the 2008–2009 Global Financial Crisis. As such, the effect of higher corporate taxes on this significant debt will likely be marginal, especially for advanced economies.

But the original 2012 aim of BEPS 2.0 was to combat elaborate tax avoidance strategies by MNEs. Typically, they engage in “profit shifting” where they allocate profits from hightax jurisdictions to low-tax jurisdictions such as the Cayman Islands, Ireland or Bermuda. The result is “base erosion” since the migration of these profits sees other states having a lower tax base from which to raise revenues.

Tech companies, with their ability to generate earnings from delivering services online across borders, have been singled out as those practising “aggressive tax avoidance”. Advocacy group Fair Tax Mark, for example, claims the “big six” — Amazon, Apple, Facebook, Alphabet, Microsoft and Netflix have avoided US$100 billion in global taxes over a decade.

In general, this new global stance on tax will affect large-cap firms more than anyone else, especially, the top 100 or 200 firms, says Brian Arcese, portfolio manager at Foord Asset Management.

Simon Poh, associate professor in accounting at the National University of Singapore (NUS), says that small domestic firms could continue to enjoy lower corporate tax since they are not covered by BEPS 2.0.

Yet, ripple effects from the policy could still hit small firms nonetheless. L J Suzuki, fractional CFO at CFOshare, writes in Inc. that a global minimum tax could level the playing field for small businesses. However, when the large companies are compelled to pay higher taxes, one way to make up for it is to squeeze their suppliers - the smaller companies. “Corporate supply chain contraction from lower profits is subtle but powerful,” says Suzuki.

Will it or won’t it?

However, with negotiations ongoing, nobody knows what the final tax agreement will look like. Martin Hennecke, Asia investment director at St James’s Place, believes that low tax jurisdictions and countries with tax concessions or tax-free zones would raise concerns, prolonging the negotiation process and potentially undermining the whole exercise by insisting on an unwieldy list of exemptions.

Martjin de Lange, managing director at insurance broker BMS Group, wonders if developing countries would face obstacles to development without tax incentives. “I’m not entirely sure whether the interests of developing countries have been taken into account,” he muses. But EIU’s Baptist notes that tax is typically not a big driver of real FDI for developing countries compared to portfolio FDI as in Ireland, with corruption, poor infrastructure and unpredictability being greater barriers to investment.

Out of the 139 countries which took part in the initial talks, nine of them, including tax-friendly Ireland, opted out. With its veto over EU rules surrounding the tax, Ireland is set to defend “legitimate tax competition” to minimise the economic impact of BEPS 2.0. “Changes to global corporation tax arrangements have the potential to lower tax revenues and hamper the government’s capacity to invest and support the economy,” says Central Bank of Ireland governor Gabriel Makhlouf.

Fellow EU member country Hungary has also declined to endorse the deal, which could lead to difficulty implementing BEPS 2.0 in the EU. The UK, a G7 country, is ironically seeking exemptions for its financial sector too. Meanwhile, some countries actually want the minimum tax rate to be higher, with Argentina demanding “more than 15% and not less than 21%”.

As in the various new international orders and systems, where China moves or positions itself can make a significant difference. But geopolitical friction with the G7 and China’s distinct economic structure may prove obstacles even as China joined fellow G20 nations to back the deal in principle. Beijing is expected to seek exemptions from the global minimum tax, as tax deductions for its hightech sectors and R&D investment result in effective rates below 15%.

James Crabtree, executive director of think tank IISS-Asia, notes that internal divisions within the G20 could prove a barrier to realising practical objectives. That said, he sees the global minimum tax as perhaps the only issue that the G20 can actually come to a consensus on. Given that failure could lead to significant tax uncertainty, unilateral actions and tax disputes, Ajay Kumar Sanganeria, head of tax at KPMG Singapore, sees governments having a strong incentive to push BEPS 2.0 to fruition.

Will it work?

The question remains, however, if the BEPS 2.0 proposal will work in practice. De Lange of BMS believes so, hailing it as the “last piece of the puzzle” in avoiding base erosion. This is the first time, he observes, that some degree of consensus about a global minimum tax for MNEs has been reached, sending a strong signal that governments are no longer willing to tolerate a “race to the bottom” in the realm of corporate taxation.

“There should be no incentive for companies to reduce the taxes at the local level, because, you know, otherwise they will lose out on many fronts,” agrees Ajay. Given the institution of top-up taxes for home jurisdictions, tax incentives would only serve to subsidise tax collection for other countries. States may thus have a greater incentive to invest in non-tax areas such as infrastructure or grants that could generate more value-add, creating a “race to the top”.

Enforcement of BEPS 2.0 is likely to be backed by force of law, with a combination of multilateral instruments and national legislation lending legitimacy. The moral force of the international community — including economically influential countries like the US and the EU — creates significant international pressure to comply. Still, there could be challenges in passing the necessary laws in national legislatures; US congressional Republicans have already vowed to block BEPS 2.0-related legislation.

More optimistically, Lim of ESSEC, sees these benefits being obtained with minimal costs to the global economy. “A minimum tax need not be binding,” he points out, highlighting that many sectors and industries have an effective tax rate above 15%. Other factors like rising commodity prices, inventory and labour market shortages and recovering consumer confidence will likely have a greater economic impact.

Even low-tax jurisdictions will not be too badly hurt, even if they experience losses due to a reduction in MNEs siting headquarters or financial offices within them. Lim explains that except for the most egregious tax havens, many of these offshore entities have very small employment footprints and are typically not significant contributors to government fiscal revenues. Employment rates and public spending levels are unlikely to be too badly affected.

For investors, how might the proposed tax changes impact them? Andy Budden, investment director, equity and multi-asset, Asia Pacific at Capital Group, does not see a negative impact from the presumably heavier tax burden. Given how the tax is not particularly high, any changes are also likely to be fairly gradual or be signalled well in advance to keep markets calm. “We don’t think it’s going to get in the way of stock returns, and if anything it actually takes away an overhang and a risk,” says Budden.

Most importantly, says Aurobindo Ghosh, assistant professor of finance at Singapore Management University (SMU), countries that are losing out from base erosion will stand to gain an additional US$150 billion in additional tax revenue. While tax arbitrage will continue to exist, the SMU don says that countries will still be guaranteed a modicum of tax revenue to address challenges faced by their citizens.

In the broader context, the global minimum tax is but the latest example of international cooperation to solve common economic problems. Whatever the outcome of BEPS 2.0, a tax agreement of this nature was always a long time in coming. “The viability of the system was always reliant on an untenable proposition: that large, powerful economies were unable to coordinate and cooperate to prevent a global race to the bottom in terms of taxation,” says ESSEC’s Lim.

Given how fiscal pressures in advanced economies are at such high levels, this tax deal faces resistance for sure and risks being scuttled. “But I suspect that the stars are aligned for such an initiative,” says Lim.

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