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Time to pay? Fundamental reforms to global tax rules

The story so far

On 31 October, G20 leaders publicly backed reforms that will profoundly change the way multinational corporations are taxed. The reforms will effectively bring an end to a century-long consensus that companies should be taxed where they are based and instead see (some) taxing rights handed to authorities in countries where sales are made. With the introduction of a new 15 percent minimum global tax rate for the world’s largest multinationals, the changes will also overturn the established view that unconstrained tax competition is a sensible way for countries to compete for investment from mobile global companies.

The agreement endorsed by G20 leaders and developed under the auspices of the OECD/G20 Inclusive Framework of 140 countries aims to tackle two distinct but related problems with the existing rules. The first is to address a perceived ‘race to the bottom’ on corporate tax rates that has seen them decline from an OECD average of over 40 percent in the mid-1980s to a little over 10 percent today. The second is to address what the OECD terms the ‘tax challenges arising from digitalisation’: essentially the way companies, particularly those in the tech sector, often pay little tax in countries where they make significant sales but have little or no physical presence.

This is the logic for a deal. But history tells us that successful global tax negotiations require one essential ingredient: the support of the US government. Under the Trump presidency, talks went backwards. Joe Biden’s election has unlocked progress over the last six months as his administration sought to translate a domestic agenda raising taxes on large corporates to the international stage. The basis of a deal was reached by the G7 in June and now has the backing of countries that account for over 90 percent of global GDP, including all G20, OECD and EU countries.

The implications for governments and business

The agreement in its current form will raise an additional $150 billion a year, a transfer from large multinationals to government coffers around the world. This comes almost entirely from the imposition of a new 15 percent minimum global tax rate.

When the agreement is eventually implemented, the winners and losers will vary from country to country and company to company. Unsurprisingly a deal cooked up by the largest Western economies sees them benefit the most in revenue terms. Developing countries gain relatively little, a point the G24 of emerging economies has said makes it unsustainable and exemplified by how Sri Lanka, Nigeria, Kenya and Pakistan ultimately refused to sign up. Smaller economies with low or no corporate tax rates are relative losers. This includes traditional tax havens in the Caribbean and elsewhere, but also EU countries like Ireland and Hungary where low corporate tax rates are a core plank of their economic strategy and who eventually signed up only under pressure from the US and other EU member states.

For companies, size matters. The hundred or so largest multinational companies will be caught by new rules requiring them to pay tax on annual profits above ten percent in jurisdictions where they make sales. Extractives and regulated financial services are excluded. Only companies with revenues above €750 million will be affected by the 15 percent minimum global tax rate.  What originally began as a process to get big tech companies to pay more tax has broadened out and now has the potential to affect any large company, including those operating in the pharmaceutical, traditional media and automotive industries.

Much of the detail, however, is still to be worked out and could have a significant impact on the final outcomes for governments and companies. How, exactly, will profits be allocated between different countries? How will the new regime ensure there is no double taxation? Who will benefit from agreed (but as-yet-undefined) carve-outs for investment and manufacturing? What exactly are ‘regulated financial services’? These questions remain unresolved.

Will a global deal clear Congress?

The current deal may yet prove meaningless without domestic sign off from the US, something that is far from assured. Many US legislators on both sides of the political divide dislike the idea that the US is ceding taxing rights over US companies to other countries. In spite of his majority in Congress, a fractious political environment in Washington and strong Republican opposition to the global agreement means the legislative path is a difficult one. This is the biggest obstacle to the deal actually being implemented. 

US Treasury Secretary Janet Yellen has already said she will look at innovative ways to implement the deal, without treaty changes that would require a two-thirds majority in the Senate that the Democrats do not have. Whether this can be done is the subject of debate among legislative experts in the US and we likely won’t know the answer until some point next year when the details of the global agreement have been settled.

An end to digital taxes?

Much of the impetus for the US to join a deal stems from its desire to prevent a further proliferation in unilateral digital taxes. Over recent years countries including France, the UK, India, Italy and Spain have all introduced national digital taxes aimed primarily at large US tech companies.

The G20-backed agreement says that these taxes must be removed when the deal comes into force and prevents signatories from implementing new ones in the meantime. A side agreement reached in October between the US and European countries that have already introduced national digital taxes sets the terms for the removal of these national digital taxes in exchange for the US lifting the threat of retaliatory trade sanctions.

However, jurisdictions are already looking at workarounds while technical discussions on exactly what constitutes a ‘digital tax’ continue. These conversations include the EU, which agreed to delay publication of plans for an EU-wide digital levy in the summer, but is expected to bring forward proposals in the coming months (having already banked the revenues as EU own resources in last year’s EU budget negotiations). The recent Autumn Budget also saw the HM Treasury quietly announce its intention to consult on options for a new online sales tax that may well cut across the spirit if not the letter of the global deal.

The road ahead

The OECD/G20 Inclusive Framework has committed to legislate the agreement and bring it into effect by the end of 2023. To do so will require two multinational conventions that will override bilateral tax treaties and ensure the rules are implemented in a consistent way. It will also require relevant changes to domestic law with nothing guaranteed until the US has the necessary legislation in place. The EU is expected to bring forward two directives to implement the deal; there are growing concerns that this may ‘goldplate’ the global deal with additional requirements.

This is an ambitious timetable with so much of the technical (and still highly political) detail still to settle. The risk for business is that loose commitments to ‘progress in consultation with stakeholders’ translate into little meaningful engagement on rules that will have a major impact on many businesses across different sectors.

Keeping up-to-date and ready to engage will be key for those affected, and will pay dividends over the long-term on what is likely to be a once-in-a-generation reform to the global tax architecture.

Author

Ed Odell, Director leads Flint’s work on Tax policy. Before joining Flint, Ed spent eight years at HM Treasury advising ministers on a range of domestic and international policy issues. Ed worked extensively on personal and business tax issues, oversaw government expenditure on international development and led on major reforms to the UK’s pensions and savings landscape.

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