The implications of global minimum tax on company tax revenue of developing countries

In October 2021, members of the OECD/G20 inclusive framework on BEPS issued a statement on a Two-Pillar solution to address the tax challenges arising from the digital economy. As of 4th November 2021, 137 countries have signed the framework. In this article, I attempt to explore the implications of the global minimum tax regime on the tax revenue of developing countries. The global minimum tax is one of the Two-pillar solutions being introduced to tackle harmful tax planning by transnational companies.

Implications of tax planning by transnational companies
Tax revenue, especially company income tax constitutes a major chunk of a country’s income. Data from the Nigeria Federal Inland Revenue Service (FIRS) showed, that N1.8 trillion was generated from company income tax in 2021 representing 43.1% of the non-oil tax revenue collected in 2021.
Countries have different laws and regulatory frameworks governing the effective levying, collection, and administration of company income tax within their territories. In Nigeria, the Companies Income Tax Act governs the levying, collection, and administration of company income tax. Even the tax rate varies from country to country, for instance, the company’s income tax rate for Nigeria is 30% of net income, and for South Africa 28%, for the United States, and the United Kingdom, 27% and 19% respectively.
Over the years multinational companies have exploited the mismatches between the tax laws of different countries to minimize their tax exposure. While it is generally accepted that companies have the right to take steps to minimize their tax expenditure, such tax minimization efforts have come under greater scrutiny in recent years. It is believed that multinational companies exploit the divergence in the tax laws to deprive countries where economic activities are carried out of their fair share of tax revenue.

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It is estimated that globally countries lose about $100-$240 billion in revenue annually to harmful tax planning by multinational companies. In Africa, the annual estimated tax revenue loss has been put at not less than $50 billion. While sub-Saharan Africa the estimated loss is between $450 and $730 million per year.

There have been several national, bilateral, and multilateral initiatives to tackle the harmful effect of tax minimization by multinational companies, prominent among such efforts is the Organization of Economic Corporation and Development (OECD) Base Erosion and Profit Shifting (BEPS) project.

In 2013, the BEPS project was launched by the OECD and the G20 countries. The OECD worked on 15 separate action items to address BEPS and concluded most of its work on those items with reports published in 2015. The aim of the BEPS project was to close gaps in international tax rules that allowed multinational companies to legally shift profits to low or no-tax jurisdictions.
Challenges of taxation of Digital Economy
The problem of BEPS has been further exacerbated by digitalization. The digital economy is fast becoming the most innovative and widest-reaching economy in the world. According to World Bank 2021 data, the digital economy is equivalent to 15.5% of the global GDP, growing two and half times faster than the global GDP over the past 15 years. Several companies now operate and generate huge incomes in different countries without having a physical place of business in those countries.
There has been an attempt by individual countries to fashion out an appropriate framework to tax the digital economy. For instance, Nigeria through the Finance Act, 2022 introduced the concept of Significant Economic Presence (SEP) through the Significant Economic Presence Order, 2020. The Order imposes a tax on Non-Resident Companies (NRCs) providing digital, technical, management, consultancy or professional services in Nigeria will be deemed to have a significant economic presence in Nigeria in any accounting year where it; a) derives from Nigeria, a gross turnover or income exceeding N25 million or its equivalent); b) from any or a combination of digital services provided; c) uses a Nigerian domain name (.ng) or registers a website address in Nigeria; or d) has a purposeful and sustained interaction with persons in Nigeria, by customizing its digital platform to target the Nigerian market, including reflecting its product or service price in Nigerian currency or providing options for billing or payment in Nigerian currency.

The Global Minimum Tax
In October 2021 members of the OECD/G20 inclusive framework on BEPS issued a statement on a Two-Pillar solution to address the tax challenges arising from the digital economy
Under Pillar One, taxing rights on more than $125 billion of profit are expected to be reallocated to market jurisdictions each year. Developing country revenue gains are expected to be greater than those in more advanced economies, as a proportion of existing revenues.

Pillar Two introduces a global minimum corporate tax rate set at 15%. The new minimum tax rate will apply to companies with revenue above €750 million and is estimated to generate around $150 billion in additional global tax revenues annually. Further benefits will also arise from the stabilization of the international tax system and the increased tax certainty for taxpayers and tax administrations.

As of 4th November 2021, 137 countries have signed the treaty. It is estimated that the countries behind the global minimum tax rate together account for over 90% of the global economy. Signatories to the agreement are expected to domestic the agreement in 2022 while implementation takes effect in 2023.

Implications of the Minimum Tax on Developing Countries
The minimum tax regime seems to be a double-edged sword for developing countries. While on the one hand it is expected to soar Company income tax revenue, it might serve as a disincentive for investing in developing countries by multinationals.

Developing countries, typically rely on incentives such as low taxes, tax waivers, or deferred tax to attract investors. It is therefore understandably some developing countries, such as Nigeria, Kenya, Pakistan, and Sri Lanka are yet to sign the agreement.
The OECD projects an annual increase of about $150 billion in global tax revenue, however, there is no data showing how much of that amount will flow to developing countries. There is also no available data to assess if the projected tax income inflow will be more than the likely capital freeze by transnational companies who are mostly incentivized by low tax or tax holidays to invest in developing countries.

Conclusion and recommendation
There is no doubt the minimum tax regime was well thought out to curb the seemingly intractable problem of Base Erosion and Profit shifting by multinational companies. It is a welcoming development that most of the countries classified as tax havens have subscribed to the global tax treaty. It is hoped that countries will faithfully implement the provisions of the agreement.
There is a need for OECD/G20 to consider the issues raised by developing countries, especially the cost of implementation and the fears of reduced investment inflows.
Developing countries should be given the flexibility to negotiate tax agreements that are in their best interest. Foreign capital inflow is a major driver of development in developing countries and they should not be encumbered from providing incentives to attract investment.

Moses Omorogbe, LLB, BL, LLM, is the Company Secretary/Legal Adviser of Linkage Assurance Plc.