An historic agreement on corporation tax

Tom WickerMonday 15 November 2021

For years, multinationals have frustrated world governments with the innovative ways they’ve dodged hefty tax bills. Global Insight assesses the new global minimum corporate tax rate, agreed by the G20, and whether the damaging era of tax havens is coming to an end.

At the end of October, at their meeting in Rome, the G20 – comprising 19 countries and the European Union – formally agreed to impose a new global minimum corporate tax rate of 15 per cent. United States Treasury Secretary Janet Yellen declared that this ‘historic agreement’ will ‘end the damaging race to the bottom on corporation taxation’.

The Organisation for Economic Co-operation and Development (OECD) says that the anticipated introduction of the Inclusive Framework – the rules governing the rate – in 2023 will raise an additional $15bn in annual tax revenue.

The creative ways that multinational companies have dodged significant tax bills – ranging from headquartering in low-tax locations such as Ireland, to claiming hefty royalties on ‘intangible assets’ like intellectual property (IP) that are then routed to tax havens – have frustrated world governments for years.

The new global corporate tax rate would target overseas profits to eliminate such tactics and to discourage countries from undercutting each other. Governments will still be able to set local corporate tax rates but could ‘top up’ the taxes of companies in their countries to compensate for lower-rate payments elsewhere. It’s an easy win, politically at least, after years of headlines decrying the offshore tax tactics of various multinational companies.

But is a global minimum tax rate the magic bullet it’s being touted as? Since the 2008 financial crisis, the demand for regulation and country-by-country tax reporting on companies have increased significantly around the world. However, an analysis by the EU Tax Observatory, published in September, revealed that leading European banks are still booking around €20bn a year – equivalent to 14 per cent of their total profits – in tax havens. How much change, and to whose benefit, can we expect?

Ricardo Leon-Santacruz is Co-Chair of the IBA Taxes Committee and managing partner at Mexican law firm Sanchez Devanny. He accepts that a restructuring of the world tax order ‘is taking place, whether we like it or not’. The 2008 crisis ‘flipped the scales’, he says, from attacking tax structuring and avoidance to a realisation between the governments of the most developed economies that competing over tax rates was damaging. The political will of this ‘club of governments’ gained further traction with the election of then-president Barack Obama in the US in 2008.

‘You now have country-by-country reporting, which pretty much forces multinationals to disclose how they’re structured to their home governments, and those governments are exchanging information’, Leon-Santacruz says. In particular, he highlights the huge scrutiny paid – particularly by the US – to ‘tax-dodging’ in the lucrative ultra-high-net-worth landscape.

Digital ‘horrors’

Crucially, the global minimum tax rate is one aspect of this drive towards oversight and transparency and is spearheaded by the OECD. The OECD’s Inclusive Framework, a two-pronged effort to tackle what’s known as Base Erosion and Profit Shifting (BEPS), builds on years of work and BEPS recommendations by the 38 states comprising the OECD, including multilateral reporting agreements. ‘It’s daunting’, says Leon-Santacruz, ‘to realise the amount of regulation you’re now dealing with’.

The Inclusive Framework divides into two ‘pillars’. The first seeks to address the tax challenges presented by our digital age economy: how (and where) do you report tax revenue from sales made without a physical office?

The imposition of a global minimum corporate tax rate is part of Pillar Two. Politically, particularly for the relationship between the US and the other G20 member states, commentators agree that Pillar Two is less contentious.

Janet Yellen, US Secretary of the Treasury.  Shutterstock.com/Alexandros Michailidis

As home to one of the world’s largest concentrations of digital and technology companies, the industry-specific targeting of digital companies with market-based taxation – that is, where sales occur – has major implications for the US business sector. No government wants to see more tax revenue flow into the coffers of another country.

In 2019, the Trump administration in the US threatened France with tariffs on $2.4bn worth of exports in response to the country’s proposed three per cent digital tax. France delayed collection, but other European countries proceeded to implement their own DSTs, including the post-Brexit UK which is seeking new trade relationships with countries like the US. Tellingly, implementation of the OECD’s Pillar One framework will be coordinated with the transitional – and total – removal of DSTs.

Talk of a ‘compensatory’ global corporate tax rate makes for neater headlines and is less contentious than cross-border digital services. It’s also a far easier to sell than raising tax rates domestically. ‘You don’t want to be lowering taxes, you need to be putting them up’, Greenbank says. ‘But you can’t do that. It will make you uncompetitive and drive all business offshore.’

An inability on the part of EU Member States to agree on a united approach to what Ashley Greenbank, a corporate tax partner at London-based firm Macfarlanes, calls ‘the horrors of the digital economy’ in the context of the existing international tax framework has resulted in the implementation of bespoke digital services tax (DST) measures by different countries. This kicked off ‘something of a trade war’, says Joe Duffy, Webinar Officer of the IBA Taxes Committee and a tax partner at the Dublin-based law firm Matheson.

