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What is the Historic G7 Deal on International Taxation?

Editor, TRANSFIN.
Jun 15, 2021 3:15 PM 6 min read
Editorial

June 5th 2021 was a watershed moment...

...in the world of international taxation. Yay!?

The finance ministers of G7 who met up  in London agreed to a deal around two objectives: (1) countering tax avoidance by big multinationals and (2) working towards a global minimum corporate tax rate.

The ministers also put in place an arrangement to ensure a transatlantic thaw in hostilities over digital levies as well as a commitment to make it mandatory for firms to report the climate impact of their investment decisions.

The highlights, however, were the first two points, which have been called “the single biggest change in a century to international tax rules”.

Why Was an International Tax Plan Deemed Necessary?

The aim, to put it simply, is to make big corporations pay their fair share of taxes and to plug the tax loopholes they have exploited for years.

The latter mainly points to tax havens i.e. Jurisdictions where corporate tax rates are low or non-existent.

Tax havens have exploited globalisation’s loopholes over the past few decades, becoming extremely rich whilst enabling big businesses to shirk tax obligations. Bermuda, the British Virgin Islands (BIV), the Cayman Islands, Hong Kong, Ireland and Singapore are some examples.

Big multinationals such as Alphabet, Apple, Facebook, Amazon, Nike, Starbucks etc. For years have been setting up local branches/subsidiaries there in order to declare profits, so they shell out a lot less money as taxes, even though their goods and services have been sold in other countries.

The system is so broken that it has created some ludicrous realities for global commerce. One-tenth of all global FDI comes from little Luxembourg. Between 2000 and 2017, more than a third of all foreign investment that India received came from the tiny island of Mauritius.

To use the words of US Treasury Secretary Janet Yellen, the G7 tax agreement aims to "end the race to the bottom in corporate taxation”.

 

Why Now?

While this international tax reform plan faces a few hiccups before it can actually be implemented, even its endorsement is nothing short of remarkable. Years in the making, its progress was stymied by global hesitation to impinge on countries’ sovereign right to taxation and years of Trumpian hostility against multilateralism.

But now, with the COVID-19 pandemic having depleted government coffers the world over and with a White House more sympathetic to the cause of corporate tax reform, “a revolution” in global tax policy is underway.

Now, coming to the deal itself, let’s address its pillars one-by-one…

 

Pillar One: The Attack on Profit Shifting

The G7 deal aims to make multinationals with a profit margin of at least 10% pay more tax in the countries where they are selling their products or services (or the “market countries”), rather than wherever they end up declaring their profits.

At least 20% of profits exceeding the 10% mark “for the largest and most profitable multinational enterprises” would be taxed in their market countries.

This pillar is a major victory for countries like India, France, UK and Canada, which have borne the brunt of Big Tech’s tax evasion antics for years. The move to impose digital taxes - the so-called Google Tax - by many nations has drawn bipartisan criticism and reciprocal levies from Washington.

For the US, this is a bittersweet pill to digest. On one hand, no digital levies from individual countries means more certainty for Big Tech (all of which are American companies). But on the other hand, the amendment to the tax code this move demands will be difficult to push through the US Congress, where the Democrats hold a razor-thin majority. Republicans have already opposed the plan, saying it cedes US tax authority to foreign countries.

 

Pillar Two: The Minimum Rate

The G7 deal envisages a minimum corporate tax rate of “at least” 15% across countries to avoid nations from undercutting each other.

Three things here. One, this number is quite low. It is lower than the lowest G7 rate today. And it is lower than the 21% initially pitched. This may be because countries aiming for a higher number (US and France in particular) had to compromise to ensure the plan’s endorsement by the G20 and to placate the concerns of low-tax jurisdictions.

Two, Pillar Two has invited criticism for treading on countries’ sovereign right to decide the tax rate they want and not be beholden to a rate defined by an exclusive club of big economies. Think of a developing country hit hard by the pandemic. A sure-shot way for it to boost revenues would be by inviting foreign investment - which can happen easily if it boasts of low corporate taxes. A global minimum rate would take this advantage away.

Three, this pillar can play out differently in different countries. In the US, ensuring a minimum global tax rate and taking aim at tax havens is critical for the Biden administration’s plan to raise the US corporate tax rate to 28%, so as to downplay critics’ concerns that doing so would encourage American companies to offshore operations overseas.

Meanwhile, Pillar Two could “all but kill the [tax] havens”. Some will be hurt more. For Cayman’s and BIV, for instance, offshore corporate and financial services account for over half of government revenue. Others, like Singapore and Ireland, have more diversified economies. Nevertheless, expect these tax paradises to put up a tough fight in the coming weeks for a further reduction to the 15% number (a 12.5% figure is sought by Dublin and Nicosia). 

 

The Taxes They Are A-Changin’

We’re talking about big money here.

Corporate tax avoidance costs the US Treasury nearly $50bn a year, according to the Tax Justice Network (TJN). India’s number is estimated at over $10bn. All in all, tax abuse by multinationals and rich individuals costs the world economy a stunning $427bn annually.

The TJN estimates the G7 proposals could generate an additional $270bn a year in tax revenues (OECD estimates are more modest). However, the actual sum would depend on the terms of the final deal.

FYI: The amount recovered in unpaid corporate dues is directly proportional to the minimum rate. A higher 25% rate could raise $780bn in additional revenues worldwide - and still leave multinationals with three-quarters of their gross profits.

FYI #2: The current plan, while a big step, is skewed in favour of rich countries (considering the home country of the multinational enterprise is given priority for taxation), with over 60% of the revenue gain expected to be pocketed by G7 nations and only c. $100bn for others.

 

How Have Big Companies Reacted?

Well, corporations can hardly endorse tax loopholes in the open, can they?

Amazon thinks the plan “will help bring stability to the international tax system” Facebook says it is a "significant first step towards certainty for businesses and strengthening public confidence in the global tax system". Google “strongly [supports] the work being done” and hopes “countries continue to work together to ensure a balanced and durable agreement”.

 

What Happens Now?

The plan will be discussed in detail at next month’s G20 summit in Venice.

FYI: The Indian government has said it will look into “the pros and cons of the new proposal...and the Government will take a view thereafter”.

Most countries are expected to jump onboard. There may be some murmurs from China, considering that Hong Kong, Asia’s top tax haven, would be negatively affected. Singapore and Switzerland might not be too pleased. Ireland, Cyprus, Malta and Hungary could strongly object. But the EU is likely to convince the latter countries to toe the line. And other critics are expected to follow the precedent of major economies nonetheless. As for other tax havens, their diplomatic clout is rather limited.

Saturday’s tax deal is a big deal. It may have fallen short of many observers’ expectations, but it is definitely a step in the right direction. What’s more, it signals a welcome return of multilateralism and the championing of a progressive tax policy.

Change is both crucial and overdue. After all, the nitty-gritties that govern the international tax system have barely changed since the 1920s.

FIN.
 

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