Everyone loves accounting, right? You have debits and credits that change the balance of assets, liabilities, and equity on the balance sheet and report cash flows and accrued expenses on the income statement. The rules are complex. To make matters worse, accounting rules for taxation are different from those for financial accounting used to generate reports for shareholders.
Well, if this exciting introduction isn’t enough to get you excited to read the rest of this blog, maybe learn about a new accounting method included in model rules because the global minimum tax will pique your interest.
A simple comparison of the results of the tax calculations, the financial accounting methods and the overall minimum tax shows that the results of the effective tax rate are quite different under the different approaches.
Businesses calculate their tax liability according to tax rules established by Congress, and this determines the amount of taxes the business pays each year to the Internal Revenue Service (IRS). Next, companies use financial accounting rules (also known as generally accepted accounting principles or GAAP) to present their assets, liabilities, shareholders’ equity and net income (and taxes) to their shareholders.
Since financial accounting rules require companies to report financial effects when they occur, not just when they are paid, and different types of income and expenses are accounted for in both systems, the burden of Tax reported in the financial statements will be different from the tax expense paid to the IRS.
Often, these differences arise because tax rules allow businesses to deduct capital expenditures more quickly than accounting rules allow. These temporary differences create deferred tax assets and liabilities in the financial statements.
Usually, over time, the taxes reported to the IRS are roughly equal to the taxes reported to shareholders.
Currently, the US federal corporate tax rate is 21%. If you include an average of state-level corporate tax rates, the total rate is closer to 26%, applying for both tax and financial accounting purposes.
Deductions for expenses (such as the purchase of new equipment) reduce income and therefore tax payable. For example, an expense of $100 will reduce income by $100 and thus reduce a company’s tax liability by $26 at a corporate tax rate of 26%.
The higher the tax rate, the greater the tax savings on a given expense. The lower the tax rate, the less the deduction will be of value.
This is where the Global Minimum Tax Model rules come in. Although businesses calculate their tax and accounting income using the tax rate applicable in the appropriate country, the minimum tax rules use by 15%. (It is unclear why the national corporate tax rate was not used instead.)
This means that a company that has income and deductions could have an effective tax rate of 15% under the minimum tax rules, even if it faces a higher corporate tax rate in the country. where she operates. Any expenses that the minimum tax rules do not allow to be deducted or any tax credits that a company may be eligible for will push the company below the 15% rate and potentially trigger additional tax.
A $100 expense that could reduce taxes by $26 based on the combined statutory tax rate would only reduce taxes by $15 following the overall minimum tax calculations.
For example, suppose a company buys a new machine for $1,500. US tax rules allow the entire amount to be deducted when purchasing the machine, creating a $1,500 deduction. This generates a tax saving of $390 at a corporate tax rate of 26%.
Accounting rules require that deductions for this machine be spread equally over the three years the machine can be used. Equal deductions of $500 over three years reduce tax payable by creating tax savings of $130 each year as the business recognizes its costs. During these three years, however, $390 in total tax liability reduction will be achieved.
This is purely a timing difference between tax rules and accounting rules regarding when a business can claim a deduction for the purchase of the $1,500 machine.
The global minimum tax rules would turn those $500 deductions into tax savings of only $75 due to the 15% lower tax rate. A total of $225 in tax savings is realized.
|Tax value of deductions for $1,500 equipment that lasts 3 years|
|Year 1||Year 2||Year 3||Total|
|Overall minimum tax value||$75||$75||$75||$225|
Source: Author’s calculations.
The implications of this can be further explored by studying a company’s effective tax rate if the company both benefits from the $1,500 machine expense deduction and is eligible for certain tax credits. ‘tax.
If the company earns $2,000 in revenue in the same year it buys the machine at $1,500, it will get $1,500 in tax deductions and $500 in deductions for both accounting and tax purposes. overall minimum tax. Deductible expenses for equipment are also referred to as “depreciation expenses” as shown in Table 2.
Let’s say the company also gets $30 in research and development tax credits. After accounting for the tax credits, the business will owe the IRS $100 and will have an effective tax rate of 20%.
Since accounting rules only allow a deduction of $500, the business will show a higher tax liability ($360) and effective tax rate (24%) in its financial statements.
The global minimum tax rules present a rather different picture. Even though the company has an effective tax rate of 20% based on what it owes to the IRS and 24% based on accounting rules, the effective tax rate under the l overall minimum tax is 13%.
|Calculation of taxes||Accounting calculation||Calculation of the global minimum tax|
|Income before tax (Income – Depreciation expense)||$500||$1,500||$1,500|
|Tax before credits (tax rate x income before tax)||$130||$390||$225|
|Tax responsibility (tax before credits – tax credits)||$100||$360||$195|
|Effective tax rate (tax liability/pre-tax income)||20.0%||24.0%||13.0%|
Source: Author’s calculations.
The 13% tax rate could be a problem for this company. This may mean that the company will have to pay additional taxes either to the US government or to a foreign government. There are other complex rules that will impact the true top-up tax rate, but for now it is important to see how the tax rate can be less than 15% for minimum tax purposes global.
Using the 15% rate reduces the value of deductions for investing in machinery to the point of rendering the $30 tax credits essentially worthless to the business.
Similar examples would show how this impacts loss deductions and credits like the Research and Development Credit or the Work Opportunity Tax Credit.
Even though the business would benefit from certain tax credits when filing taxes with the IRS, the overall minimum tax will make those credits much less valuable and expose the business to minimum tax.
This will make many U.S. tax credits less effective at a time when policymakers are otherwise supporting business activities that would make them eligible for tax credits for research and development or clean energy investments.
Not all deductions are treated equally under minimum tax rules. In some cases, an allowable deduction for normal tax and accounting purposes will be disallowed when calculating minimum tax. An example is deductions for things (like a long-term lease) that take more than five years to fully pay off.
An important insight from this exercise is that the company risks paying the overall minimum tax even if it pays more than the 15% rate to the IRS or declares a high tax rate to its shareholders.
One way to correct this distortion would be to allow businesses to use the global minimum tax rules but apply the same tax rate used for tax and accounting calculations. Further nuances with the overall minimum tax will likely result in a slightly different final corporate tax rate, but the distinction will likely be less.
As policymakers around the world work to implement the Global Minimum Tax, it’s important to understand these results and the potential for a business to pay taxes twice – once under the normal rules and once under global minimum tax rules – even if the company has a high effective tax rate. Double taxation impacts the ability of businesses to invest in valuable things like improving their supply chains, developing new products and hiring workers, and it can be remedied if the minimum tax uses a country’s own tax rate.
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