Picture this – an American e-commerce company with millions of customers in East Africa generating billions of sales revenue.
The company’s headquarters are not in East Africa where corporate income tax rates average at about 30% but in Ireland, a country with a population of 4.9 million people, where the Corporate Income Tax (CIT) rate is at 12.5%. The company’s sales are booked and taxes paid in Ireland while the Uganda Revenue Authority (URA) and their cousins across our borders get nothing!
Multinational Corporations (MNCs) have taken advantage of disparities in national tax rates to shift profit away from the countries where the economic activity takes place (most of these countries like in East Africa have high CIT rates) to low tax jurisdictions that offer sand, sea, beaches and financial secrecy. That is what the new global tax agreement that was signed on Friday, 8 October 2021 is expected to bring an end to.
The agreement was signed by 136 countries, accounting for over 90% of the global economy to ensure that MNCs pay a minimum tax rate of 15% and make it harder for them to avoid taxation. The minimum tax rate will come into force in 2023 regardless of where the MNC is headquartered provided that they generate a minimum of 750 million Euros ($868 million) in sales globally.
The goal is to end the unfair practice of tax competition between countries which involves governments offering low CIT rates to businesses in order to attract foreign investment. The multinational corporations have taken advantage of tax competition to shift their profits.
Corporations whose turnover exceeds Euro 20 billion (to be reduced to Euro 10 billion) will have 25% of their profits that are in excess of 10% of revenue re-allocated to market countries where they earn their revenues. This is expected to shift taxing rights to more than $125 billion to countries where the revenues are earned, away from low tax countries where the revenues are currently booked thereby bring about a fairer distribution of profits.
The changes are in response to the increased digitalisation and globalization of the world economy that have created inequality in the international tax system, with highly successful and profitable companies minimizing their tax payments in countries where they earn their income. Several large technology and ecommerce MNCs have paid little or no tax in certain countries where they operate.
New corporate tax deal
Tax avoidance by technology and digital companies has been so huge that countries had taken unilateral measures and imposed digital services taxes prior to the agreement. In 2019, Kenya introduced a tax aimed at collecting 1.5% of the gross revenues earned by persons providing digital services or digital marketplace to users in Kenya. In view of the dominance of non-resident persons in the technology and digital space, the implementation of this tax was fraught with challenges from the start.
However, the new global tax agreement calls for an end to unilateral digital services taxes such as the one imposed by Kenya. Kenya abstained from the deal while the other East African countries are notably not part of the list of the 136 countries that signed the deal.
It remains to be seen how the agreement will be implemented with minimum distortion and whether developing countries that have largely been the victims of profit shifting will indeed benefit from the new tax order.
The changes are largely in response to the increased digitalisation and globalization of the world economy that have created inequality in the international tax system, with highly successful and profitable companies minimizing their tax payments in the countries where they earn their income.
Crystal Kabajwara is an Associate Director with PwC Uganda’s tax practice.