Taxation is the core activity of the state. If a state cannot effectively tax it quickly ceases to be an effective state and in extreme cases, a state at all. While taxation may be at the heart of the state and citizens enjoy the benefits it provides in roads, hospitals, schools and many other fruits of the public purse, that does not mean that is an enjoyable practice. The dislike of taxes and tax collectors is so pervasive as to even feature in the Bible.
The advent of footloose multinationals and a world of “capitalism without capital” has given rise to aggressive tax practices across the world. The sterling work by economist Gabriel Zucman, now of the European Tax Observatory, has highlighted the deterioration of global public revenues following the tax practices of companies and high net worth individuals, along with complicit national governments. This all came to light in 2013 with the US Senate Committee on Investigations hearing on offshore profit shifting brought about the Pulitzer Prize winning 2012 reporting at the New York Times in “How Apple Sidesteps Billions in Taxes”.
In this series of blogs, we aim to explore the global response to this situation. Since 2013 the OECD has been working on the Base Erosion and Profit Shifting BEPS Programme as a multilateral solution to this problem of global taxation.
Why is taxation so difficult?
One of the earliest authors on economic topics was Jean-Baptiste Colbert (1619-1683), the finance minister to Louis XIV. His definition of the art of taxation has come down to this day as the most singular articulation of the practice:
The art of taxation consists in so plucking the goose as to obtain the largest amount of feathers with the least possible amount of hissing.
Adam Smith (1723-1790), the father of economics, stated how to achieve this in his canons of taxation - fairness, certainty, convenience and efficiency - found in Book 5, Chapter 2 of The Wealth of Nations.
There are many different taxes levied to ensure the operation of the state. We are all too aware of personal income tax, and the bite of value added tax and excise tax at the supermarket checkout or petrol pump, but corporate taxation is much more complex. The world of tax seeks to tax income and profits. For income tax purposes, there are two central taxation systems: worldwide and territorial. These systems rely on residence and source of income.
As individuals and entities engage in cross-border operations, rules allocate the income and profits among governments. These rules link the item of income with the territory (i.e., nexus) and the rules are applied to allocate taxing rights to the source state and the residence state.
As stated, changes to the practices of global commerce changed the rules of the engagement with respect to taxation. According to the OECD, governments lose around USD 100-230 billion annually in global corporate income tax revenue alone. Consequently, the OECD led a multilateral response since 2013 made up of its 125 members to address the challenges of digitalisation — the result was the formation of the BEPS (Base Erosion and Profit Shifting) project.
The OECD BEPS project has been an ongoing exercise among the OECD nations to address global taxation problems. The challenge to more effectively tax the revenue in a digital world was highlighted as a critical action area in a bid to tackle the base erosion and profit shifting problem. The BEPS project aims to provide governments with tools to tackle tax avoidance. These tools are grouped into 15 actions to target different areas.
The OECD BEPS project has recently entered an implementation phase, proposing two pillars for international coordination: Pillar One, on global profit allocation and nexus rules, and Pillar Two, on global minimum taxation.
The rise of the intangible economy and aggressive tax practices by multinational firms over the last decade triggered a backlash, first seen in the US Congressional hearings, highlighting the deficient levels of tax paid by globally notable companies such as Apple. This resulted in legal actions taken by the European Commission against Ireland and Apple on the matter of illegal state aid and the escrowing of €13bn in potential tax liabilities. The US government responded with the GILTI (Global Intangible Low-Taxed Income) tax in 2019.
Since last year, the OECD has been working on a final project to tackle the challenges related to allocating the revenue and a minimum tax rate. At the end of last year, a Blueprint project for Pillar One and Pillar Two was released by the OECD and subjected to a round of consultations with the stakeholders, comprising representatives from digital business, manufacturing, retailers, and pharma MNEs (multinational enterprises).
The aim of BEPS Pillar One is to introduce a tax policy to reallocate the taxing rights 'where economic activities generating the profits are performed and where value is created'—built upon the awareness of a new paradigm due to the growing importance and reach of the digital economy. As the digital economy has become increasingly integral to all sectors around the world, the goal of Pillar One is to achieve international consent over a new set of rules that aim to adapt the international taxation order to a new status quo. A plan to reach this goal is to have a set of rules, acknowledging the new digital business scenario, which will determine the allocation of part of the revenue to the marketplace.
On the other hand, Pillar Two of the BEPS framework proposes a global anti-base-erosion (GLOBE) to ensure that profits are taxed at a minimum effective rate. It also restrains the taxpayers’ ability to erode a jurisdiction’s jurisdiction tax base—for example by using intragroup deductible payments. Proposed benefits of the implementation of minimum tax rules worldwide are that MNEs would be taxed in their jurisdiction, thus helping countries to meet their revenue needs and levelling the playing field between foreign and domestic companies.
Significant developments have occurred in recent months – an overview of these events is presented next – and with the increased momentum and urgency of settling a global policy to deal with the tax challenges arising from the digital economy, further significant developments are imminent.
Moving towards an agreement
On 14 and 15 January 2021, a public consultation meeting on the Pillar One and Pillar Two Blueprints was held virtually, with representative voices from digital business and other MNEs, academia, and civil society.
Later, on 28 January 2021, as part of the 11th plenary meeting of the OECD/G20 Inclusive Framework on BEPS, national government views were expressed in a panel discussion between Finance Ministers.
In both meetings, the vast majority jointly expressed strong support to achieve a global/international consensus-based solution instead of unilateral measures. Notably, the US willingness to reach an agreement as Biden’s administration settled, was repeatedly emphasised. The alignment of all these factors lends weight to the idea that we have at this moment a unique window of opportunity to achieve consensus for a global solution.
