What’s the real impact?
The G-7 finance ministers on 5 June issued a statement in support of a 15% global minimum tax imposed on a country-by-country basis, and expressed a commitment to reaching “an equitable solution” on the allocation of taxing rights among jurisdictions.
Pillars One and Two
The ministers endorsed the efforts being led by the G-20/OECD Inclusive Framework to address the tax challenges arising from globalisation and the digitalisation of the economy and to adopt a global minimum tax. The OECD’s initiative centres around a two-pronged proposal issued in late 2019.
Pillar One of the OECD blueprint would revamp tax allocation rules so that a portion of a multinational entity’s residual profit would be taxed in the market jurisdictions where the revenues of the multinational are derived. Broadly, this would allow countries where a digital business’s users are located to tax up to 20% of the profits that exceed a 10% margin of the largest and most profitable multinational enterprises. This reallocation would be calculated using a formula rather than the arm’s length standard.
Pillar Two focuses on the implementation of a global minimum tax that the G-7 finance ministers suggest should be at least 15%. Under this proposal, all participating countries would ensure that businesses with headquarters in their jurisdictions pay at least 15% corporation tax on all domestic profits, and pay a top-up tax on the profits of their foreign subsidiaries taxed locally at less than 15%. Companies with affiliates located in low-tax jurisdictions that do not participate in Pillar Two would lose the benefit of that low tax because they would have to pay the top-up tax in their home countries, which would remove the advantage of shifting profits to those low-tax jurisdictions.
In addition to supporting both Pillars One and Two of the OECD plan, the G-7 ministers backed the goal of reaching agreement on both pillars in tandem. The ministers also vowed to provide international coordination to apply the proposed international tax rules and repeal the various digital services taxes that have proliferated in recent years (see BDO’s interactive map).
While this announcement is a major vote of confidence in the OECD’s plans, it leaves many details—both technical and policy-related--unresolved. A discussion of the major hurdles that must be overcome before global agreement is reached follows.
Is the right amount of profit reattributed?
Under the G-7 proposal, the amount of profit to reallocate seems relatively modest. For example, if a multinational entity achieves a net margin of 15% (high by global standards) then reallocation of 20% of the excess over a 10% margin leaves an amount equivalent to just 1% of its global revenues to be reallocated, or about 6.7% of its global profits. Small and developing nations may make a case that a higher quantum of profits should be reallocated (whether through a lowering of either of the two global thresholds at which the rules apply or an increase in the amount of the residual profit that is subject to reallocation). It is possible that the reallocation figures proposed by the G-7 finance ministers may be adjusted during the negotiations, or over time after the new rules come into force.
Should there be a 10% margin threshold?
Another challenge posed by the current proposal is that some major international digital businesses operate on low margins (well below 10%) and would therefore fall outside the scope of the Pillar One reallocation rules. Some countries have already stated that an agreement that leaves businesses like Amazon outside the scope of the rules would not be acceptable.
There has been significant pushback on bespoke segmentation of financials to carve out business lines by type, and therefore the 10% profit margin is seen as an initial position designed to ease administration. However, to resolve the tension created by the possibility that large technology businesses may be out of scope, a potential subject of discussion during negotiations is the use of financial statement-based segmentation for multinational groups that have business lines with varying levels of profitability. It would be rather ironic if such an approach does come to the fore again, given that the size and profit criteria put forward in the original OECD proposals were intended to make the question of scope more objective.
The U.S. has floated a proposal that would use revenue and profitability measures to limit the number of companies subject to the reallocation rules to approximately the largest 100 global multinational enterprises, but restricting the scope of the rules in that manner may not be acceptable to smaller members of the OECD Inclusive Framework.
What sectors should be in scope?
Some countries have already called for exclusion from the rules for favoured industry sectors; for example, the UK and several EU countries have suggested that financial services businesses should be excluded. As negotiations continue, other nations may try to support their favoured sectors in a similar manner. The arguments in favour of exclusion vary by sector and may be open to challenge, but this issue illustrates the sort of negotiating tactic the OECD will have to navigate to reach an agreement that all 139 Inclusive Framework member states can support.
What should the Pillar Two minimum tax rate be?
A 15% minimum rate of corporation tax cuts across the tax policies of many countries that have engaged in the ‘race to the bottom’ of corporate taxes to attract businesses. Jurisdictions that have benefited from low corporate tax rates are already lining up to oppose a 15% rate. It remains to be seen if such countries can be brought on board.
Can—and should—unilateral measures coexist with these proposals?
