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A lot has happened over the last months with respect to international tax harmonisation. Joe Biden’s early-April announcement of a vast revamp of corporate taxation in the US – the “Made in America Tax Plan”- already put an end to several decades of corporate income tax decreases. And at the beginning of June the agreement reached by the G7 set up the foundations of an international framework for the taxation of multinational companies.
These events are, perhaps, the first milestones of a new cycle of international tax harmonisation after “thirty-year race to the bottom on corporate tax rates”, in the words of the US Treasury Secretary Janet Yellen.
SINCE THE BEGINNING OF THE 1980S, MORE AND MORE TAX COMPETITION
Since the beginning of the 1980s, the cycle of deregulation has led to increased tax competition between states and, as a result, to a gradual decrease in effective corporate tax rates. The average global corporate tax rate has thus fallen from 40% in 1980 to 24% in 20191. The pros and cons of this tax competition are debatable. Its defenders will see it as a protection against the supposed tendency of governments to increase the tax pressure on companies. Opponents will point to the inequity of taxation between different economic actors. Irrespective of one’s personal opinion, it is a fact that tax competition represents a loss of revenue for states and erodes their ability to implement public policies.
Indeed, the OECD estimates that this loss of earnings represents between USD 100 and USD 240 billion per year in the OECD and between USD 500 and USD 600 billion per year on a global scale2, which is very significant.
The downward trend in average corporate tax rates by region (OECD)
Faced with the erosion of their tax base, states have progressively strengthened mechanisms to fight against tax optimisation over the last two decades. In 2000, the OECD published for the first time a list of tax havens. Then, in 2009, the G20 in London established the principle of sanctions against non-cooperative jurisdictions in terms of banking secrecy. In 2015, the OECD launched its “inclusive framework on base erosion and profit shifting (BEPS)” which coordinates the efforts of 125 countries to reduce tax optimisation. On the EU side, the ATAD directive on combating tax evasion that came into effect in 2019 has already limited some common optimisation practices. Moreover, a project to establish a common consolidated corporate tax base (CCCTB) is currently being debated in the Council.
THE BIDEN INITIATIVE: A CORPORATE TAX RATE OF AT LEAST 15%
In early April, at a G20 summit, U.S. Treasury Secretary Janet Yellen made a strong announcement that work was underway to set a minimum corporate tax rate. At the end of that month, the Biden administration again showed its determination by proposing that OECD member countries adopt a rate of at least 15%, with the explicit objective of raising it to 21%. And finally, at the beginning of June, the finance ministers of the G7 countries announced an agreement on a global minimum tax rate. In spite of several negative reactions here and there, this agreement truly represents a breakthrough in international coordination on corporate taxation, and it could be a starting point on the road to global reform. The agreement includes two pillars.
The first pillar essentially establishes a right for jurisdictions to tax multinational companies based on the country where revenues are realised, and not where profits are declared. This is a particularly effective measure for the taxation of multinational digital companies. And more generally this would reduce the incentive of profit-shifting to low tax countries.
The second pillar gives jurisdictions a right to “tax back” when other jurisdictions abroad applied a lower level of income taxation. This measure would create de facto a global minimum corporate income tax rate for multinational companies, thus side-lining many tax havens.
THE DEVIL HIDES – PERHAPS – IN THE DETAILS
In any case, the G7 agreement is a breakthrough in regard to international tax harmonisation. That being said, it may not – yet – truly derail tax optimisation. A first limitation to this agreement is that it only applies to companies above a 10% profit margin threshold, and only to 20% of the profits realised above this threshold. This means that a company such as Amazon, to choose the most mediatised example, may not be concerned. This was denied by U.S. Treasury Secretary Janet Yellen. Yet, it remains to be seen how jurisdictions would ensure this.
The details of the agreement will be determining. A key point will be whether the final agreement includes an approach known as “segmentation”, meaning that jurisdictions could calculate taxes based on companies’ revenues by segment, and not only at company level. This is particularly relevant for companies like Amazon, where one division is highly profitable, while the overall entity’s profit margin is below the 10% threshold. On the first Pillar, such “details” will be decisive.
Next, G7 members will have to convince other countries – and notably China – to join the agreement, starting with the G20 finance taking place from the July 10. The deal also needs to be passed at the US Congress. At the EU level, it could then be passed into law under the French presidency of the Council, during the first semester of 2022.
In any event, the G7 agreement will remain a historical step. It lays the foundations for an international fiscal framework for the 21st century, adapted to a globalised, digitalised economy. Some have criticised the 15% rate as being too low, as most multinational companies are already complying with it. Yet, this agreement is a first step, and it is establishing instruments to tackle the most aggressive forms of corporate income tax optimisation.
THE PANDEMIC AS A TRIGGER, BUT A TREND FOR THE MEDIUM TERM
The Biden initiative and the statements that accompany them, mark a turning point in the attitude of the U.S. administration towards tax optimisation, and multinational companies in general. The new American voluntarism may well be initiating a cycle of rising corporate tax pressure, regulatory tightening and international tax harmonisation. The heavy economic impact of the anti-Covid measures has made it necessary for governments to implement costly stimulus plans, even though their budgetary leeway is – in most cases – limited. In this context, the Biden administration has clearly expressed its willingness to find these additional budgetary resources – up to USD 2 trillion– through corporate tax increases. The new measures against tax optimisation play an essential role in this, since they must prevent companies from escaping these tax hikes.
In the medium term, beyond the Covid19 crisis, and given the US political context critical of growing inequality, we can expect that the momentum against tax-optimisation will continue in the US, as in most OECD countries. These structural changes may continue to impact the financial markets in coming years and could herald a progressive regaining of control by governments over multinational companies.
1JP Morgan Cazenove, The Long-View: Towards a global minimum corporate tax?, Avril 2021