July 2, 2021
FOUR WEEKS ago the finance ministers of the G7 countries trumpeted in London that they had sealed a “historic” and “global” deal to reform the taxation of multinational corporations and thus curb tax avoidance. In fact, this was just the preliminary stage to an agreement reached on July 1st after lengthy virtual negotiations with 130 jurisdictions. Although the talks were held under the auspices of the OECD, a business club consisting mainly of rich countries, rich and poor have agreed to the agreement.
Officials signed a five-page statement with two main elements: a new minimum tax rate on the profits of multinational corporations; and a redistribution of the right to tax the largest, away from where they register their assets and towards where they do their sales. In return for these new tax laws, governments would neglect some unilateral measures, particularly taxes on giant tech companies. It is a remarkable achievement to get so many countries to agree on such a sensitive subject. However, much remains to be done before the future of corporate taxation is settled.
For years negotiators have tried to bridge the gap between the places where multinational corporations do business and where they make profits. With the digitalization of the global economy, the gap has widened – for example, companies have registered intangible assets in tax havens and posted profits there. A study published by the IMF in 2018 found that lowering a country’s corporate tax rate by one percentage point increased its reported profit before tax by 1.5%. The effect has increased over time. In the hunt for these fleeting profits, tax rates were lowered.
Governments have had enough now. The proposed minimum tax of at least 15% would reduce the incentives for companies to play the system by reducing the profits from siphoning off profits in havens. The redistribution of taxation rights should also reduce the power of companies to play with their tax base. The location of customers is more difficult to manipulate than that of intangible assets such as brands or algorithms.
The deal is structured to affect more companies over time. Initially, the redistribution of taxation rights will apply to those with global sales in excess of 20 billion euros (24 billion US dollars). But if all goes well, this threshold could drop to 10 billion euros. To counter the common complaint that digital companies can make profits somewhere without registering the physical presence often required for their taxation, governments can levy taxes when local revenues only exceed EUR 1 million. In small, poor countries with a GDP of less than 40 billion euros, the threshold will only be 250,000 euros.
The approval was not entirely general. Of the 139 jurisdictions participating in the online negotiations, nine have withdrawn, including Ireland, Hungary and Estonia, as well as Barbados and St. Vincent and the Grenadines. Their resistance is hardly surprising. All of these low-tax locations lose both a competitive advantage and tax revenue. More notably, ports like Bermuda, the Cayman Islands, and Jersey have signed up.
Other hold-outs are Nigeria and Kenya. According to one interviewee, there is concern that the redistribution of taxation rights will cost revenue if one takes into account the elimination of unilateral measures. Pascal Saint-Amans from the OECD is sad about her decision. “We ran through the numbers and considering both pillars would certainly benefit these countries,” he says. On July 1, the African Tax Administration Forum, a club of the continent’s tax officials, issued a statement that “if the process is to lead to a just result, it will be important that developed countries not exert political pressure on developing countries” .
After reaching a high-level agreement, the negotiators agreed a deadline of October to settle important details. Some countries are pushing for a minimum tax rate of 15%; others want the ground to be higher. The assessment basis of the profits subject to minimum taxation, the exact amount of the taxation rights to be converted and the exact scope of the measures to be withdrawn unilaterally must also be clarified.
According to this, the governments have to work out an international agreement on the redistribution of taxation rights in 2022, which is to be implemented in 2023. The agreement also stipulates that minimum taxes will be required by law in 2022 and implemented in 2023, although countries could do so without entering into a treaty. The agreement is a big step forward. But there is still a lot of hard work ahead of us.