Insights

Global Minimum Corporate Tax and Taxation of Digital Economy: The era of tax havens is finally ending?

In Recently concluded meeting, Representatives from G-7 countries (United States, Britain, Germany, France, Italy, Japan and Canada) reached a landmark accord to implement Global Minimum Corporate Tax (15%) proposal backed by the Biden administration. This proposal would be limited to the world’s 100 largest companies with revenues of over $20 billion. The proposal would apply to digital services companies as well as to those selling tangible goods.

Major economies are aiming to discourage multinational companies from shifting profits – and tax revenues – to low-tax countries regardless of where their sales are made. Increasingly, income from intangible sources such as drug patents, software and royalties on intellectual property has migrated to these jurisdictions, allowing companies to avoid paying higher taxes in their traditional home countries.

The global minimum tax rate would apply to companies overseas profits. Therefore, if companies pay lower rates in a particular country, their home governments could “top-up” their taxes to the agreed minimum rate, eliminating the advantage of shifting profits to a tax haven.

Global Minimum Corporate Tax would remove the incentive for companies to shift profits to low-tax countries. If those companies escape taxes abroad, they would have to pay it at home anyway.

Why Global Minimum Corporate Tax/Taxation of Digital Economy

For decades, many big corporates are indulged in the practice of shifting their corporate earnings to tax havens to avoid the tax in their home tax jurisdiction.

Due to digitalisation, globalisation and new business models (scale without mass, reliance on intangible assets, and the centrality of data), many Multinational Enterprises (MNEs) are able to make large profits in countries without necessarily booking these profits in these countries. This is partly due to the fact that they may operate business without establishing any physical presence and partly because rules to allocate profits are no longer relevant in a globalised and highly digitalised economy where value is concentrated on intangibles.

The fundamental elements of the global tax system which determined where taxes should be paid (“nexus” rules based on physical presence) and what portion of profits should be taxed (“profit allocation” rules based on the arm’s length principle, are facing a serious challenge from these new business models. The minimum tax is expected to make up the bulk of the $50 billion-$80 billion in extra corporate tax that the OECD estimates companies will end up paying globally.

Framework for Global Minimum Corporate Tax/Taxation of Digital Economy

Action Plan 1 of OECD/G20 Base Erosion and Profit Shifting (BEPS) Project Addressing the Tax Challenges of the Digital Economy and Multinational Enterprises (MNEs) has been issued in 2015. Action 1 Report observed that while digitalisation could exacerbate BEPS issues, it also raises a series of broader tax challenges. Action Plan offers 3 options to tax digital economy:

Ø  A new nexus based on the concept of significant economic presence

Ø  A withholding tax on digital transactions

Ø  Equalisation Levy (Digital Service Tax)

Action Plan 1 also raises the question relating to taxing rights on income generated from cross-border activities in the digital age and its allocation among jurisdictions. Since early 2019, the OECD/G20 Inclusive Framework has been developing a Two-Pillar approach to address those challenges

Pillar One – Re-allocation of taxing rights

Ø  Addresses the question of business presence and activities without physical presence;

Ø  Will determine where tax should be paid and on what basis;

Ø  Will determine what portion of profits could or should be taxed in the jurisdictions where customers and/or users are located

Pillar Two – Global anti-base erosion mechanism

Ø  Will help to stop the shifting of profits to low or no tax jurisdiction facilitated by new technologies;

Ø  Will ensure a minimum level of tax is paid by multinational enterprises (MNEs);

Ø  Levels the playing field between traditional and digital companies;

The new tax reform is meant to address these two objectives through setting a minimum global corporate tax rate to deal with companies operating in multiple countries.

How Global Minimum Corporate Tax/Taxation of Digital Economy would impact Tax Haven like UAE

Though the architecture of each pillar is now well established, It would be really too early to predict the operational realty, structure and mechanisms of this proposal. But for now it has sparked global debates about its impact on the global economy and mainly on the major tax havens that attract firms such as Amazon, Apple, Google and Facebook. I will discuss here some major changes which could possibly be seen:

Ø  Implementation of Global Minimum Corporate Tax would give the tax haven countries room to implement corporate tax equal to the Global Minimum Corporate Tax. Even with the envisioned impact of a minimum global corporate tax, the UAE will remain a relatively low-tax environment and will remain competitive.

Ø  This global minimum tax proposal could erode the benefits of the tax incentives granted by UAE to attract such foreign investments but its political stability, sound policies, robust ecosystem, ease of doing business, intellectual property protection and strong talent pool would compensate the loss in the long run

Ø  UAE will need to accelerate the build-up of its X-factors to attract and retain the MNCs. Policymakers will have to get creative and consider restructuring various business-related fees

Ø  UAE has already launched a series of reforms, including allowing foreigners full ownership of businesses to boost the “competitive edge and ease of doing business”. These reforms would play a major role while attracting MNCs to invest in the UAE.

Ø  Finally I don’t think the UAE government will truly miss any of the firms or investors who only care about preferential tax treatment over the long run. The UAE would relies on its image as an international hub and will be keen to be seen as part of the global system rather than a tax haven