In 2019, the IMF stated that “tax havens collectively cost governments between $500bn and $600bn a year in lost corporate tax revenue”.
Hong Kong is one of the most attractive low-tax jurisdictions for investment. The top 2,190 multinational companies have established 10,374 subsidiaries in low-tax jurisdictions, of which 40% are in Hong Kong.
Special economic zones (SEZs) that offer lower tax rates are also used to attract investment. China is a prime example of a country that uses SEZs to attract investment, with the zones offering lower tax rates than the country itself. The country set up its first SEZ in the 1980s and officially has 14 open coastal cities, five special economic cities and one special economic province. In 2017, the World Bank reported that “national SEZs contributed 22% of China’s GDP, 45% of total national foreign direct investment (FDI) and 60% of exports”.
Countries with higher tax rates than these low-tax jurisdictions often allow for exceptions to attract investment. In the UK, the corporate tax rate is currently 19%; however, companies investing in R&D, across any sector, are eligible for R&D tax relief in the form of a cash payment and/or corporate tax reduction.
UK and Switzerland among those attempting to offset plan
In anticipation of the new deal, countries are already implementing measures to maintain their competitive tax environments. Although it is in neither the G7 nor the G20, if Switzerland were to sign up to the G7’s proposal, officials recently revealed plans to offset the agreement through research grants, social security deductions and tax credits. This is to maintain favourable conditions for multinationals such as Nestlé, Glencore and Roche. Currently, 18 of the country’s 26 cantons offer tax rates under the proposed 15% minimum rate.
Meanwhile the UK government is seeking to exclude the City of London’s financial services companies from the new regulations, arguing that they already pay their fair share of tax. The UK will increase its corporate tax rate from 19% to 25% in April 2023, but in the meantime will introduce a temporary ‘super-deduction‘ of up to 130% to encourage investment in productivity-enhancing plants and machinery as it attempts to recover from the economic shock of Covid-19. This means that companies investing in new plant and machinery assets that meet this criteria can take a deduction of 130% of the costs in the year the investment is made. For example, if a business spends £1m ($1.38m) on qualifying investments, it can deduct £1.3m (130% of the initial investment) when calculating its taxable profits. In effect, companies can cut their tax bill by up to 25p for every £1 invested.
Biggest tax avoiders could be off the hook
Experts have warned that some of the biggest tax-evading companies may escape the new rule due to a large loophole. In its current phase, the new deal would only apply to companies with a profit margin exceeding 10%, which could let some companies off the hook.
Amazon is the world’s largest online retailer, with a market cap of $1.8trn and sales of $386bn in 2020, a $106bn increase on 2019. However, its profit margin in 2020 was only 6.3% as its business model focuses on reinvesting heavily and gaining market share. In May 2021, it was revealed that the company’s Luxembourg-based subsidiary Amazon EU Sarl paid zero corporation tax in 2020 despite recording a sales income of €44bn.
Coffee giant Starbucks could also be unaffected by the new deal due to its low profit margins (4% in 2020). The US chain received £4.4m in tax credits from the UK government in 2020 due to temporary closures brought on by the pandemic despite its parent company making a $1.2bn profit during the same time.
However, several companies whose past tax practices have been widely criticised, such as Apple, which recorded a net profit margin of 20.9% in 2020, and L’Oreal (12.7%), would fall under the remit of the proposal.
Impact on countries that rely on corporate tax for FDI job creation
The G7 proposal has caused concern for countries that rely on corporate tax cuts to bolster their investment attractiveness. Ireland’s Finance Minister Paschal Donohoe admitted that the deal could have “a very meaningful effect” on corporate tax policy in Ireland. The country’s 12.5% corporate tax rate has helped attract numerous US multinational tech companies and according to IDA Ireland makes it “one of the most attractive global investment locations”.
In addition, countries such as the Netherlands, Luxembourg and Hong Kong that place corporate tax at the centre of their FDI proposition may be forced to reassess their strategy for appealing to investors.
Without these tax incentives, it can be argued that smaller, less-populated countries will be unable to compensate for the market size and resources enjoyed by larger, wealthier countries such as the US and China. Corporate tax is a tool to encourage FDI that every country can use whereas market size is generally determined by geographic size – something that locations are largely powerless to change.
An end to the four-decade decline in the global corporate tax rate?
The proposed deal could put an end to a four-decade decline in corporate taxation levels. Tax cuts formed a key facet of the 1980s supply-side economics that influenced the policies of Ronald Reagan in the US and Margaret Thatcher in the UK. The theory claims that the best way to grow a country’s economy is by freeing companies from regulations, cutting tax rates and allowing free trade.
To attract FDI, countries open their markets, but due to international competitors they are tempted to relax investment regulations, including tax rates. This has led to an inevitable race to the bottom as countries cut taxes more and more to remain a viable option for investors.
In the 1980s the global average corporate tax rate was about 40%. According to data from KPMG, the rate fell to 29% in 2003. By 2010, it had dropped to less than 25% and by 2021 it had fallen again to 23.7%.
