For many years, governments have been challenged by the task of taxing companies that operate across many countries.
Multinational companies are legally able to set up branches in countries with lower corporate tax rates and declare profits there. This allows them to only pay the low local tax rate, even if the majority of their profits come from sales elsewhere, in places with higher tax rates.
As the right to tax is a sovereign issue, it has previously been difficult to coordinate international action against larger multinational corporations and online technology companies.
However, during talks in London in June, the G7 group of wealthy nations (which includes the US, UK, France, Germany, Canada, Italy and Japan, plus the EU) have made a landmark deal aimed at serious tax reform, which would create a global minimum corporate tax rate. This deal seeks to close taxation loopholes, which have allowed some of the largest companies in the world to avoid certain taxes previously.
Tech giants like Google, Amazon and Facebook will be caught by the agreement and the EU Tax Observatory analysis suggests that such reforms would also include companies such as BP, Shell, Iberdrola, Anglo American mining firm, telecoms operator BT and banks such as HSBC, Barclays and Santander. The billions of dollars collected by these taxes may allow debts that have been incurred during the Covid pandemic to be paid.
There are two main pillars that make up the G7 deal. The first enables countries to tax some of the profits made by large companies based on the revenue they make within that country, instead of where the company is located for tax purposes or where they end up declaring their profits. Such reform could force multinational companies to pay tax in all of the countries they operate in.
This pillar will target the largest and most profitable multinationals. The rules would apply to global firms with at least a 10% profit margin. For these companies, 20% of any profit above that 10% margin would be reallocated and subjected to tax in the countries in which the company operates.
The second pillar sets out a minimum global corporation tax rate, which would avoid countries undercutting each other with lower tax rates. This global minimum corporation tax rate will start at 15% and be operated on a country-by-country basis. As such, pillar two seeks to create a more even playing field and crack down on tax avoidance.
This pillar is expected to catch more companies than pillar one, with up to about 8,000 multinationals being included according to US Treasury secretary, Janet Yellen.
So, what does this bill mean for corporate taxation? Under the global minimum corporate tax rate, each country would collect the underpaid taxes of its multinationals. Therefore, if a UK-based company has operations in another country with lower tax than the minimum rate, the UK would then impose an additional tax on those profits until they reach the minimum rate.
As stated by the US Treasury secretary Janet Yellen, “a global minimum tax would end race-to-the-bottom in corporate taxation, and ensure fairness for the middle class and working people in the US and around the world”.
In addition, digital businesses that operate across the world, but only declare small profits in each country, will be caught by the agreement. This means that large tech corporations may have to pay more tax in different places.
Interestingly, however, it appears that tech giant Amazon would avoid the pillar one taxes due to the fact that it falls outside of the 10% profit margin threshold, with a profit margin of only 6.3% in 2020. It is expected that the UK and US will push for the scope of this bill to be expanded to capture specific parts of Amazon within its jurisdiction and to raise more tax from other large corporations.
This issue may be resolved through an approach known as ‘segmentation’, which means that profitable parts of businesses would pay tax in their own right. As such, Amazon would have to pay tax on profits of its subsidiaries, such as Amazon Web Services (AWS), which made a profit margin of 30% in 2020.
Last October, the OECD estimated that as much as £57bn ($81bn) additional tax revenues would be raised each year under the reforms. Under pillar one, between $5 and $12bn would be brought in, whilst under pillar two, between $42bn and $70bn would be collected.
However, countries such as Ireland could look to lose business – up to €2bn (£1.7bn) a year according to its finance minister, Paschal Donohoe. This is because they levy corporation tax at lower rates, whilst also having lower rates for profits on patents.
The UK’s chancellor of the exchequer, Rishi Sunak, said that “these seismic tax reforms are something the UK has been pushing for and a huge prize for the British taxpayer – creating a fairer tax system fit for the 21st century”.
Whilst multinational and digital corporations have been developing over time, some of the taxation systems in place have not yet developed in tandem. These new developments mark an important step in re-negotiating global taxation to suit the nature of contemporary business modes and practices.
In addition, initial responses from tech corporations have generally appeared positive. A spokesperson from Amazon said that the agreement is a “step forward” in bringing “stability to the international tax system”, whilst a Google spokesperson told Reuters that “we strongly support the work being done to update international tax rules”.
It seems that even Facebook has welcomed the changes, with Vice‑President for Global Affairs and Communications, Nick Clegg, stating that “Facebook has long called for reform of the global tax rules and we welcome the important progress made at the G7”.
However, this does not mean that the deal has been without criticism. Campaigners such as Oxfam have argued that the global minimum tax rate of 15% is too low; Joe Biden himself proposed higher rates of 21%. Labour shadow chancellor Rachel Reeves also said that Britain must fight harder for the 21% proposal. However, as it had been stated that the 15% is the minimum tax rate, there is potential for this to be negotiated to a higher percentage in the future.
The BBC has also reported that in the UK, corporation tax is already at 19% and is set to rise to 25% by 2023 in response to spending during the pandemic. This demonstrates how the 15% may be a starting point from which increased taxation can develop over time.
The overarching response seems to be one of cautious hope for both future tax reforms and for the contributions these resulting funds may allow. When speaking with the BBC, chief executive of the Tax Justice Network, Alex Cobham, stated that “we’ve got one step of the way today – the idea of a minimum tax rate – what we need is to make sure that the benefits of that, the revenues, are distributed fairly around the world”.
Whilst this historic deal has been made between the G7 countries, negotiations still need to be made with several other leading countries including China, India, Brazil and Russia. In addition, in the US the deal must be passed into law by both houses of Congress. The G7, however, hopes that their agreement and its strong message of unity will generate momentum for these additional counties to agree to deals themselves.
Following the G7 meetings, more than 130 countries will be participating in a parallel exercise to agree on a global tax framework as part of a deal by the Organisation for Economic Cooperation and Development in October.
Whilst it may take months and even years of discussion and development for these new tax practices to come into full force, it seems that the G7 deal sets a precedent for taxation regulation reform moving forwards. Hopefully, these discussions will be the starting point of a process that has the potential to develop further in the future.