The global tax deal that the G-7 reached over the weekend is not like an emergency brake that brings a runaway train to a standstill. The impact will be small for most businesses and will not be felt for some time.
But the two proposals – a system that taxes businesses based on their location and a minimum corporate tax rate of 15% – may ultimately make it difficult for multinationals to move their revenues to tax havens and reduce their tax burdens.
However, the immediate impact will not be significant given the relatively low 15% rate and the many details yet to be clarified. Still, a move away from a global tax regime that attracts countries in a race to the bottom for businesses could lead to higher corporate taxes overall.
Higher corporate taxes, in turn, usually drag the markets down because they eat up corporate profits. However, to know how much investors should understand the global package, Treasury Secretary Janet Yellen and her counterparts in Canada, France, Germany, Italy, Japan and the UK have approved of 137 countries supported by the Organization for Economic Co-operation and Development (OECD ) were convened.
Jefferies strategist Sean Darby breaks the G-7 deal:
“First, multinational corporations will pay a minimum global corporate tax rate of at least 15% in every country they operate from,” he wrote. “Second… taxes would be levied on any global company with a profit margin of at least 10%. Thereafter, 20% of any excess profit would be allocated and taxed in the countries in which they operate. “
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To be clear, the G-7 proposals are international agreements that represent a huge step forward in the way countries approach the taxation of multinational corporations. But nations have their own tax laws that will take years to draft, negotiate, and pass – and which could be very different from what the G7 proposes. For example, Republicans in the US are currently opposed to corporate tax increases.
The x-factor of every country that has to pass its own laws to implement the G-7 agreement explains why last weekend’s proposals will not have an immediate impact. Then combine that with the minimum tax rate of 15% which is just not that high.
Earlier this year, Goldman Sachs’ David Kostin calculated that a minimum rate of 15% would add $ 1 to earnings per share for the S&P 500 in 2022. That’s not much compared to other corporate tax hikes currently being considered by Democratic politicians in Washington.
Today the corporate tax rate in the US is 21%, up from 35% in 2017 by a Republican-led Congress. A rise in the statutory corporate tax rate from 21% to 28% – halfway between the current rate and the pre-2018 rate – would reduce the index’s forecast earnings of $ 203 per share by $ 8 next year. And two other proposals from the Biden government, doubling global low intangible tax income to 21% and adding social security wage taxes, could each devour $ 5 of S&P 500 profit in 2022 if implemented according to Kostin’s math.
But a global deal on a 15% minimum would have wider implications than deducting just a dollar from S&P 500 profits – if it would leave international scramble and encourage countries to raise corporate tax rates across the board, two believe Analysts from Gavekal Research.
“By overcoming long-standing prejudices about national tax sovereignty in favor of supranational cooperation, the agreement reduces international tax competition,” write Yanmei Xie and Udith Sikand. “In the long term, this should only lead to higher effective corporate tax rates.”
Companies with significant income from intangible assets will be hardest hit by the G7 proposals. According to Darby at Jefferies, these are particularly large internet and pharmaceutical companies.
For a company that like digital services
(Ticker: FB) or Google parent Alphabet (GEL) to register a corporate office in a low-tax country like Ireland and shift its overseas profits there, as there is relatively little physical presence in the countries where it generates revenue.
Ditto for a pharmaceutical company that registers its patents in one country but sells drugs worldwide. This is in contrast to a manufacturing company that employs workers in a factory and sells physical goods there, which such a tax avoidance maneuver cannot pull off.
Goldman Sachs’s Kostin examined S&P 500 companies that generate at least 50% of their income outside the US and have an effective foreign tax rate of less than 15%, which found 30 names, the vast majority of which are in the tech or healthcare industries .
Take semiconductor designers, for example
(NVDA). According to Kostin estimates, the company generates 67% of its income from abroad and pays an effective tax rate of 4% on these profits. Nvidia’s total effective tax rate for the past fiscal year was 1.7%, according to the company, while its net profit margin was 26%. It paid $ 77 million in taxes on net income of more than $ 4.3 billion.
“Our effective tax rate for fiscal years 2021 and 2020 was lower than the US federal statutory tax rate of 21%, largely due to income generated in jurisdictions including the British Virgin Islands, Israel and Hong Kong, where the tax rate was lower than statutory US federal tax rate, recognition of US federal research tax credits, and excessive tax breaks associated with stock-based compensation, ”wrote Nvidia in its latest annual report.
Nvidia’s tax burden would rise under the G7’s proposals, allowing countries to levy higher rates on the company on businesses within their borders, regardless of which foreign entity those profits are ultimately passed on to.
The screen also includes tech heavyweights
Electronic Art (EA),
(EBAY), plus payment giant
(V). Pharmaceutical giant
(AMGN) and medical device manufacturer
(EW) and Stryker (SYK) also make the list.
Investors are unlikely to lose their stocks due to recent G-7 moves. But these could only be a precursor to future corporate tax penalties.
Write to Nicholas Jasinski at Nicholas.Jasinski@barrons.com