The view from the US

‘It’s highly unlikely that the United States will have anything to do with Pillar One’, says Kristin Konschnik, Treasurer of the IBA Taxes Committee and a partner at Butler Snow in London. She says that based on discussion around the G20 agreement, Pillar One is likely to be implemented via a multilateral convention, which would need two-thirds approval by the US Senate. ‘And that seems highly unlikely at this stage’, adds Konschnik.

In addition, Konschnik anticipates that the Pillar Two global minimum tax rate rules, even if implemented by other countries, will have to co-exist with the US global intangible low-taxed income (GILTI) regime – a Trump-era tax reform that lowered the tax rate for US companies, provided they brought offshore profits back.

‘The United States is going to say, “well, our GILTI rules are effectively good enough to be considered a minimum tax”’, says Konschnik. She expects an increase in the current GILTI rates between the 15 per cent global minimum and the 21 per cent President Joe Biden originally proposed as his opening gambit – a rate that some argue he put forward to keep the far left of the Democratic Party on board. ‘By implementing something like GILTI, they don’t have to worry about somewhere like Ireland turning around and undercutting them’, adds Konschnik.

‘And GILTI is a potent weapon, because it doesn’t care what type of income it is’, says David Shapiro, Session Reporters Liaison Officer for the IBA Taxes Committee and a partner at Saul Ewing Arnstein & Lehr in the US.

Not plain sailing

One of the ‘big challenges’ Shapiro anticipates in relation to the new rules is ‘inconsistency between countries in interpretation over what that “global minimum rate” means’. He wonders if ‘we’re in for a conflict around how income is computed, because that global minimum tax says that you have to have a standard for what the tax base is’.

Most commentators agree that there are likely to be numerous disagreements over the fine print of the Inclusive Framework, including what counts as a ‘parent company’. Greenbank, at Macfarlanes, also sees potential disputes when one jurisdiction exercises its right to withhold topping up tax ‘because they’re interpreting the rules differently to another jurisdiction’.

Others, such as Konschnik, are also sceptical about how much the Inclusive Framework will benefit emerging countries, or those outside the G20. Based on recent discussions, she sees Pillar One as ‘kind of just reallocating income among already well-off European jurisdictions, rather than helping developing countries. You have to question whether, in fact, that was one of the aims – to give them more tax certainty and a level playing field.’

Some commentators have also expressed concerns about the effect of a minimum global tax rate on jurisdictions whose economic health is argued to depend on their attractive tax regimes. Ireland, for example, with its 12.5 per cent corporate tax rate, is the European base for Apple, Facebook and Google. On a per capita basis, professional services company EY reports that Ireland won the most foreign investment projects in Europe in 2019.

Konschnik points out that, as per the guidance in the Inclusive Framework, the 15 per cent minimum corporate tax rate will only apply to businesses whose turnover is more than €750m annually. ‘Ireland can continue to apply their 12.5 per cent rate to smaller companies’, she says. This isn’t a minor consideration for one of the hubs of the emerging growth sector. Nevertheless, Konschnik suspects the US ‘leaned on them heavily’ to sign up.

Between the lines

Konschnik says a ‘more realistic interpretation’ of implementing a global minimum corporate tax rate is that it’s about favouring those jurisdictions in which the tech giants and major corporations are based, rather than about giving a leg up to ‘those market economies that are consumers of services but don’t necessarily have the digital services companies headquartered there’. It’s ‘less about making sure those economies are getting their fair share’.

As an example, she points to Pillar One’s agreed phasing out of all DST measures in favour of taxing the world’s biggest companies. ‘The quid pro quo is that jurisdictions have to give up all of their DSTs, for every company’, she says. ‘They basically have to give up their taxing authority. There’s a question over whether they would actually recover sufficient amounts under Pillar One to make up for what they are required to give up.’

In Pillar One’s ‘nexus’ rules, in-scope companies – multinationals with more than €20bn turnover – would see 20–30 per cent of residual profit (defined as over ten per cent of revenue) allocated to market jurisdictions.

Konschnik posits the hypothetical impact of this on, for example, Nigeria’s ability to secure tax revenues from a company like Amazon – if the rule applies – after giving up its right to impose a unilateral tax. ‘The 25 per cent of taxable profit has to be allocated to all market jurisdictions, based on some sort of a proportional formula. So, Nigeria has no idea what it’s going to get in exchange.’

For Ricardo Leon-Santacruz at Sanchez Devanny, this is already an issue with global tax regimes. ‘You can see the tightening of oversight and scrutiny’, he says. ‘But I haven’t perceived an initiative globally for more financial discipline from governments when it comes to transparency and disclosure on the reporting and the use of monies – that varies significantly by region.’

In developing countries, a bracket in which Leon-Santacruz includes Mexico, ‘we’re feeling the pinch, with greater enforcement, but we’re not seeing the benefit’.