The G-7 proposal includes a commitment to help coordinate the rollback of all digital services taxes and other relevant similar measures. But over 60 countries have already enacted some form of digital tax, and the EU has stated that it will move forward to seek the required unanimity from its members to proceed with a new digital levy, even if the OECD successfully agrees a multilateral solution in the form of Pillars One and Two. If the new taxing rights that the G-7 proposals create yield lower tax revenues for these jurisdictions than a domestic digital tax would, it is difficult to see why they would agree to participate in the OECD/G-20 project and revoke their digital taxes. How the OECD seeks to resolve that potential tension remains to be seen, and the possibility of the OECD backing some form of multilateral digital services tax cannot be ruled out.
What do the proposals mean for developing countries?
Even if the G-7 plan is adopted in full, would that really level the tax playing field for smaller and developing countries? While these jurisdictions may receive a fairer share of tax profits derived from their markets, it is likely that most global companies would remain based in major jurisdictions. If the advantage of using low corporate tax rates to lure businesses to a specific country is counteracted by a global minimum tax, major trading nations are likely to switch to non-tax subsidies and incentives to attract global businesses. The Swiss finance ministry has already stated that “Switzerland will take the necessary measures to continue to be a highly attractive business location”. Unless the current WTO rules are tightened considerably, the OECD plan may just convert tax avoidance behaviour into more local subsidy hunting, which may be marginally more transparent, but would it be any fairer globally?
How will the risk of double taxation be mitigated?
The introduction of new taxing rights would create an environment where two or more territories may claim taxing rights over the same income. The OECD Pillar One proposal includes an entire section on the elimination of double taxation, but accomplishing this stated goal may be easier said than done. Should reallocated profit be exempt in the territory in which the profit currently sits, or should the territory from which the profits are reallocated provide a credit for taxes paid elsewhere? The former approach could result in multinational companies paying less tax than they do today under some fact patterns, an outcome that would be a hard sell politically. However, it would be more challenging to ensure that no double taxation arises through the interaction of different tax regimes under the latter approach.
Will the global minimum tax be subject to a global revenue threshold?
Implementation of a global minimum tax would likely pose serious administrability challenges for both taxpayers and tax authorities, which would be exacerbated if all businesses fell within the scope of the minimum tax provisions. Conversely, setting a global revenue threshold that would exclude multinational enterprises with revenue below the threshold could diminish the intended impact of the proposals if only a comparatively small number of large global enterprises ended up being subject to the minimum tax.
Will global revenue thresholds simply be a starting point?
There is an inherent tension in the way the current tax system operates, given its focus on physical presence in a world where physical presence is becoming increasingly irrelevant. Restricting the proposals to only the largest multinational enterprises has no technical grounding; it is simply a function of the need to ensure the system is administrable for taxpayers and tax authorities alike. If consensus is reached and processes are developed around the administration of a new regime, global revenue and/or profit thresholds might decrease over time to bring an increasing number of companies within the scope of the new rules.
What is a realistic time frame?
While achieving high-level political consensus on these international tax issues at the G-7 stage is an important milestone, it is only the first step in a long process. The next stage in the process is the 30 June - 1 July meeting of the OECD’s Inclusive Framework, to be followed by the G-20 finance ministers’ meeting on 9-10 July. If the outlines of a deal can be agreed during the summer, it is possible that the G-20 leaders will be able to confirm a final international tax plan at their 29 October meeting in Rome to present to the Inclusive Framework.
The nature of the two-pillar plan means that domestic legislation would have to be enacted in each individual jurisdiction, and tax treaties would have to be overhauled to implement any agreement reached by the G-20 and the Inclusive Framework. The EU has stated an intent to seek to implement changes amongst member states through Tax Directives. Achieving the necessary changes would be a major task for any government and local political considerations could be a major obstacle for global implementation. For this reason alone, even the most optimistic time frame for implementing any agreement is likely to run into the mid-2020s. In addition, if one or more of the G-7 countries cannot implement it at all, the complexity of the approach and the risk of double taxation would increase.
It seems unlikely that a global agreement on Pillars One and Two can be achieved without some hard political negotiations on the portion of global profit subject to reallocation and the possibility that other digital tax measures may coexist with the new framework.
In theory, it should be easier to reach global agreement on Pillar Two than on Pillar One, with the focus primarily on determining an appropriate minimum rate. However, there is reluctance about detaching Pillar Two from Pillar One; they are seen as going hand in hand, and the G-7 has explicitly stated its intention to continue work on both pillars in parallel. Therefore, unless the pot of global corporate taxes is increased significantly, whether immediately or through a gradual increase in scope over time, the path to final agreement is uncertain. In theory, the proposals should ensure that far less global profit goes untaxed (or is subject to low tax); whether enough is recouped globally (and perhaps more importantly by each country) to keep all participating countries on board with the new rules remains to be seen.
In the meantime, multinational businesses should track and manage their exposure to an ever-increasing number of new digital taxes as countries around the world take matters into their own hands.
You can follow future developments in the G-20 and OECD plans at Taxation of the digital economy.
Content adapted from BDO Global.
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