Tax net closes in on multinationals

More multinational companies must now pay tax in the countries in which they do business. Peter Taylor-Whiffen looks at the logistics and the implications



In October 2021 the Organisation for Economic Co-operation and Development (OECD) announced that a total of 136 countries had signed up, as part of the OECD/G20 ‘Inclusive framework on base erosion and profit shifting’ (BEPS), to a ‘Statement on a two-pillar solution to address the tax challenges arising from the digitalisation of the economy’. This agreement obliges all multinationals to declare profits and pay more tax in the countries where they do business and forces all companies with revenues of more than €750m to pay a minimum 15% corporate tax. By December 2022, 138 member jurisdictions had agreed.

It would be the most radical international tax reform in a century. The OECD’s plan would not only finally be closing low-levy loopholes exploited by the world’s biggest companies but also end the ‘race to the bottom’ of countries offering ever lower tax rates to entice foreign investment.

It’s an ambitious project but it’s already succeeding, says Barbara Angus, global tax policy leader at EY. “Having as many as 140 countries working together is something we’ve never seen – and it’s even more remarkable given the huge level of complexity. Each country has its own tax system so reaching agreement and then implementing it globally is very challenging. Yet progress is being made.”

Jurisdictions that previously offered incentives such as ‘tax holidays’ or free trade zones may decide it’s not worth their while

The agreement is based on two pillars. First, according to the OECD announcement, is “to ensure a fairer distribution of profits” by reallocating taxing rights so companies with global sales above €20bn and profitability above 10%, such as tech giants Amazon, Google, and Facebook, must pay tax in “the markets where they have business and earn profits, regardless of whether firms have a physical presence there”. The proposals, which would see 25% of profit above the 10% threshold reallocated to market jurisdictions, are expected to reroute rights on more than US$125bn of multinationals’ profits to countries worldwide.

The second pillar – the minimum 15% corporate tax – is anticipated to generate around US$150bn per year in additional global tax revenues and, claims the OECD, will result in further benefits arising from the “stabilisation of the international tax system”.

The plans aim to correct a model that was developed almost a century ago by the League of Nations, which in the late 1920s sanctioned inter-country treaties that taxed companies in jurisdictions where they made products and were based, but meant the market country that sold the products had no corporate tax rights. The rise of globalisation, spread of ecommerce, and the worldwide increase in services over manufacturing have increasingly placed buyers and sellers in different jurisdictions and created opportunities for large multinationals to create their main sales bases in whichever (low or zero-tax) jurisdiction they choose, resulting in many nations reducing their corporate tax rates to attract global firms.

Adoption of Pillar Two is well advanced and looks set to go on stream in many jurisdictions by 2024 – largely because there’s less necessity than in Pillar One for jurisdictions to act in lockstep. “The goal was to move away from a system that had incentivised companies shifting profits in different ways towards more real economy outcomes, and there are several ways to do this,” says Daniel Bunn, president and CEO of US think tank the Tax Foundation. “One is to adopt the rules on top of your existing rules. Another is by changing the tax structure for individual companies in your jurisdiction. You get to a simpler outcome without all the countries adopting the rules by the letter.”

The second pillar – the minimum 15% corporate tax – looks set to go on stream in many jurisdictions by 2024

Jurisdictions that previously offered incentives such as ‘tax holidays’ or free trade zones may decide it’s not worth their while, say tripling the size of their tax administration for the sake of slavishly adhering to the rules – but, says Daniel, they may find other solutions. “A lot of these jurisdictions have high corporate tax rates but small bases [small proportion of companies that pay the high rates] because of all the incentives and exclusions in their tax codes, so they could lower the rates but broaden the base.”

It is up to each country to choose whether to adopt the rules, says Barbara. She explains that there is broad agreement regarding the model rules and their related explanations but “there is continuing work on the interpretative guidance, so countries are watching each other to see what they do”. Global negotiators should note how much alignment there is between jurisdictions’ legislative activity “to avoid risk of controversy or double or multiple taxation, but broadly countries are moving forward together,” she says.

