- A 15% minimum tax on foreign profits of the largest multinational enterprises will have major implications for international investment and policy, says UNCTAD
- The tax proposal is part of reforms planned for implementation in 2023 or 2024 to discourage multinationals from shifting profits to low-tax countries
- UNCTAD cites potential downward pressure on the volume of investment that a higher tax on foreign direct investment activities will exert
- UNCTAD estimates that cross-border investment in productive assets could decline by 2%
A proposal to impose a minimum tax of 15% on foreign profits of the largest multinational enterprises (MNEs) will have major implications for international investment and investment policy, according to the UNCTAD World Investment Report 2022 published on June 9.
The report entitled, “International tax reforms and sustainable investment,” provides a guide for policymakers to navigate the complex new tax rules and adjust their investment strategies.
The proposed reforms, planned for implementation in 2023 or 2024, aim to discourage multinationals from shifting profits to low-tax countries. Key implications are:
- Increased tax revenue from multinationals for most countries
- Higher taxes on foreign profits of multinationals
- Potential downward pressure on new investment by multinationals
- Reduced effectiveness of low tax rates and fiscal incentives to attract investment
- Urgent need for investment promotion agencies (IPAs) and special economic zones (SEZs) to review investment attraction strategies
“While the tax reforms are going to increase revenue collection for developing countries, from an investment attraction perspective, they entail both opportunities and challenges,” said UNCTAD Secretary-General Rebeca Grynspan.
“Developing countries face constraints in their responses to the reforms, because of a lack of technical capacity to deal with the complexity of the tax changes, and because of investment treaty commitments that could hinder effective fiscal policy action. The international community has the obligation to help.”
Impact on countries
Tax rates on the foreign profits of multinationals will increase, UNCTAD said. Foreign affiliates that pay tax rates below the minimum on profits reported in host countries will be subject to a top-up. Also, multinationals will reduce profit-shifting and pay host-country rates on a larger profit base.
The estimated rise in the effective tax rates faced by multinationals is conservatively estimated at 2 percentage points. This corresponds to an estimated 15% rise in profit tax – closer to 20% for large firms –that multinationals directly affected by the reforms will have to pay host countries.
Both developed and developing economies are expected to benefit substantially from increased revenue collection, the report said, adding that offshore financial centers stand to lose a substantial part of revenues collected from foreign affiliates.
It said that for smaller developing countries – which generally have lower rates – the application of the top-up tax could make a major difference in revenue collection.
The flipside of increased tax revenue is the potential downward pressure on the volume of investment that a higher tax on foreign direct investment activities will exert. UNCTAD estimates that cross-border investment in productive assets could decline by 2%.
Policy implications
UNCTAD said the planned reforms will have major implications for national investment policymakers and investment promotion institutions, and for their standard toolkits. It pointed out that fiscal incentives are used to draw investment, including as part of the value proposition of most special economic zones.
The UN agency said international investment policymakers and negotiators of international investment agreements (IIAs) need to consider the potential constraints that IIA commitments may place on the implementation of key provisions of the reforms.
If host countries, often developing ones, are prevented by IIA provisions from applying top-up taxes or removing incentives, the tax rise to the minimum will accrue to mostly developed home countries. Host countries would lose out on tax revenue without offering any benefit to investors.
“The tax revenue implications for developing countries of constraints posed by international investment agreements are a major cause for concern,” the report notes. It adds that the international community, in parallel with or as part of negotiations on the tax reforms, should alleviate the constraints that are placing developing countries at a disadvantage.
“We need to vastly scale up technical assistance to support implementation of thereforms, and we need a multilateral solution to remove implementation constraints posed by IIAs. As a stop-gap measure, we need a mechanism to return top-up revenues raised by developed home countries that should have accrued to developing host countries,” the report says.
Meanwhile, the report shows that global foreign direct investment recovered to pre-pandemic levels in 2021, but uncertainty looms in 2022.
