Corporate Tax

Globe editorial staff: “Ctrl-Alt-Del” on the world’s largest corporate earnings tax loophole

In early June, ahead of the G7 heads of state and government meeting last weekend, the G7 finance ministers came together and reached a groundbreaking deal on corporate taxation in the digital age.

The G7 chief financial officers, including Chrystia Freeland, said they would “strongly support” the continuation of the work “to address the tax challenges posed by globalization and digitization of the economy and to introduce a global minimum tax”. The summit of the G7 heads of state and government affirmed the confirmation: “We need a tax system that is fair worldwide.”

The steps that the G7 countries are committed to taking could have a major impact on the future of corporate taxation. They aim to reduce the ability of multinational corporations to use legal and accounting techniques to lower tax burdens by shifting profits and expenses out of countries like Canada.

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Two years ago, more than 100 countries agreed on a roadmap for this reform within the Organization for Economic Co-operation and Development. The G7 announcement is the next step. The plan has two pillars.

The first pillar aims to tax companies in the countries where they actually do business and generate income. The focus is on large internet companies.

After a “me-first” pandemic, the G7 leaders are feeling the need for defensive globalism

Before the G7 meeting, countries like France introduced a 3 percent tax on digital services; Canada plans to do the same starting January next year, which is expected to raise $ 3.4 billion over five years. The G7 finance ministers have now agreed to support the replacement of these taxes with “taxation rights” that countries could apply to “the largest and most profitable multinationals” that sell products and services within their borders.

The second pillar provides for a worldwide minimum tax rate of 15 percent. That’s a lower rate that applies in every G7 country, so it’s not about raising corporate tax rates domestically. Instead, the use of tax havens by multinational corporations, especially internet giants, is to be eradicated.

When one hears the term “tax haven” one thinks most often of places like the Cayman Islands. But also countries like the Netherlands, Luxembourg, Singapore and Ireland are regularly cut by multinational companies. Accounting exercises, which are easiest for tech companies with limited physical assets, can minimize profits in countries where sales are made and increase profits in other jurisdictions with lower tax rates. It is noteworthy that Amazon has an office in Luxembourg City and Dublin is Google’s European headquarters.

This shuffling of money for tax purposes is what the International Monetary Fund calls “phantom investments”. These now account for up to 40 percent of global foreign direct investment – at least on paper.

The IMF says Luxembourg is home to more than $ 4 trillion in FDI, with just 600,000 residents, or roughly the population of London, Ontario. That is more than in China and as much as in the United States. How can that be?

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This is possible because most of these Luxembourg investments are only real in legal and accounting terms. Trillions of dollars have not been invested in factories, shops, and jobs in a tiny country.

The tax money at stake is considerable. The OECD cited its 2019 study suggesting that implementing the two pillars could recoup lost corporate taxes of up to $ 240 billion a year. The IMF also suspected in 2019 that the figure could be up to $ 600 billion.

While the G7 has now advocated a way forward and confirmed years of work, much remains to be done. Attention is drawn to a meeting of G20 finance ministers in Venice in early July, where the debate will be difficult. And while US Treasury Secretary Janet Yellen was instrumental in driving things forward, US Congress approval is far from certain. As for the European Union, while its largest Member States are on board, low-tax Ireland is not.

While reaching a final agreement will not be easy and could take months or years, it is remarkable that the G7 was able to agree on basic principles. Even Facebook and Google are publicly backing the process, with Facebook recognizing that its tax bill could go up.

A century ago, rules for the taxation of cross-border companies were first agreed by the League of Nations. Times are changing. To level the playing field, it’s time to write some new rules.

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