As the global economy continues to evolve, it’s important for businesses to understand international tax challenges. As of 2021, over 130 countries and jurisdictions have joined a plan to reform international taxation rules to hold multinational enterprises more accountable.
The countries participating in this new plan represent 90% of the total global GDP. The taxation reform is split into two pillars, with the first focusing on ensuring a fairer distribution of profits.
The second pillar is intended to limit tax competition on corporate income tax through the implementation of a global minimum corporate tax. Although this will not completely eliminate tax competition, it will establish multilaterally agreed limitations.
This agreement is expected to generate USD 100 billion in tax revenue for local market jurisdictions each year. And with a global minimum tax rate of at least 15%, countries will likely see an additional USD 150 billion in tax revenues per year. The goal is to stabilize the international tax system and benefit the progress of globalization.
Problems with Existing International Tax Rules
Whenever different countries are working together under various sets of rules, there are bound to be complications. International tax challenges exist because countries are operating under agreements made in the 1920s. The purpose of the updated tax agreement will aim to solve these challenges moving forward in the global economy.
1. Outdated Taxation Laws
Many of the old agreements were based on physical operations. But with the digital economy, many countries felt the need to adapt and make adjustments. For instance, the existing rules state that profits of a foreign company can only be taxed in another country where the foreign company has a physical presence.
Obviously, this rule made more sense when companies were establishing factories and warehouses to ship physical goods. However, with the growth of the Internet makes it possible for global companies to operate globally with little or no physical presence.
2. Corporate Tax Avoidance
Another issue with global taxation is that most countries only tax domestic business income. This means they don’t tax foreign income, based on the assumption that international profits will be taxed wherever they are earned.
Global corporations often take advantage of this loophole to avoid taxation. It allows these businesses to shift profits to other countries that impose little or no tax, to maximize their bottom line. However, for businesses looking to go global in today’s economic landscape, they’ll need to be aware of these changing regulations to avoid hefty fines and penalties.
3. Impact on Developing Countries
The Organization for Economic Cooperation and Development (OECD) estimates companies save between USD 100-240 billion annually from tax avoidance. This comprises anywhere from 4-10% of global corporate income tax revenues. Developing countries are negatively affected by this because they tend to rely more heavily on corporate income taxes than advanced economies.
These updated regulations are meant to avoid competitive escalation that can lead to trade wars and increased international uncertainty. Without such rules in place, countries will implement measures at a national level for Digital Services Taxes (DSTs) and retaliatory tariffs.
Impact to International Companies
Although these regulations are designed to distribute profits to more countries, it will mostly impact about 100 of the biggest and most profitable international businesses. However, the regulation that will impact all global enterprises is the global minimum corporate tax. This new rule will apply to any company making over EUR 750 million of annual revenue. Even if businesses try to shift profits to a tax haven, those profits will be subject to at least a 15% rate.
Additionally, the purpose of the updated international agreement is to address the challenges associated with the digital economy. Currently, many companies are taking advantage of the existing rules to avoid paying higher tax rates.
The End of Tax Havens
Companies using tax havens will soon be subject to new international tax challenges. This includes the end of things like bank secrecy and shell companies.
The work of the G20 and the Global Forum has ended bank secrecy, which lead to the automatic exchange of bank information. Additionally, the BEPS Project requires businesses to have a certain level of substance to put an end to shell companies. Transparency rules have been put in place so that tax administrations can more effectively enforce their various tax rules.
The fact that companies will now be subject to a 15% tax on their profits in most operational countries will effectively eliminate tax havens as we know them.
Navigating international tax challenges is a complicated and time-consuming task. Global Upside, a Safeguard Global company, can help businesses expand into any country by offering talent acquisition, human resources, accounting, payroll, tax, incorporation, and professional employer organization (PEO)/employer of record (EOR) services.
Our comprehensive solution offers a one-stop shop for establishing businesses, maximizing operations, and complying with various taxation laws and regulations.