This fresh impetus from the US administration can be seen in their business tax agenda for the coming years. As well as a displayed intention to engage in the global arena to build an international tax framework, the fixing of 21% as the new GILTI minimum tax on a per-country basis suggested the US ideal rate for a global minimum corporate tax. The US tax plan sparked a specific discussion around the to-be-agreed minimum tax rate, turning the tax rate into a mechanism for tax harmonization by itself and displacing the discussion from nexus and allocation renewal.
This was followed by a statement from the Minister for Finance for Ireland, a country which has a corporate income tax rate of 12.5% and a composite effective average tax rate (EATR) of 12%. The Minister for Finance stressed the vital role that advances in technology, pharma, and biotech is playing throughout the pandemic crisis, as well as their relevance to achieving the recovery of all society. In particular, it was highlighted how technology has played an essential role in keeping businesses, governments, and households functioning. The benefits for society, in ensuring that tax systems are clear and stable, and that they remain supportive towards research and development, were emphasised.
One month later, on 12 May 2021, the European General Court annulled a 2017 ruling by the European Commission that Amazon's tax deal with Luxembourg had amounted to illegal state aid, thus reversing a decision that would have required Amazon to pay about €250 million in back taxes to Luxembourg.
On 18 May 2021, the European Commission published a Communication setting out the EU tax agenda and policy framework for business in the 21st Century. This Communication outlines five actions, featuring among them the creation of a single corporate tax rulebook for the EU (i.e., “Business in Europe: Framework for Income Taxation” or BEFIT) involving the consolidation of the profits of the EU members of a multinational group similar to Pillar One revenue sourcing rules. It is also worth noting that the EU strategy for data includes plans to create a single market for data to ensure competitiveness.
On 5 June 2021, the claim to have found the ideal minimum tax rate to shape “a safe and prosperous future for all” was made by the G7. Following the OECD BEPS Pillar One, the United Kingdom, Canada, France, Germany, Italy, Japan, the United States, and the EU, committed to awarding the market countries at least 20% of the profit exceeding a 10% margin for the largest and most profitable MNEs. Also shadowing Pillar Two and GILTI, G7 countries committed to a global minimum tax rate of 15% on a country-by-country basis. These commitments were expected to be agreed upon at the July meeting of G20.
As of 5 July 2021, the OECD reports that “131 countries and jurisdictions have joined a new two-pillar plan to reform international taxation rules and ensure that multinational enterprises pay a fair share of tax wherever they operate”. Ireland was notably absent, reflecting the importance of the MNC sector to Ireland as well as its 12.5% rate of corporate tax, which can often be much lower at the effective rate. Ireland’s logic behind this decision has been informed by a desire not to damage a foundational support to the economy in the form of the tax rate while the OECD agreement still awaits the approval of the US Congress. It is likely that the success of the OECD’s proposal will hinge upon the agreement of the US Senate with the White House. Taxation is inherently political, and all politics are local.
The discussion on a global tax policy has been centred on the tax rate, but there are wider issues. From a cursory look at the performance of the statutory corporate income tax rate for resident corporations, it is noteworthy that in the last 15 years — out of 109 countries — just 14 jurisdictions decreased their corporate tax rate while 29 remain unchanged. Conversely, 66 jurisdictions had raised the tax rates.
To frame the G7 announcement to commit to a global minimum tax rate of 15% on a country-by-country basis within a particular context, Hungary, Ireland and Switzerland top the list of countries that had a tax rate below 15%, with Canada, Maldives, and Mauritius among the countries having a corporate tax rate at 15%, according to the OECD.Stat data and metadata for OECD countries and some non-member economies.
There are different causes that affect the core concern — tax revenues lost — with multiple side effects in society. To reduce this concern to a tax rate ignores the existence of other factors such as the effective tax rates targeted to specific industry or income types, deduction rules, arbitrage between equity and debt financing, Controlled Foreign Company rules, Transfer Pricing rules and the scope of terms.
The G7 announced that, to some extent, a percentage of the tax would be reallocated to the countries where the MNEs operate. There is a lot yet to be discussed around the term “operation”, which falls under the so-dismissed Pillar One. Moreover, when discussing Pillar One, stakeholders pointed out the lack of understanding of some digital businesses, for the classification into automated digital services (ADS) and consumer-facing businesses (CFB), and the compliance of rules to track the source of the revenue.
An urge to change the status quo of international taxation to recognise a new reality has been the main driving factor behind recent global tax policy discussions and plans for change. This change is expected to be through adapting the scope of basic tax terms and understandings and is an issue wider than tax rate alone.
However, it was not anticipated that the new international tax order would be decided in the middle of the pandemic and economic crisis, where the reliance in the digital economy and development has been a lifesaver for individuals, business and governments.
It is not a surprise that, throughout the discussions over recent years, governments and stakeholders highlighted one key criticism: the Pillars are overcomplicated. Perhaps that is the main reason the focus and the starting point is set in a more tangible solution: the minimum tax rate. There is a tight schedule, pressure on governments' and companies' finances, oblivion for double taxation, and current domestic solutions. Overall, it is a massive paradigm shift in international cooperation and multilateralism.
As important as it is to start consenting on these minimum tax rules, BEPS, GILTI, GLOBE, and now BEFIT share an interest in addressing the rise of the intangible economy and aggressive tax practices by multinational companies, highlighting the very low levels of tax paid by globally, an issue which is broader tax rate alone.
Lastly, it is worth asking questions of this latest round of policy solutions: Has the G7 hit the taxation sweet spot? Will this tax rate put to an end the so-called “race to the bottom” in tax rates?
All articles posted on this blog give the views of the author(s), and not the position of the IPR, nor of the University of Bath.