Historic Global Tax Reform: 136 Countries Reach Sudden Agreement on 'Digital Tax' (Comprehensive)

[Sejong=Asia Economy Reporter Son Sun-hee] A total of 136 countries worldwide, including major advanced nations, have reached a final agreement on the so-called 'digital tax,' which allocates 25% of the excess profits of global companies to the countries where sales occur (market jurisdictions) and applies a global minimum tax rate of 15%. This is regarded as a 'global tax reform' achieved after four years of intense multilateral negotiations.

The Organization for Economic Cooperation and Development (OECD) and the G20 Inclusive Framework (IF) held the 13th plenary meeting on the 8th (local time) and adopted the final agreement, the Ministry of Economy and Finance reported. The digital tax is expected to be fully implemented starting in 2023.

Among the 140 countries participating in the discussions on key issues that were unresolved at the July plenary meeting, 136 countries reached a consensus. The four countries that did not participate in the agreement are Kenya, Nigeria, Pakistan, and Sri Lanka.

The so-called 'digital tax,' which allocates taxing rights to market jurisdictions for global companies, was finally agreed upon at 25% (Pillar 1). It targets multinational corporations with consolidated annual sales exceeding 27 trillion KRW (20 billion euros) and operating profits exceeding 10%. Advanced countries with large global companies, including South Korea, had supported a relatively low rate of 20%, while many other countries receiving taxing rights had supported a higher rate of 30%, and this agreement represents a compromise between these positions. In South Korea, companies such as Samsung Electronics and SK Hynix are expected to be subject to this tax.

However, in cases of related disputes, 'selective application' will be allowed for developing countries with low dispute response capabilities. This is intended to accommodate countries with limited experience and capacity in dispute resolution. Whether a country qualifies for this will be periodically reviewed.

Once this system is implemented, existing digital services taxes and similar levies will be abolished. Additionally, between the date of the agreement and the effective date of the multilateral agreement (before December 31, 2023), no new digital services taxes or similar levies will be imposed.

The global minimum tax rate was finalized at 15%. This aims to prevent global companies from engaging in 'tax avoidance' by applying excessively low corporate tax rates in certain countries. By setting the rate at the lowest level discussed, it was possible to secure the participation of low-tax countries such as Ireland and Hungary, which had opposed the proposal at the July plenary meeting.

If a global company shifts income abroad so that the ultimate parent company is subject to low taxation or if the parent company's jurisdiction does not introduce income inclusion rules, the 'income inclusion rule' will apply, allowing other countries to exercise taxing rights instead. Unlike other elements of the digital tax, this rule will take effect starting in 2024, with a one-year delay. However, it will be exempted for five years for multinational companies in the early stages of overseas expansion. This applies to companies with tangible assets abroad of 50 million euros or less and operating in five or fewer other jurisdictions. This is intended to alleviate concerns about a sudden increase in tax burdens due to overseas expansion.

If a parent company applies a nominal tax rate lower than a certain threshold on payments such as interest and royalties to a foreign related party located in a low-tax jurisdiction, an additional 9% taxing right will be granted to the source country.

The agreed Pillar 1 and Pillar 2 digital tax proposals will be reported at the upcoming G20 Finance Ministers' meeting in Washington next week and are expected to be endorsed at the G20 Summit at the end of this month. After finalizing technical details by early next year, the necessary institutionalization processes will be undertaken in each country, with enforcement and implementation scheduled to begin in 2023.

The Ministry of Economy and Finance evaluated the agreement, stating, "After four years of intense multilateral negotiations, the framework for historic global tax reform has been finalized." It added, "Through Pillar 1, by reallocating taxing rights to market jurisdictions, it has become possible to secure taxing rights over large digital companies that generate sales in our country but have not been sufficiently taxed until now." Furthermore, it said, "With the introduction of Pillar 2's global minimum tax, it is expected to prevent reckless tax competition among countries and block various forms of tax avoidance by multinational corporations."