For Joe Duffy at Matheson, the initial fanfare in June over the agreement about the 15 per cent global minimum tax by the finance ministers of the G7 richest nations – which helped pave the way to the G20 agreement – also belied the fact that many jurisdictions were already making changes based on the OECD’s BEPS actions. When it comes to Ireland, for example, he says the infamous ‘Double Irish’ corporate tax tool – by which multinationals could channel international profits through Ireland and then to tax havens – is gone.

David Shapiro at Saul Ewing, like some others, believes that an announcement of a global minimum corporate tax is as much a political gesture as anything else. ‘Companies very often will have subsidiaries in jurisdictions that you might look at and say, “OK, that’s a tax haven”’, he says. ‘But those companies are well-advised and are being responsible with their reporting. On the US side, they’re including anything in their US income that’s subject to rules like GILTI.’

Considering the alternatives

From Shapiro’s perspective, the focus should really be on ‘information-gathering and enforcement, rather than simply establishing a minimum tax’. In particular, he identifies ‘the real action’ when it comes to tackling tax avoidance as dealing with the allocation of profit, ‘which is a far harder question than a minimum rate. There’s been a cat-and-mouse game between the larger companies and the tax authorities in terms of their transfer-pricing processes.’

In theory, one of the key benefits of a global minimum tax rate is that every country can implement it within their own laws. However, from the tension that’s likely to continue between the US and an EU that still favours taxing the technology industry, to the inevitable carve-outs, opt-outs and other complexities, it’s far from straightforward. There’s a possibility this will result – in Ashley Greenbank’s words – in ‘a very loose compromise’ that doesn’t fully satisfy anyone.

Shapiro also argues that tax rates don’t tell the full story. ‘We only need to look to India to see that tax rate as the main driver of competition for company operations may be overstated’, he says. ‘India historically had a very high tax rate and aggressive taxing authority. And yet businesses still flock there.’

He points to factors such as low labour costs as major contributors to the appeal of such jurisdictions. ‘That was always the Irish model – we’ll bring in the company, we’ll tax the workers’, he says.

Shapiro believes that the adoption of ‘formulary apportionment’ is likely to be a more successful approach in allowing certain countries to capture tax revenues from large multinationals than the minimum tax rate would be. ‘Let’s look at overall company profits and multiply that by a fraction’, he says. ‘The numerator is sales to customers in our jurisdiction and the denominator is sales every year. And that’s the tax base for the state’, he explains. ‘It’s a formula that’s hard to manipulate.’

However, he concedes that this is more challenging in the more intangible realm of ‘value generation’ in the digital sector.

And the line between what is legally defensible and what some may consider ethically ‘right’ is a blurred one throughout all of this. The EU Tax Observatory’s report into how leading European banks are booking the equivalent to 14 per cent of their total profits in tax havens is a good example. A spokesperson for HSBC, one of those named in the report, said the bank did ‘not employ tax avoidance strategies, including those designed to artificially divert profits to low-tax jurisdictions’. Barclays, another one named in the report, said it was the fifth-largest UK taxpayer.

In another wrinkle, the OECD’s focus on the globe’s top 100 companies for the ‘top-up’ 15 per cent tax is likely to exempt the banking sector, after lobbying by the City of London and other international finance centres. On the face of it, says Shapiro, ‘that doesn’t look good’, but he points out there are ‘lots of areas of the law where banks have special rules applied to them, because of how they have to manage their assets, and because of their liquidity requirements’.

Kristin Konschnik similarly acknowledges that banking is ‘a protected industry’. However, reflecting on the UK’s lobbying, she finds it interesting that, ‘in the same way the US is protective of their digital services and technology companies, the UK has an awful lot of banks headquartered here’.

Konschnik also finds it interesting that there doesn’t seem to have been significant change in the use of tax payments by banks over the period since country-by-country reporting has come in. She says there was at least an expectation that behaviour might change because, now, people can assess how much money lies in tax havens. But, she highlights, that didn’t happen.

Ultimately, Konschnik says it comes down to the cost-benefit analysis of the public relations risk of any negative headlines.

‘One of a company’s goals is to increase their return to their shareholders’, she says. ‘We can have a discussion about whether that’s appropriate or not, but that’s the way it is for most companies right now. And the banks have basically said: “we don’t think the people who have staggering amounts of money with us will take it out and walk away.”’

Between now and 2023, this is arguably what the fine-tuning of the OECD’s Inclusive Framework and the global minimum tax rate will boil down to: the balance between PR and substantive change. ‘Make no mistake about it,’ says Konschnik, ‘this is political. “We’re doing all of this great stuff that’s going to stick it to all of these big companies.” But the proof is always in the pudding.’

Tom Wicker is a freelance journalist and can be contacted at tomw@tomwicker.org