G7 backs global corporate tax, in first step towards reform

Finance ministers from G7 countries gave formal support on June 5th to a potentially ambitious shake-up of worldwide taxation of company income. The initiative seeks to let countries impose taxes on profits from digital goods sold in their markets, while obliging them to impose a minimum 15% profit tax rate.

  • The initiative faces a long and rocky path to implementation, as it will require the agreement of sitting governments and lawmakers, including in the EU and the US. However, a reform broadly along these lines is likely to take effect in the next 2-5 years.
  • The plan would shift, and lift, corporate tax revenues primarily among rich countries and China by apportioning rights to tax earnings on digital goods and reducing the appeal of tax havens.
  • The main sectoral implications remain ill-defined, but heavier taxes would likely fall on technology firms, which broadly back the measures given that they prohibit the imposition of digital service taxes (DSTs), and pharmaceutical firms, which have made few comments on the proposal.

Two pillars and one requirement

The weekend communiqué bolstered an emerging consensus around the policy, stymied by disagreements among national policymakers until the election of Joe Biden as US president and his appointment of Janet Yellen as Treasury Secretary. The plan is based on two “pillars” that have long been under discussion by the OECD, Group of 20 (G20) countries and their so-called Inclusive Framework. One would allow countries where large firms make sales to charge taxes “on at least 20% of profit exceeding a 10% margin for the largest and most profitable multinational enterprises”. This would permit, say, France to tax profits on digital sales of firms such as Alphabet, Apple and Facebook (all US).

The second pillar would require all countries to impose a corporate profits tax of “at least 15%”, in an effort to limit the ability of countries, such as Ireland, to attract corporate establishments with low or zero rates of tax. The G7 statement stipulated that the 15% rate should be “on a country by country basis”, meaning that firms could not offset tax paid in one market against obligations in another. This pillar would provide space for national governments to raise domestic corporate tax rates, as the Biden administration seeks to do, while mitigating the risk that firms will move activities to low-tax locations.

A third key provision, although not formally a pillar, would oblige countries to scrap existing, and refrain from imposing, DSTs on the sales of non-physical goods and services, such as smartphone apps, digital advertising, cloud computing and streaming entertainment. Such taxes in France, India, the UK and other countries have primarily fallen on US-based technology companies. In response, the Biden administration has ordered tariffs on those countries’ exports to the US in retaliation (although these have been suspended for the time being).

A long and rocky path to implementation

Policymakers will have many opportunities to refine the proposals over the course of this year. The topic will be discussed at the G7 leaders summit in the UK on June 11th-13th, at OECD group meetings in Paris on June 30th-July 1st, and then again when G20 finance ministers and central governors meet in Venice on July 9th-10th. The G20 includes developing countries such as Brazil, China, India, Indonesia and Saudi Arabia. The non-G7 members of the G20 are thought to be broadly favourable to the reform, although apart from China their governments and firms are unlikely to be important net tax recipients or payers. If events proceed according to plan, the G20 heads of state and government may sign off on the initiative when they meet in Rome on October 29th-31st.

However, global corporate tax reform will prove difficult to implement in G7 economies. In the EU the plans will require a directive, subject to veto by the low-tax economies of Ireland or Hungary, and passage of associated changes by national parliaments. Ireland will resist staunchly, at least initially, as it sees this as the thin end of the wedge of undermining national sovereignty on taxation. Hungary has been a thorn in the side for EU policymakers in defending national sovereignty on other issues and is likely to stand its ground on tax policy as well.

Political prospects are difficult in the US too. The opposition Republicans are united against the Biden administration’s proposed hike to the domestic corporate profits tax. In 2017 the Trump administration had lowered corporate tax from a tiered system ranging as high as 35% to a flat 21% (a plan that also included a complicated minimum tax on US firms’ overseas earnings). The Biden team could probably push through the global reform in the evenly divided Senate under so-called “reconciliation”, which requires a simple majority, if they can do so before the November 2022 mid-term elections or do not lose seats in that electoral contest. However, tax treaties, and changes to them, require a two-thirds vote in the Senate for ratification.

OECD-led initiatives have led to important advances in international economic cooperation in recent decades, but on fairly technocratic matters such as automatic exchange of taxpayer information. By contrast, taxation is a core element of national sovereignty and many elements of the global reform package require legislative approval. As a result, the path to implementation is unlikely to be smooth. However, over the medium term a reform similar to this proposal is likely as states’ revenue collection tools catch up with the ways modern firms generate profits.

Impact on countries’ tax revenues

Given that many details about the plan have yet to be agreed, the tax consequences across economies remain highly uncertain. A study from the Tax Justice Network, an NGO, indicates that most of the shifts in taxation would occur among developed and middle-income countries, including G7 economies: Canada, France, Germany, Italy and Japan, the UK, the US plus the EU. The data indicate that China would be the second largest recipient of increased tax revenues.

The main losers from the plan would likely be zero-rate tax havens such as the Bahamas, Cayman Islands and Jersey. These jurisdictions attract company registrations owing to their lack of tax on profits, but they earn revenues on licensing fees, legal and accountancy receipts and other charges.

The impact is more uncertain for low-tax locations like Ireland (12.5% tax rate on companies) and Hungary (9%), both members of the EU. Ireland in particular has used its low taxes–combined with a favourable business environment, integration with EU markets and educated English-speaking population–to become a major business hub, especially for technology firms. The proposed 15% minimum tax rate, down from an earlier mooted 21%, is only slightly above Ireland’s current 12.5% rate. However, Ireland has been adamant that it will resist any change to tax rates and will oppose the plan. Other widely used business locations such as Hong Kong, Singapore and Switzerland already have tax rates above the proposed 15% minimum.

Impact on economic sectors

The burden is likely to fall primarily on technology and pharmaceutical firms that have been able to place their business locations and intangible intellectual property in low- or no-tax locations and book their revenues in those jurisdictions. Tech firms have supported the tax reform despite its impact on their profits, with Amazon, Facebook and Google releasing statements backing the G7 decision. They are keen to avoid the recent proliferation of DST regimes, primarily in Europe. Pharma firms have commented little on the proposals, by contrast.

Many other economic sectors–including automotive, consumer goods, finance, health, primary industries and others–almost always operate through incorporated entities in the markets where they make their sales, and as a result have not shielded income from tax and would probably not be greatly affected by the plans. At any rate, the digital profits tax would apply only to firms making profit margins of over 10%–meaning many disruptive firms with low margins, including possibly Amazon (US)–would remain exempt.

The details about which firms would be affected have yet to be worked out and so the consequences are difficult to discern. The Biden administration has proposed that some 100-150 firms worldwide would be subject to the special tax treatment, though there is so far no fixed criteria for inclusion in that roster and the G7 statement did not add any specifics.

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