The ease with which companies could previously legally avoid paying fair tax has in recent years been exposed by revelations from LuxLeaks, the Panama Papers, and the Paradise Papers, which between them named various behemoths including Apple, Google, Nike, AIG and Pepsi, along with a plethora of wealth management and other financial institutions, as exploiting the system to pay less tax. Corporate tax avoidance schemes, largely funnelled through tax havens, were costing jurisdictions worldwide a total US$483bn in 2021, according to the State of tax justice report released that year by the international trade union conglomerate Public Services International. This figure has not been updated since because of the “OECD’s failure to publish aggregated country by country reporting data”, according to the ‘stopgap edition’ published in November 2022. “Without this data," it says," governments and their public are unable to assess whether the OECD’s proposed tax reforms are in their interests”.

Double Irish

The proposals will significantly reduce the effectiveness of tax avoidance accounting techniques such as the ‘double Irish’ and a Netherlands-based variation called the ‘Dutch sandwich’. Because Ireland and the US define corporate tax residency differently (Dublin imposes taxes if they are controlled and managed in Ireland, Washington levies according to where a company is registered), US multinationals have moved money to an Irish subsidiary, then to a Dutch one and then to another Irish one in a low or no-tax jurisdiction. Google famously siphoned money in 2016 by licensing intellectual property from its tax-registered entity in Bermuda, where no taxes are payable on IP royalties to foreign shareholders – making Google Ireland’s €13bn pre-tax profit effectively tax-free, while a similar scheme used by Apple in 2014 effectively reduced its tax bill to 0.005%.

However, public and political pressure has in recent years motivated many companies to transparently pay more realistic taxes. The double Irish was abolished in 2015 but there followed a five-year moratorium for companies registered in Ireland. When this moratorium ended in 2020, Google Ireland repositioned to put more of its tax liability back in the US, and its corporate tax in Ireland rose from €263m for 2019 to €622m in 2020 after the company agreed to pay an additional €218m in backdated payments and interest charges.

The economic advantages of a simplified, aligned global tax system could offset the pain for some multinationals of having their tax loopholes closed

If harmonisation goes ahead, multinationals based around intellectual property are likely to see the biggest change – the tech giants but also international firms involved with chemicals, computer chips, and electronic engineering. Analysis by the London Business School finds that in the days after the agreement was signed, Apple, Microsoft, Meta, and Alphabet all took a hit to their share prices, while large firms that concentrated on a domestic market and therefore did not have IP as a priority (such as Walmart in the US), stayed steady.

However, it might not be all bad news for the tech giants. A set corporate tax rate will be easier and significantly cheaper to manage, and an increased levy will potentially cause more hurt to companies with smaller balance sheets. For firms on the way up, it might reduce the incentive for global expansion, thus removing some of the tech giants’ competition.

But the economic advantages of a simplified, aligned global tax system could offset the pain for some multinationals of having their tax loopholes closed – especially when the cost of compliance in different jurisdictions is higher than any tax they might pay. Jurisdictions also currently have a cost burden of administering different individual systems for companies from different countries. “So it’s currently a burden to comply and a burden to administer,” says Barbara. “Countries finding a way to work together to build in simplification gets rid of those dead weight costs that don’t benefit anyone.”

A widespread 15% global corporate tax will, of course, significantly impact countries which, like Ireland, have hitherto had attractively low tax rates. Aside from Bermuda, nine countries famously charge no corporate tax at all – Anguilla, Bahamas, Bahrain, Cayman Islands, Guernsey, Isle of Man, Jersey, Vanuatu, and Turks and Caicos Islands, but many of the other lowest rates are in Europe, particularly Eastern Europe, with levies of 9% (Hungary and Montenegro), 10% (Andorra, Bosnia and Herzegovina, Bulgaria, Gibraltar, and Macedonia), 12% (Moldova) and 12.5% (Cyprus and Liechtenstein).

“The aim of Pillar Two was to reduce tax rate competition among countries but the corollary to that is it reduces the ability of countries to use tax-based incentives to attract investment, so jurisdictions have to look at alternative incentives,” says Barbara. “Certainly, tax has never been the only basis on which an investment decision is made.”

