Quora Answer: What is the Global Tax Reform?

The following is my answer to a Quora question: “The G20 finance ministers agreed to go ahead with global tax reform.  What is it about?” 

The global tax reform is not solely an agreement among the G20.  140 nations were involved in the discussion, and 136 of those signed it after extensive negotiations.  This began as an American initiative to address an American issue, and they made it a global issue.  The intent was to set taxes for the foreign earnings of American corporations, which has used this as a means to avoid paying corporate taxes in the US.  It was simpler to make it a global problem instead of reforming the American system, which is rotten.  As it is, the tax treaty requires 67 votes in the Senate to be ratified, and in this climate of hyper-partisanship, that would be challenging. 

There are two parts of the reform.  The first past is focused on changing where large companies pay taxes, while the second part is the actual global minimum corporate tax.  The second part would have no teeth without the first since not every single tax jurisdiction in the world is subject to this. 

The first part, called Amount A, would apply to companies with more than €20 billion in revenue. and a profit margin above 10%.  A portion of their profits would be taxed in jurisdictions where they generate sales revenue, 25% of the profits above that 10% margin may be taxed.  After a review period of seven years, this €20 billion threshold may fall to €10 billion.  However, companies which generate revenue from extraction of minerals, such as the oil and gas industry, and mining companies, as well as financial services companies such as banks and insurers, are excluded from this, because their revenue is restricted to specific jurisdictions by law, and may only be taxed there.  Amount A is an attempt to partially redistribute tax revenue from countries that currently tax large multinationals based on the location of their headquarters and operations to countries where their sales revenue is generated.  American corporations would be the single largest group affected by this.  There is also an Amount B, which is a simpler method for companies to calculate the taxes they owe on foreign operations such as marketing and distribution.  The outline, however, provides no new details. 

The second part is the aforementioned the global minimum tax.  It contains two main rules, and then a third rule pertaining to tax treaties.  They are meant to apply to companies with more than €750 million in revenue.  The first is income inclusion, which determines when foreign income of a company should be included in the taxable income of the parent entity.  The minimum effective tax rate is 15%, otherwise additional taxes would be owed in that company’s home jurisdiction. 

The income inclusion applies to foreign profits after a deduction for 8% of the value of tangible assets, and 10% of payroll cost.  These deductions are to be reduced annually over a 10-year transition period.  At the end of transition, the deduction for both tangible assets and payroll would be fixed at 5%.  This will increase the tax costs of cross-border investment and impact business decisions such as hiring and investments. 

The under-taxed payments rule allows a company to deny a deduction for or place a withholding tax on cross-border payments.  If a company in one country is making payments back to its parent entity, which is in a low-tax jurisdiction, then the under-taxed payments rule applies.  Companies that have been in the scope of this for less than five years, have a maximum of €50 million in foreign tangible assets, and operate in no more than five other jurisdictions, are excluded. 

Together, the income inclusion and the under-taxed payments rules create a minimum tax both on companies investing abroad and on foreign companies that investing domestically.  They are both tied to the minimum effective rate of at least 15%, and they apply for each jurisdiction where a company operates.  Additionally, there is the subject to tax rule, used in a tax treaty framework to give countries the ability to tax payments that would otherwise only face a low rate of tax.  The tax rate is set at 9%. 

The changes are meant to be put in place by 2023.  Countries need to write new laws, adopt new tax treaty language, and repeal some policies that conflict with the new rules.  This is the most significant change in international tax laws in the modern era.  Digital services taxes and similar policies are removed as part of implementing this.