Minimising the minimum tax? The critical effect of substance carve-outs

From EU Tax Observatory: In July 2021, 132 countries agreed to a minimum tax rate of at least 15% on their multinationals’ profits.

However, the joint statement includes a provision that could substantially reduce the effectiveness of this policy. Specifically, the proposed agreement allows multinationals to reduce profits subject to the minimum tax by an amount equal to 5% of the value of their assets and payroll in each country. This carve-out would allow companies to escape taxation as long as they have sufficient operations (assets and employees) in tax havens.

In this note, we model how this carve-out would affect the revenues of a global minimum tax. We also discuss the economic issues raised by this type of exemption.

Key findings
A carve-out would reduce tax revenues by 15% to 30% in the EU relative to a minimum tax without carve-out (depending on the rate of the carve-out and the rate of the minimum tax).

More precisely, in the European Union :

A 5% carve-out would reduce revenues  :

a) of a 25% minimum tax by 21%, from €168 billion to €132 billion ;

b) and of a 15% minimum tax by 15%, from €48 billion to about €41 billion

A 7.5% carve-out (which is envisioned during the first 5 years of the international agreement) would reduce revenues :

a) of a 25% minimum tax by 31%, from €168 billion to 115 billion €

b) and of a 15% minimum tax by 23%, from €48 billion to about 37 billion €

What are substance carve-outs?

Under Pillar 2 of the OECD proposal, substance-based carve-outs consist of a reduction in the tax base on which the worldwide minimum tax (a priori 15%) will be applied. This reduction is determined based on two factors: employee compensation and tangible assets. Find out more here.

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