Canada is taking steps to comply with a 15 percent global minimum tax on multinational companies starting in 2023, but a report says the new regime could adversely affect Canadian wealth and tax revenues and make countries vie for the international taxes on a “first-come, first-served” basis.
The C.D. Howe Institute’s May 31 report, written by Angelo Nikolakakis, a partner with international law firm EY Law, says that if Canada doesn’t make “other strategic adjustments,” it “will likely be impoverished.”
The global corporate minimum tax scheme championed by the Organisation for Economic Co-operation and Development (OECD) and G20 consists of two pillars. Pillar One allocates new taxing rights to countries where about 100 of the world’s largest multinational enterprises (MNEs) operate. Pillar Two establishes a minimum tax of 15 percent on MNEs that have annual consolidated revenues of $750 million euros (C$1 billion), which includes many Canadian MNEs.
“The regime contemplates the introduction of a veritable tax smorgasbord,” Nikolakakis said.
The report analyzed the most recent releases from the OECD regarding implementation of the minimum tax’s “Model Rules,” which describe the process countries are to use in calculating the required top-up tax if a company’s effective tax rate is below 15 percent and how Canada could potentially compete to get more of this tax revenue.
“The best outcomes would arise if Canada were to adopt a Canada-first approach, whereby Canadian MNE groups had the incentive to reduce foreign taxes, in a way that results in Canada being the country that collects the 15 percent global minimum tax,” Nikolakakis said.
But instead of raising additional tax revenues under the regime, Canada could suffer losses, according to the report. Nikolakakis pointed out that if the relevant foreign jurisdictions increase their tax rates, either in general or under Pillar Two, Canada’s adoption of Pillar Two might not raise the $3.5 billion in annual tax revenues once estimated by Canada’s finance minister.
This is because, as Nikolakakis explained, if Canadian-based MNEs pay more foreign tax, it would likely result in an offset against Canadian taxes otherwise payable by them, and more importantly, result in lower after-tax foreign earnings for those MNEs.
“This, in turn, would reduce their ability to reinvest, and reduce their distributions to Canadian stakeholders, with adverse implications for the overall Canadian economy,” the report stated.
Telling Choices to Be Made
Nikolakakis criticized the model rules. While he said they would not completely eliminate the benefits for MNEs to earn cross-border income from low-tax jurisdictions, those benefits would be diminished. He added that the rules would also create incentives for certain governments to opportunistically raise their tax rates and, in addition, the rules could discourage governments from relying “on their tax systems as instruments of industrial and social policy, through the use of investment and development incentives.”
The report laid out considerations for Canada in the implementation of the 15 percent minimum tax. One option could be to reform the country’s international tax system to increase the likelihood that MNEs pay the top-up tax to Canada rather than to foreign jurisdictions.
The model rules allow a country to impose the top-up tax on an MNE’s profits in another country where no top-up tax is imposed and where the effective tax rate is less than 15 percent.
Canada is a relatively high-tax jurisdiction, with a federal corporate tax rate of 26.5 percent, and Nikolakakis says MNEs would be inclined to keep earnings in foreign jurisdictions to avoid paying anything more than the minimum 15 percent.
Another consideration for Canada, however, is attracting business and income from foreign MNEs that would prefer to pay their top-up taxes to their parent jurisdictions, in which case Canada might decline to impose a top-up tax, according to the report.
Canada is one of 137 OECD members that have so far agreed to the OECD/G20 framework for overhauling international taxation for large multinationals.
The regime’s objective is to end the “race to the bottom” in corporate taxation, where countries such as Ireland have attracted MNEs with low corporate tax rates.
Canada has been working on a digital services tax (DST), but the feds said in Budget 2022 that they hope the new international system will soon come online and make the DST roll-out unnecessary.
The federal budget also announced the launch of a public consultation on implementation of the 15 percent tax and the domestic minimum top-up tax, while acknowledging that it’s “not possible to reliably estimate the revenue impact [of the global minimum tax] at this time.”
