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Explainer: What is the global minimum tax deal, and what does it mean for Latin America?

A global deal to ensure big companies pay a minimum tax rate of "at least" 15% and make it harder for them to avoid taxation has been agreed by 136 countries. Now what?

Reuters and LABS

08.Oct.2021 18:50 BRT
UPDATED 18:59 BRT

A global deal to ensure big companies pay a minimum tax rate of “at least” 15% and make it harder for them to avoid taxation has been agreed by 136 countries, the Organisation for Economic Cooperation and Development (OECD) said on Friday.

The OECD said only four countries — Kenya, Nigeria, Pakistan, and Sri Lanka — had not yet joined the agreement, but that the countries behind the accord together accounted for over 90% of the global economy.

“Today’s agreement will make our international tax arrangements fairer and work better,” OECD Secretary-General Mathias Cormann said in a statement. “This is a major victory for effective and balanced multilateralism.”

The OECD said that the minimum rate would see countries collect around $150 billion in new revenues annually while taxing rights on more than $125 billion of profit would be shifted to countries where big multinationals earn their income.

Why a global minimum tax?

With budgets strained after the COVID-19 crisis, many governments want more than ever to discourage multinationals 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 minimum tax and other provisions aim to put an end to decades of tax competition between governments to attract foreign investment.

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How would a deal like this work?

The global minimum tax rate would apply to overseas profits of multinational firms with 750 million euros ($868 million) in sales globally.

Governments could 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.

A second track of the overhaul would allow countries where revenues are earned to tax 25% of the largest multinationals’ so-called excess profit — defined as profit in excess of 10% of revenue.

Some countries, like the U.S. and Argentina, were advocating for a higher local corporate tax rate. And, well, this would make a huge difference for Latin American economies.

A study by Tax Justice Network and other researchers suggested the so-called METR (minimum effective tax rate) of 21%. With this rate, the top five countries that would recover the most underpaid corporate tax from multinationals would be the U.S. ($166bn under OECD proposal; $148.9 bn under the METR suggestion); China ($64.4bn; $101.4 bn); Japan ($59.7bln; $79.3 bn); Germany ($39.4 bn; $47.8 bn), and France ($25.8 bn; $28.6 bn).

Low and middle-income countries would also gain with a METR of 21%. Brazil could go from $6 billion estimated under OECD rate to $14 billion under METR, and Mexico from $6 billion to $11 billion.

Another study, by the EU Tax Observatory, also shows higher rates for Brazil and Mexico if the tax rate was bigger: With a 15% tax rate, Mexico and Brazil would gain an additional $600 million and $1.1 billion, respectively, compared to $1.1 billion and $4 billion with a 21% rate, and $1.5 billion and $8.8 billion with the 25% rate.

What happens now?

Following Friday’s agreement on the technical details, the next step is for finance ministers from the Group of 20 economic powers to formally endorse the deal, paving the way for adoption by G20 leaders at an end of October summit.

Nonetheless, questions remain about the U.S. position which hangs in part on domestic tax reform the Biden administration wants to push through the U.S. Congress.

The agreement calls for countries to bring it into law in 2022 so that it can take effect by 2023, an extremely tight timeframe given that previous international tax deals took years to implement.

Countries that have in recent years created national digital services taxes will have to repeal them.

Economists expect that the deal will encourage multinationals to repatriate capital to their country of headquarters, giving a boost to those economies.

However, various deductions and exceptions baked into the deal are at the same time designed to limit the impact on low tax countries like Ireland, where many U.S. groups base their European operations.