Global Tax Announcement
On 5 June 2021, the G7 Finance Ministers announced a global corporation tax of a minimum of 15%. Since then, over 130 countries, representing 90% of the global GDP have agreed to overhaul the global tax system, ensuring “companies pay their fair share everywhere”.
US Treasury Secretary Janet Yellen said at the time that it was “a historic day for economic diplomacy.” The OECD declared on July 1 that countries had committed to a two-pillar plan to reshape the global tax system. It is important to note that countries such as China, India and Russia are part of the agreement.
Why has this happened?
So why has this happened? In recent years, the focus has been on large multinational groups that have paid very little taxes outside their country of residence. Countries have not been able to tax companies that generate sales and make profits. This is because they do not have a permanent establishment in those jurisdictions.
In addition, Biden’s management has stated its intention to increase corporate tax to 28%. This follows a downsizing during the Trump presidency, which some refer to as the race to the bottom. On top of this, Trump failed to reverse the tax-exempt status of US-based multinationals.
First Pillar, what does it consist of?
The first pillar of the new agreement refers to tax rights. It asserts that a portion of the residue of the relevant multinational must be taxed in the jurisdiction where the income is derived. This will tie the tax rights to the source of income as opposed to physical presence. However, the Pillar 1 criteria would only apply to companies with more than € 20 billion in revenue and a profit margin greater than 10%.
For those companies, a portion of their profits would be taxable in the jurisdictions where they have sales; 20-30% of profits above a 10% margin may be taxable. Extractive sector companies (such as oil, gas and other mining companies) and financial services companies would be excluded from the policy.
Therefore, the benefits are most likely small given the scope of the pillar. In addition, countries must report taxes on digital services. This is because countries have started taxing digital services like Google and Facebook, which has been avoiding taxes due to lack of physical presence. The companies affected by this are predominantly American and have seen these taxes as discriminatory and have imposed penalties.
It can be argued that the United States will be the hardest hit by digital taxes. Therefore, they are willing to redistribute some taxes to avoid digital taxes as a quid pro quo. In the UK, the government will lose more Pillar 1 taxes instead of imposing taxes on digital services. Therefore, it makes little sense for countries to waive their tax rights for the limited benefits of Pillar 1.
However, the United States has imposed a 25% tariff on six countries on their taxes on digital services. While these tariffs are currently suspended to allow time for global tax negotiations to continue, they show a sign of the actions the United States will take on those who do not adhere to the new agreement.
Second Pillar, what does it consist of?
The second pillar deals with the global minimum. Therefore, a minimum tax rate of at least 15% will be applied on all income of multinational companies in the jurisdiction in which they operate. If not applied, a supplementary tax will be applied to the parent company. However, it can be argued that 15% is too low, considering that Ireland’s tax rate is 12.5%. In addition, European OECD countries currently charge a 21.7% corporate tax, some closer to 30%.
While a considerable number of countries, including the world’s largest, certain jurisdictions were not part of the talks. Ireland and Estonia, which only tax distributed earnings, have not yet acceded to the reforms. However, there are many exemptions from corporate tax today and it will be interesting to see if they continue with the reforms.
An example of this is Malta, where companies must pay a 35% corporate tax. However, when the profits are shared with foreign shareholders, they can request a refund of 6/7 of the tax to be paid by the Maltese company. This means, effectively reducing the corporate tax to 5%.
The OECD / G20 Inclusive Framework will make a final decision on the remaining issues and the implementation plan in October.