Groundbreaking Global Tax Reform Ahead

Jan 27 , 2024
By Austine Sequeira , Andrea Sequeira

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Corporate taxation is on the cusp of a seismic shift as countries line up their financial calendars with the Gregorian year, particularly in January.

This is a critical period for fiscal policy, marked by the introduction of national budgets and the struggle with the new tax year. The coming two years are crucial in this transition, mainly due to implementing the Pillar Two provisions of the Base Erosion & Profit Shifting (BEPS) project, an initiative spearheaded by the Organization for Economic Cooperation & Development (OECD).

In October 2021, the OECD's international tax plan, endorsed by 137 countries, marked a groundbreaking step in global fiscal policy. The crux of this plan is to ensure that multinational corporations (MNCs) pay a minimum effective tax rate of 15pc on their profits, not where they are registered but in every jurisdiction where they operate. It is an approach aiming to recalibrate the global tax regime, levelling the playing field that has long been skewed by countries vying to attract investments through tax incentives and holidays.

Profit shifting, a practice where multinational firms, especially tech giants, sell their products and services globally but channel profits into tax havens to understate their tax burdens, has been a persistent issue. These corporations, often benefiting from tax breaks and concessions from jurisdictions eager to attract foreign investment, have historically paid meagre taxes. A notable example is a leading global company known for its technological products, which, despite its worldwide presence, limits its tax rate to about five percent by concentrating its revenues in a low-tax country.

According to an OECD working paper published last year, up to 37pc of global net profits MNCs earn are taxed below an effective 15pc rate. This disparity contrasts with domestic firms, which typically face an average income tax of 30pc on their domestically generated profits. This imbalance not only skews investment and returns but also favours multinationals over local businesses. For instance, American and British companies selling products from smartphones to gasoline in Africa often pay less than 15pc tax on their income, while a domestic manufacturer might shoulder a 30pc tax rate on its profits.

Studies estimate that over 125 billion dollars in MNC profits annually should be reallocated to market jurisdictions, rather than their places of registration. The primary beneficiaries of the current system are countries like the United States (US) and some European nations, while the losers are often impoverished African and Asian countries, extending development incentives without realising the significant tax drain on their national budgets.

The OECD's two-pillar solution, backed by the International Monetary Fund (IMF), represents a major stride in international taxation.

Pillar One outlines methods to allocate profits to countries where MNCs have significant business activities but limited or no physical operations. This is particularly beneficial for underdeveloped countries struggling to tax MNCs operating digitally or indirectly. Pillar

Two, kicking off in 2024, focus on implementing the new effective minimum tax regime. Under this pillar, signatory countries must enact 'top-up' tax rules, allowing MNC headquarters to collect additional taxes to meet the minimum if the taxes in the operating country fall short. This pillar also introduces the Domestic Minimum Tax (DMT), ensuring that taxes are retained within the country and not redirected through top-up mechanisms.

These reforms initially target large MNCs but are laden with complex operational rules. Tax analysts predict potential new disputes, double taxation issues, and sub-political trade conflicts. However, these reforms mark a significant step towards addressing the competitive tax offers driven by politics in developed and developing countries, including those with aggressive tax systems such as Ireland, China, and India, as well as numerous underdeveloped nations.

The consulting firm KPMG noted that these international tax reforms could neutralise the era of low tax incentives and potentially lead to tax exports. If a country offers a low tax rate to an MNC, the corporation may need to pay additional top-up tax from its income in the parent jurisdiction. Consequently, countries with lower headline tax rates might need to elevate their minimum effective tax rates to 15pc. On the other hand, countries with broader tax bases, like the UK and USA, could potentially face losses.

The stakes are high for African countries, the majority of which are signatories to the OECD's global tax regime. The International Institute for Sustainable Development (IISD) reports that Africa loses approximately 23 billion dollars annually in public revenue due to wealth imbalances and loopholes in domestic tax regimes favouring MNCs. For Sub-Saharan countries, numerous questions surround the BEPS initiative, but most economists view it as a positive development.

The new tax regime is likely neutral for countries like Ethiopia, which have a broad-based, high domestic effective tax rate. However, countries with free zones and differential or aggressive tax systems may need to increase taxes or await the repatriation of top-up taxes to their treasuries. The African regional trade block, ACFTA, will need to align its trade rules with an annual minimum effective tax rate of 15pc.

African countries must develop and implement robust, formal tax regimes to consolidate taxes and curb evasion. This entails leveraging technology, expanding the tax base to sectors serviced by MNCs, implementing value-added tax systems to prevent double taxation, and enhancing the capacity of tax administrations with qualified accountants and economists. This comprehensive approach aims to raise public funds for sustainable development.

The prospect of a uniform global tax regime by the next decade presents opportunities and crises for underdeveloped African countries. The region's public finance systems face a crucial decade of reform. The outcome of these changes will significantly impact the ability of these countries to attract investment and sustain economic growth, setting the stage for a potentially transformed global economy.

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PUBLISHED ON Jan 27,2024 [ VOL 24 , NO 1239]

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