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Two Important Questions to be Addressed in the "Global Tax Reform."

Two Important Questions to be Addressed in the

After years of debate, leaders from more than 130 countries are moving quickly to agree on key changes to international tax rules, possibly by the summer. These changes would force some multinationals to pay more taxes in the countries where they sell and adopt a global minimum tax.


However, there are two important issues that must be part of the agreement and which are normally not highlighted: the elimination and prevention of tax measures contrary to the agreement and the basis for calculating the global minimum tax. 

First, the global agreement must highlight current tax policy measures contrary to the new framework and set a clear path both to eliminate these policies and prevent future unilateral tax approaches by foreign companies.


The new negotiated policy would force some multinationals to pay taxes in the countries where they sell. The intention is to restore peace in some recent international tax disputes. In recent years, countries have adopted various tax instruments, such as the Digital Services Tax (DST), which applies to foreign companies. Indeed, politicians often comment on daylight saving time, calling in particular certain large digital companies.

But taxing a foreign company with a discriminatory policy, like DST, can have consequences. The United States has threatened to impose tariffs on several countries that have adopted DSTs, and a trade and tax war would cost the global economy dearly.

So part of the global deal is for a country like the United States to say to France and other countries, "Okay, you can tax our companies more, but we have conditions." As described by the U.S. Treasury Department in a presentation in early April, these conditions include limiting the application to the top 100 companies and repealing and preventing conflicting future rules.


A global agreement would not be worth the document being drafted if it provided countries with a new instrument for taxing foreign companies without also eliminating the problematic instruments they currently use. A full list of counter-policies should not be limited to DSTs. Still, it should also include policies such as compensatory taxes and diversified income taxes that are also used to target foreign companies.


In a sense, the point of negotiation is to remove the weeds of international taxes before planting the seeds of a new system. But since weeds can grow back, the deal must also avoid new tax rules that go against the new structure. 

Second, the global agreement must define a coherent tax base for the global minimum tax.


Recently, the United States announced it would feel comfortable with a minimum overall tax rate of at least 15%.

 

The objective of the global minimum tax is to establish a statutory minimum rate and an effective tax rate that considers the design of the tax base. Two countries can have a statutory tax rate of 15%, but if one country offers more deductions or credits than the other, the actual tax rates would be different in the two systems.


The United States has implemented some sort of minimum foreign income tax since the 2017 tax reform passed the Global Intangible Low Tax Income (GILTI). The Biden government proposed an increase in the minimum rate for GILTI (from 10.5% to 21%) and a change in the tax base by removing deductions.


However, an Organisation for Economic Co-operation and Development (OECD) proposal from October last year had a different tax base than that of GILTI. Based on documents released last fall, lawmakers took into account several features that are not present in GILTI, including accumulated losses and the deduction of labor costs.

Suppose the United States suggests an effective rate of 15% as the minimum acceptable rate for a general agreement. In that case, the tax bases of the various minimum taxes adopted under the agreement must be aligned to minimize complexities and unwanted consequences.


The Biden government has made several proposals to change the tax base of GILTI, some of which are contrary to the OECD proposal. The proposal to eliminate a GILTI deduction for foreign assets, such as plants, equipment, and machinery, actually goes against the OECD outline. This outline provides for a deduction of part of the value of foreign assets and staff costs. The outline also considers provisions for annual adjustments, such as excess taxes carried forward, another element missing from GILTI.


Having a standard tax base is useful when a business calculates whether it has paid an overall minimum effective tax rate of 15%. Otherwise, a foreign corporation may use a calculation with different deductions, loss treatments, or taxes paid than a U.S. corporation.


The tax base and the rate should be a minimum standard (preferably at full charge). If the overall minimum tax goal is to limit the benefits of shifting income to low tax jurisdictions, the tax base should reflect that goal.


However, the Biden administration's approach is difficult and would influence U.S. business decisions regarding foreign investment, whether it is a foreign production or distribution operation serving foreign markets. In short, it would penalize the global success of American companies.


As the Biden government suggested for GILTI, a large-scale global minimum tax could discourage international investment and have negative economic consequences in countries hosting large multinational corporations. The existing evidence we have of these consequences could be compounded by the widespread adoption of higher taxes on the profits of foreign companies.


While it looks like countries may be closer to an agreement this summer, some very important considerations remain. Eliminating unilateral taxes against foreign companies and adjusting the tax base to the global minimum tax are areas where policymakers need to consider and recognize that bad decisions can have serious consequences.


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