Bermuda, long known for its pristine beaches and offshore financial services, is embarking on a journey to recalibrate its status quo. taxTaxes are mandatory payments or charges that local, state, and national governments collect from individuals or businesses to cover the cost of common government services, goods, and activities.
mix. Inspired by the OECD's Pillar 2 Initiative, the island will become the first Corporate taxCorporate income tax (CIT) is levied on business profits by federal and state governments. Many businesses are taxed as pass-through businesses and their income is reported under personal income tax, so they are not subject to the CIT.
At first glance, supporters of the OECD's global tax treaty might look at this development and declare that the battle against tax havens has been won. However, the economic impact of this proposal could impact a large economy far beyond Bermuda's borders.
Changes in Bermuda's tax structure: Preliminary victory for the OECD
Central to the OECD's efforts is to curb tax avoidance through tax havens and protect countries from revenue losses caused by low-tax (or, in the case of Bermuda, tax-free) jurisdictions. Bermuda's decision to introduce a corporate tax marks the initial success of the OECD's envisioned goal of ensuring a minimum tax rate on income worldwide.
However, Bermuda's corporate tax is likely to change investment flows, corporate structures and economic trends.
Bermuda will lose its tax benefits and suffer from the investment diversion effects of Pillar 2. Even if a corporate tax could raise some revenue, the impact of the proposal would also be felt on the island. Companies facing this 0 percent to 15 percent tax increase may reevaluate their global tax strategies and shift income off-island. This does not necessarily mean that Bermuda will be the winner of Pillar 2.
However, Bermuda's decision to introduce a corporation tax is pragmatic and largely stems from concerns about 'top-up' taxes. If Bermuda's effective corporate tax rate is below 15 per cent, other countries may also impose these taxes by applying Pillar 2 rules to income earned within their borders. Bermuda's choice in this scenario seems straightforward. Either tax your corporate income or risk losing your income to other jurisdictions. This was the exact trade-off that Pillar 2 planners hoped to achieve for Bermuda and other tax havens as well.
A win for the OECD, but a loss for member countries?
But what initially appeared to be a success story for the OECD may have less-discussed consequences, which could perhaps have the greatest impact on member countries. This is primarily due to spillover effects on global investment trends.
Over the past few decades, complex financial networks between tax havens and high-tax countries have developed. On the other hand, offshore financial centers like Bermuda are often used to transfer funds from high-tax jurisdictions to lower-tax jurisdictions. profit transferProfit shifting is when multinational companies reduce their tax burden by moving profits from high-tax countries to low-tax jurisdictions or tax havens.
The OECD is trying to tackle that.
On the other hand, these profits are typically reinvested in higher tax jurisdictions, creating jobs and economic growth. Without these financial centers, companies would have less capital available to invest and foreign direct investment (FDI) flows would be affected.
First, the amount of FDI stock is considerable. UNCTAD estimates that the “value of the FDI stock at risk” in these offshore financial centers ranges from $4 trillion to $12 trillion. ”
Second, changes in FDI flows can also affect other countries. UNCTAD predicts that FDI stocks from these offshore financial centers will be largely withdrawn, disrupting FDI flows. In fact, researchers have found that multinational corporations use affiliates in tax havens to reallocate. taxable incomeTaxable income is the amount of income after deductions and deductions have been subtracted from income. For both individuals and corporations, taxable income is different from and lower than gross income.
This means that moving away from high-tax jurisdictions and having access to tax havens will encourage economic activity in non-haven countries. In other words, countries with high inward FDI inflows, such as France, Germany and the United States, partially benefit from tax havens and are likely to see a decline in FDI as a result of Pillar 2 implementation by other jurisdictions. be.
For example, imagine a French company using an offshore financial center (in this case Bermuda) to optimize the taxation of its profits. They then return to France, which has a higher tax jurisdiction, and reinvest. If Bermuda decides to impose corporate tax, the French company's profits from Bermuda will be reduced due to the tax. This time, if French companies want to return to France and reinvest some of their profits, they will have less money to do so. They may choose not to reinvest because there is not enough profit, or they may simply decide to invest somewhere with a lower tax burden than France. After all, the French economy will be negatively affected.
This impact occurred when the United States shut down several tax strategies that U.S. companies had deployed through Puerto Rico. Taxes on activities in Puerto Rico increased, causing businesses to cut investment and jobs.
So who wins in the end?
The OECD's objective to reduce profit shifting is clear and appears to be successful in encouraging low-tax countries to adopt policies in line with the project. But the impact of Pillar 2 goes far beyond the borders of any particular country.
As the implementation of global tax agreements evolves, policymakers will need to continually assess whether their policies are consistent with sound tax principles. What may seem like a win in global tax negotiations can have negative consequences when viewed from a broader perspective.
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