May 31, 2022 – The Global Minimum Tax of 15 percent, also called “Pillar Two”, could have a material adverse effect on Canadian wealth and tax revenues, according to a new report from the C.D. Howe Institute.
In 2022, the federal budget launched consultations on the implementation of new proposed rules for a Global Minimum Tax, which would apply to multinational enterprises (MNEs) with annual consolidated revenues generally of EUR $750 million. This proposal was previously endorsed in principle by members of the OECD and G20. In “High Stakes Ahead: Canada and the Global Minimum Tax for Multinationals,” author Angelo Nikolakakis assesses the introduction of this veritable tax smorgasbord and its potential implications for Canada.
If relevant foreign jurisdictions increase their tax rates accordingly, either in general or under Pillar Two, Canada’s adoption of Pillar Two might not raise the $3.5 billion in annual tax revenues initially estimated by Canada’s Finance Minister, writes Nikolakakis. Instead, Canada could suffer a net reduction in wealth and tax revenues.
“The reason: an increase in foreign taxes paid by Canadian-based MNEs would likely result in an offset against Canadian taxes otherwise payable by them; and, more importantly, result in a reduction in the after-tax foreign earnings of our MNEs,” the author explains. “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 Global Minimum Tax would apply to both cross-border income streams derived through low-tax entities and to value-creating business activities carried on within any jurisdiction, including Canada, subject to a modest Substance-Based Income Exclusion applying to a portion of payroll and tangible asset costs. Through a combination of mechanisms, Nikolakakis writes, the Model Rules would create: i) incentives or disincentives that would diminish, though not eliminate, the benefits for MNEs to derive cross-border income streams through low-tax entities; ii) incentives for certain governments to opportunistically raise their tax rates; and iii) disincentives for governments to rely on their tax systems as instruments of industrial and social policy, through the use of investment and development incentives.
Examining four scenarios (the Current Regime, Pillar Two, No Planning and Canada First) involving a Canadian-based MNE with operations in a high-tax foreign country, Nikolakakis finds that the differences between the various scenarios are material and that if Canada adopts Pillar Two without making other strategic adjustments, “we will likely be impoverished.”
Instead, the best outcome would be for Canada to adopt a “Canada First” approach, whereby Canadian MNE groups would have the incentive to reduce foreign taxes in a way that results in Canada being the country that collects the 15 percent Global Minimum Tax. Notably, under this scenario, Canada lost no wealth and collected more taxes compared to the others. The author notes: “It is difficult to imagine that MNE groups would consider it consistent with their competitiveness imperatives to collapse their foreign tax arrangements and start paying taxes on such earnings in Canada, unless Canada were to reduce the Canadian rate on foreign earnings to (or to a rate that is much closer to) the 15 percent Minimum Rate. If Canada were to do so, then it would be reasonable to expect a significant increase in Canadian tax revenues, and a reduction in the leakage of Canadian wealth in the form of paying foreign taxes.”
Nikolakakis writes that strategic considerations for MNE groups include identifying and implementing arrangements that serve to reduce the effective tax rate in all locations to 15 percent. For example, if a Canadian-based MNE has foreign earnings in a jurisdiction that increases its tax rates, then taxes on those earnings would likely be paid in that jurisdiction – leaving nothing to be taxed in Canada. However, if the group can shift its foreign earnings to a low-tax jurisdiction, or to Canada, then taxes on those earnings will be paid to Canada.
“Canada will need to consider very carefully how to restructure and optimize various elements of our tax and fiscal policy in order to maximize the attractiveness of Canada for all MNE groups as a location for activities and investment, as well as to create a climate in which Canadian MNE groups have the incentive to maximize the repatriation of their foreign earnings,” says Nikolakakis.
For more information contact: Angelo Nikolakakis, Partner, EY Law, LLP; or Lauren Malyk, Communications Officer, C.D. Howe Institute, 416-865-1904 Ext. 0247, lmalyk@cdhowe.org
The C.D. Howe Institute is an independent not-for-profit research institute whose mission is to raise living standards by fostering economically sound public policies. Widely considered to be Canada's most influential think tank, the Institute is a trusted source of essential policy intelligence, distinguished by research that is nonpartisan, evidence-based and subject to definitive expert review.