A cascade of events signals that global tax reform has gathered great momentum. The G7 Finance Ministers’ Meeting in June reached a consensus on two-pillar global corporate tax reform and sending and important political message. On July 1, the OECD/G20 BEPS project announced that the two-pillar global tax reform plan had been endorsed by more than 130 countries and jurisdictions.
Moreover, on July 10, the third meeting of G20 finance ministers and central bankers concluded with “a historic agreement on a more stable and fairer global tax architecture.” As the 139 countries of the Inclusive Framework continue debating remaining issues and technical details, it is estimated that a final decision on global tax reform could be made in October, and changes will be put in place as early as 2023.
The tax reform follows a two-pillar plan that has been gradually established since 2019. The first pillar is the redistribution of some tax rights — that is, to reapportion some taxes of large multinational enterprises from the place where they are registered to the place where they operate and make profits. The second pillar is to set the lowest corporate tax rate in the world to end the race to the bottom of corporate tax.
The current scheme sets more specific arrangements for the two pillars. For example, the first pillar only applies to multinational companies with a turnover exceeding 20 billion euros and profit margins exceeding 10 percent, and extractive industries and regulated financial services are excluded. The second pillar, applying to companies with a turnover of more than 750 million euros, is to create a minimum tax of 15 percent for multinationals through the income inclusion rule and the low-tax payment rule.
The global tax reform movement started as early as 2009 after the financial crisis, as many countries were increasingly dissatisfied with what they saw as abuses of globalization. The outbreak of the COVID-19 pandemic has gravely worsened the financial situation for many countries, adding urgency and new momentum for global tax reform. However, the shift of attitude in the U.S. has provided a key impetus for this round of reform.
The Biden administration supports global tax reform to achieve three goals:
First to act in accordance with the U.S. domestic tax reform. In April 2021, the Biden administration proposed the “Made in America tax plan,” which aims to raise more tax revenue to support its massive domestic investment programs. The U.S., which plans to raise its minimum tax rate to 21 percent, is counting on an increase in the world’s lowest tax rate to blunt the impact of higher corporate tax rates at home.
Second, to address the imbalance of globalization. The common practice of seeking tax havens for multinationals and the resulting large amount of tax revenue outflow have drawn the ire of many Americans, angry about the abuses of globalization. In promoting meaningful acts curbing tax havens, the Biden administration aims to protect the U.S. tax base and to promote the return of the manufacturing industry.
Third, to convince the Europeans to give up their “digital tax.” Europe’s unilateral digital service tax has triggered a major row between Europe and the United States, creating bad blood and preventing effective coordination between the two sides on many issues. Recently, the European Union agreed to put a hold on its digital tax while waiting for progress in global tax reform.
The EU is also supportive of global tax reform. For years, it has been unhappy about tax revenue that has been lost because of the existence of tax havens within its borders. It is pushing for ambitious and comprehensive tax reform within the EU to further strengthen the foundation of the European single market.
But the EU plan had been thwarted by low tax members, such as Ireland, Malta, Luxembourg and Hungary. The EU hopes to take advantage of the external pressure of global tax reform to prepare for tax reform at the EU level.
Despite the fact that global tax reform still faces uncertainties in the future as both the U.S. and EU face internal resistance and global implementation requires time, it is still quite possible that the world will see in the coming years a major reshaping of the current international tax rules that would affect both national governments and multinational enterprises.
Through the G20 platform, China has endorsed two-pillar global tax reform. An analysis of the reform arrangement shows that China will not lose from the reforms. As the major market for many multinational companies, China may get more tax revenues from the Pillar 1 reform. China’s corporate rate is well above 15 percent, and Pillar 2 will not have a major impact on China’s policy autonomy, though it may put pressure on some of its domestic tax incentives for tech companies. In addition, global tax reform will have only limited impact on China’s foreign investment, as China’s attraction increasingly lies in its complete industrial supply chain, huge domestic market and favorable opening-up policies.
For many Chinese multinational companies, especially tech companies rapidly developing their overseas operations, global tax reform is an area worthy of more attention and careful response planning. On one hand, compared with the haphazard digital service taxes, a global tax reform arrangement is more predictable and implies lower compliance cost.
On the other hand, international tax policy changes will become an unavoidable external challenge for large multinational technology enterprises. They will increase the overseas compliance costs, affect the tax costs of cross-border investment and influence the investment decisions of companies. The minimum corporate tax rate rule could also hit multinational companies that set up subsidiaries in low-tax jurisdictions to avoid taxes.