The average corporate tax rate has fallen across every world region since 2003. Asia witnessed the biggest drop, falling 8.8 percentage points (pp) between 2003 and 2021, followed by Europe (-7.5pp) and Africa (-4.9pp). European countries recorded the lowest corporate tax rates on average in 2021 (19%), while countries in the Oceania region have the highest at 28.4%.
Country rates have generally remained stable or fallen
Corporate tax rates have generally remained stable or declined across most countries since 2012. Out of the 138 countries that had data for both 2012 and 2021, 64 have seen no change in their corporate tax rate, while 55 have witnessed a fall and only 19 recorded higher rates. The map below can be adjusted to see the darker-coloured map (higher corporate tax rates in 2012) compared with the lighter-coloured map (lower corporate tax rates in 2021). Barbados has recorded the largest fall in corporate tax rates, changing from 25% in 2012 to 5.5% in 2021. Tunisia (-15pp) and the US (-13pp) have also exhibited large declines. Conversely, Chile's rate has increased by 8.5pp to 27% in 2021 and Jordan also moved up to 20% (+6pp).
How many countries would need to increase their rates to reach 15%?
In 2021, more than three-quarters (79%) of countries have corporate tax rates above 15%. In fact, 60% have rates above 20%. A total of 28 of 173 countries currently have standard rates below 15%, while a further nine countries have a 15% rate. Ten countries, including the British Virgin Islands and the Cayman Islands, have a zero rate of corporation tax. Such locations will be particularly impacted by the plan.
Some countries have already planned rate changes
Ahead of the deal reached by members of the G7, some countries already had plans in place to change their corporate tax rates. The UK's corporate tax rate is currently set at 19%; however, this is due to increase to 25% by 2023 as the government looks to regain public finances following the Covid-19 pandemic.
In the US, President Joe Biden has proposed to increase the federal corporate tax rate from 21% to 28% as part of his plans to offset the tax cuts made by Donald Trump in 2017. State levies would further raise the actual corporate tax rate that a company would pay to about 34% (depending on the state).
In April 2021, Turkey announced it would increase corporate tax from 20% to 25% in 2021 but reduce it to 23% in 2022. In contrast, France dropped its corporate tax rate to 26.5% in 2021, despite the impact of Covid-19, and has plans to reduce this further to 25% in 2022.
More recently, in June 2021, Argentina approved a corporate income tax reform that replaces the 30% fixed rate with a progressive tax rate, which could result in both increases and decreases in the corporate tax rate depending on taxable income. The bill also allows the ranges of net taxable income to be adjusted annually.
How do low-tax jurisdictions make revenue?
Low-cost jurisdictions should, theoretically, be heavily impacted by the global minimum corporate tax rate plans. Currently, countries with 0% corporate tax rates make money through company registration fees and renewals. As of the first quarter of 2021, the Cayman Islands had 113,182 companies registered. That equates to 1.7 companies per resident. Fees and renewals can vary depending on the type of company. Additionally, indirect taxation in the form of customs and import duties and departure tax ($37.50 in Cayman Islands, usually included in the airfare) also raise revenue. Low-cost jurisdictions are unlikely to be able to fill the void should companies move registrations out of the country due to a higher rate of corporate tax being introduced. Many lack the other key FDI features required to attract foreign companies.
Corporate tax is not the leading driver of FDI
The relationship between FDI and corporation tax is interesting. There have been several articles examining the impact of reducing corporate tax rates on FDI. Corporate tax rates are usually taken as one variable in a multivariant FDI model. In most cases, the impact of a 1pp reduction in corporate tax is predicted to lead to an estimated 0–5% increase in FDI. The wide range generally accounts for the different data sets used (variables and locations).
However, in isolation, there is no statistically significant relationship. There is no correlation between lower rates of corporation tax and higher levels of FDI stock on a global scale.
In fact, there is also no significant correlation when considering FDI stock per capita or when focusing solely on greenfield FDI (and greenfield FDI per capita). Other key FDI drivers such as market size, talent, stability, business environment and so on play key roles in driving decisions. If the model was rerun with a constraint on the number of countries – i.e. if assessing a smaller batch of countries that have similar FDI offerings – we would expect corporate tax rates to have more of an inverse relationship with FDI levels.
Corporate tax affects profit centres and cost centres differently
There is also a key distinction to be made when considering the impact of corporate tax on FDI in terms of the type of business operation. Lower corporate tax levels are more likely to impact profit centres than they are cost centre operations. Headquarters and sales offices, for example, would be expected to be more impacted by changing corporate tax rates than customer contact centres. Software and R&D operations are likely to be less impacted by changing rates because these operations are more cost-centre orientated and are driven less by tax and more by quality of labour, research and networks.
Marketing-seeking FDI would also be less impacted in changing rates as seen by the US (with its 27% corporate tax rate) and China (25%) continuing to top FDI league tables. This is due to companies accepting the trade-off of pay higher taxes to access a larger customer base.
More on the proposed global minimum corporate tax from the GlobalData network:
Glenn Barklie is chief economist at Investment Monitor and head of FDI services at Global Data Media.
Christine Patton is senior economist at Investment Monitor and a global expert on cross-border investment.
Naomi Davies is an FDI consultant at Investment Monitor, with expertise in location benchmarking and cross-border investment.