A A decade ago there was a series of corporate tax scandals when we all learned that large corporations often pay little tax. Amazon, Google and Starbucks were dragged before parliament to explain why their tax bills were so low. What was really shocking wasn’t the way they broke the law, but the fact that they hadn’t. The global corporate tax system was incredibly leaky. International agreements on the avoidance of double taxation have and indeed lead to a double non-taxation of corporate profits.
Large corporations routinely avoid paying their fair share of taxes by “shifting” their profits to low-tax countries. This has resulted in a dramatic decline in corporate government tax revenues. In addition, profit-shifting gives multinationals a big advantage over smaller ones: instead of competing for better service, they can simply keep costs down by paying less tax. How is your local coffee shop, which pays the 19% corporate tax rate on its profits, going to compete with Starbucks, which pay minimal taxes despite big sales?
This problem wasn’t new ten years ago, but it could be resolved soon. Chancellor Rishi Sunak breathlessly announced a “historic deal” on corporate taxation after a meeting of G7 finance ministers in London last week. The deal consists of two parts. First, a minimum tax on worldwide profits at a rate of “at least 15%”. The US desperately wants this to fund the Biden government’s spending plans. In return, the US is willing to distribute a small part of the profits of large companies to other countries in which they operate. The details have yet to be ironed out, but the idea is that companies like Amazon should pay taxes where their customers are.
Many have described the deal as a return to multilateralism after four years of Trump’s isolationist presidency. That may be partly true. Part of the urge to go along with the G7 deal is that China is not represented and the US was keen to isolate China economically. But agreement was reached less through global cooperation than through tough threats and negotiations.
In 2013, shortly after those scandals a decade ago, the OECD group of affluent countries launched a snoring-inducing review called “Base Erosion and Profit Shifting” (or BEPS for those in the know). The idea was to create a new international agreement that would end the “race to the bottom” in corporate tax. He didn’t succeed.
Instead, the current agreement was reached as countries began to go alone and introduce digital taxes on some of the tech giants. These companies are based in the United States, and the Biden government made no secret of their dissatisfaction with these taxes and the threat of tariffs in retaliation. The agreement announced at the G7 includes an agreement that countries will abolish such digital taxes.
So will the new system work? As always with tax issues, it’s complicated. There are problems for both “pillars” of the deal – the minimum rate and the revenue sharing.
First, the minimum tax rate. The US proposal was initially at 21% but was quickly lowered to 15%. In Europe, France, among others, is pushing for a higher rate. Britain should join this push. Sunak put on a big show in March with a planned increase in corporate tax to 25% by 2023. If companies have the option of paying 25% on profits posted in the UK or 15% on profits posted elsewhere, is clear what they prefer.
The details of how the minimum rate works are also critical. While tax rates are relatively straightforward to understand, defining profit can be devilishly complex. Different countries have their own rules as to whether and how, for example, investing in a new factory will reduce a company’s taxable profits. Clarity and consistency will be the difficult thing in order for profit to be measured the same everywhere but not attract the same amount of attention.
Second, the definition of which companies are covered under the Revenue Sharing Agreement may omit some of the companies that inspired this whole thing. The current proposal requires companies, among other things, to achieve a profit margin of over 10%. Amazon would fail this test. There is discussion of how to fix this, including treating Amazon Web Services – which is very profitable – separate from the rest of Amazon, but it reiterates that details are important. And no matter what arrangement is made, we should expect companies to react in the way that suits them: They will continue to “comply with all local laws and regulations in the countries where” [they] Operate, ”as Microsoft recently put it, but that doesn’t mean they want to pay more taxes.
When this deal comes off, there will be losers and winners. The tax havens that have relied on “professional services” for companies based there for so long will lose: Bermuda and the Channel Islands will appear significantly less attractive to companies when their low tax rates are no longer available. The deal isn’t good for poorer countries either, which are unlikely to receive a lot of tax from a revenue-sharing agreement based on where the sales are made.
What about the UK? While we will earn a small fraction of the profits from tech companies, it is likely that this will be less than we would have received from those companies under a digital services tax. The other parts of the deal – the minimum tax and the potential to include more companies in the tax sharing agreement than covered by the digital tax – mean that the overall effect is likely to still be higher tax revenues. The recently launched EU Tax Observatory cleaned up the numbers for EU countries, and a look at similarly sized economies – France and Germany – suggests the UK is around $ 2.5-5 billion.
Still, the deal is important to the UK. Although the money raised is small compared to total tax revenues of more than £ 700 billion, the minimum tax – if it can work – will start to level the playing field between large and small businesses. Just as low tax rates will make tax havens less competitive, it will be more difficult for large companies to compete with less taxes and undercut local competition. This is an important goal and the UK should wholeheartedly support it.