One result of the global harmonisation could be wealthier countries shifting away from tax incentives to subsidies. The flexibility of Pillar Two could also encourage jurisdictions in emerging economies – for example Africa, South America, and Southeast Asia – to find alternative incentives that benefit them. For instance, these rules provide the possibility for developing countries that might traditionally have attracted holding or letterbox companies to move towards more tangible investment, such as an industrial base or a high-value services economy.

But while Pillar Two is coming together, agreement on Pillar 1 – the reallocation of taxing rights – is some way off, largely because this does require simultaneous agreement and adoption across the world. And such reallocation of tax rights brings winners and losers – and therefore opposition.

US opposition

In the US, despite President Joe Biden committing to the harmonisation, Republicans have consistently opposed the agreement since its signing, with Senator John Barrasso widely quoted as calling it anti-competitive, anti-US, and harmful.

While other nations have gradually brought down their corporate tax rates since the millennium (Canada’s reduced from 42.4% in 2000 to 26.5% net rate today, Japan from 42% to 30.6% in the same period), America’s corporate tax rate was almost halved in one dramatic swoop from 40% to 21% in the 2018 Tax Cuts and Jobs Act. This brought it below the global corporate tax rate average of 23.8%, and the Republican Party’s recent gain of the House of Representatives in the US mid-terms makes it unlikely Democrats will succeed in bringing the global tax deal onto the statute book.

There is opposition elsewhere, too. The OECD announcement claims the plans, whose signatories incidentally represent more than 90% of global GDP, will bring “developing country revenue gains expected to be greater than those in more advanced economies” but many lower-middle income countries seem to disagree. Only 23 of Africa’s 54 nations have so far signed up and the African Tax Administration Forum has called for the minimum rate to be at least 20% “if it is to stem artificial profit shifting out of Africa as most African countries have a statutory corporate income tax rate of between 25% and 35%”, according to a release by the African Tax Administration Forum.

The main beneficiaries may prove to be the world’s most affluent jurisdictions

Furthermore the Brookings Institution, a US-based non-profit public policy organisation, points out in a blog summarising its research paper on the impact of the new inclusive framework that the 15% rate would harm the economic progress of developing nations because, it says, 60% of the reallocated taxes would go to the G7.

The Brookings claim seems to be backed up by average corporate tax rates in the world’s regions. Of developing economies, Africa’s average is 27.9% and South America’s 26.6%, and the regions that would apparently benefit the most – or suffer the least, depending on your view – from global tax harmonisation are among the most affluent, which also have the lowest regional corporate tax rates: Europe (19.8%) and Asia (19.6%), according to figures from the US-based non-profit, the Tax Foundation.

The UK, however, is among the nations that remain positive about the change, and in July 2022 the government – under then prime minister Boris Johnson – issued a policy paper outlining its commitment to a two-phase implementation beginning with the income inclusion rule coming into force on 31 December 2023.

Global tax harmonisation has its champions but it may yet be further off than those supporters hope. When the deal was signed in 2021, OECD Secretary General Mathias Cormann hailed it as an agreement that “will make our international tax arrangements fairer and work better. This is a major victory for effective and balanced multilateralism. It is a far-reaching agreement which ensures our international tax system is fit for purpose in a digitalised and globalised world economy. We must now work swiftly and diligently to ensure the effective implementation of this major reform.”

The will for fairness seems to be there, but challenges for harmonisation lie ahead. The increased revenue for developing nations may be dwarfed by the cost of their development needs. The main beneficiaries may prove to be the world’s most affluent jurisdictions – but even in these regions there is opposition from political parties believing it will harm national interests. And for many low-tax or no-tax jurisdictions, the whole idea closes up the loopholes that have enabled them to attract investment. With so many issues still needing to be ironed out, even with diligence, fairer tax rates for all may not happen as swiftly as Mr Cormann would like.


Published: 30 Mar 2023
  • Corporate finance
  • Operations
  • International regulation
  • featured
  • tax harmonisation
  • Dutch sandwich
  • double Irish
  • OECD
  • BEPS
  • corporate tax
  • jurisdictions
  • international regulation

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