From June 11-13 in Cornwall, England, leaders from the G-7 group of industrialized nations affirmed a proposal to rewrite international tax rules for multinational corporations.
While still in its infancy, the U.S. Treasury Department, President Joe Biden’s administration and many European nations have come together around a preliminary deal to enact a global minimum corporate tax rate of 15%.
Here are four things you should know about how the minimum rate plan would work and which companies it may impact:
— Right now, corporate tax rates are relative.
— The global minimum tax plan rests on two pillars.
— Tech comes under fire, again.
— Hear a lot, but don’t expect too much.
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1. Current Corporate Tax Rates Are Relative
In 1980, the average worldwide corporate tax rate was 40%. That figure has declined over time to around 23% as of last year. Currently, the U.S. has a corporate tax rate of 21%, but many companies pay an effective tax rate that’s much lower.
In 2020, Apple (ticker: AAPL) paid an effective tax rate of 14.4% and Facebook ( FB) paid 12.2%. Meanwhile, Nike ( NKE) and FedEx Corp. ( FDX), which earned pretax incomes of $2.9 billion and $1.2 billion, respectively, paid nothing in federal income taxes. Deductions and provisions explain some of the disparity, but increasingly, corporations have relied on low-tax-rate, “safe haven” countries to reduce their tax burden.
Treasury Secretary Janet Yellen has described the decline in the average global corporate tax rate as a race to the bottom, whereby smaller countries attempt to attract business and economic activity by offering low tax rates.
According to a 2017 report published in the Development Policy Review, corporations now shift between 25% and 30% of gross profits overseas, up from just less than 10% in the 1990s.
For decades, Ireland, which has a corporate tax rate of 12.5%, has successfully attracted major corporations, including Pfizer ( PFE), Google’s parent company Alphabet ( GOOG, GOOGL) and Johnson and Johnson ( JNJ).
What’s more, many island countries keep their corporate tax rates near zero. In 2017, U.S. corporations recorded profits of $58.5 billion in the Cayman Islands, nearly 10 times the country’s gross domestic product.
For years, the Organization for Economic Cooperation and Development (OECD), a global economic organization, has proposed reforms for tax rules prevent corporations from utilizing safe-haven countries to reduce their tax burden. Today, with countries carrying large debt burdens from pandemic relief, governments have increasingly seen global tax reform as a way to shore up necessary revenue for the coming years.
Simply put, “much of the world recognizes that disparate tax regimes can be gamed by multinational companies,” says Ryan Severino, chief economist at JLL. The G-7’s proposal attempts to address and mediate these disparities.
2. The Global Minimum Tax Plan Rests on Two Pillars
In early April, Yellen called for a global minimum corporate income tax rate with full support from the Biden administration.
Since then, international discussions have moved quickly. Earlier this month, finance ministers from the G-7 group formally endorsed a proposal for a new international tax regime centered on two pillars.
The first pillar seeks to ensure that the “biggest and largest” corporations pay income tax in the country where their product is consumed, not just where they establish headquarters.
“A company could have a French customer base and not have any physical presence in that country — and so France might say, ‘You’re selling products into the country but not paying us any income tax,'” says Kate Barton, global vice chair of tax at EY.
This pillar aims to address that issue. Companies with greater than 10% profit margins would be susceptible to additional taxes on 20% of their gross profits in all countries where they provide products and services. This pillar would repeal and replace the digital services taxes, a tax on revenue many European countries enact to claim these lost tax dollars.
The second pillar calls for a global minimum tax of at least 15% on a country by country basis. Importantly, each country’s legislation would require corporations that continue operating in noncompliant countries to “make up the difference” to their home government.
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Combined, these two pillars aim to increase federal tax revenues and prevent companies from exploiting corporate tax loopholes. Elena Mossina, partner-in-charge of Sikich’s international tax practice, says that the “push for a 15% rate is to bring those countries that allow you to keep profit, like Ireland and the Cayman Islands, on the same playing field as everyone else,” and to create parity between each country’s taxing regime.
The “creators of this proposal likely envisioned a world much harder to game by multinationals,” says Severino, who believes the plan “would reduce their incentive to race to tax havens.”
What’s next for the proposal? In July, it will go to the G-20 for discussion and consideration. Then, in October , it will appear before the OECD, which represents 139 countries.
Importantly, “the 139 countries in the OECD would need to enact their own laws” through their respective legislative processes, Barton says. Severino cautions that this “legislative hurdle might be the toughest” challenge the proposal faces.
3. Tech Is Under Fire, Again
Without calling corporations out by name, the G-7’s proposal largely targets multinational technology companies. In the past, many of these businesses have successfully and substantially reduced their tax burden by placing drug patents, software and other intellectual property in low-tax countries while deriving large, untaxed revenue in countries where they lack a physical presence.
“The tech industry performs all their functions in one jurisdiction but can send software downloads and software subscription services to multiple countries without having an office, server or a tech team located there,” Mossina says.
Between 2010 and 2019, Fair Tax Mark, a British tax certifying group, reported that Facebook, Apple, Amazon.com ( AMZN), Netflix ( NFLX) and Google — collectively known as ” FAANG stocks” in investing circles — as well as Microsoft Corp. ( MSFT) saved more than $100 billion by taking advantage of tax havens. Until 2019, Google booked billions of profit in Bermuda. And according to 2020 financial disclosures, Microsoft reported that 86% of its foreign pretax income was generated in Ireland and Puerto Rico, which boast lower tax rates than the U.S.
New regulations and a minimum tax rate would not prohibit these types of tax structures. Instead, they aim to eliminate incentives for corporations to operate headquarters in low-tax countries. Google could stay in Switzerland, but the company will have to make up the tax difference to the U.S.
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Additionally, this global tax plan could give countries the power to collect income tax on profits even if a company does not have headquarters there. For example, imagine if someone purchased a Netflix subscription in Poland. Currently, Netflix, which has a net profit margin of 14.2% and no offices in Poland, does not pay income tax to Poland. Under this proposal, Poland would have the right to tax 20% of Netflix’s gross profit.
“The rules were always written that you needed to have a physical presence in the country in order to be taxed in the country,” Barton says. But, as Barton adds, these new proposals seem to reflect “a fundamental rethinking of that long-standing principle.”
On Twitter, Nick Clegg, Facebook’s vice president of global affairs and communications, said, “We want the international tax reform process to succeed and recognize this could mean Facebook paying more tax, and in different places.” Google and Amazon have both released similar statements in support of the proposal.
Experts believe the repeal of the digital services tax will be a silver lining for many tech companies. This tax, different for each country and applied on revenue not profit, has increasingly become a burden for tech companies. These taxes on gross revenue “can mount quickly and become double or triple taxation,” Barton says.
While these proposals are indirectly targeted at FAANG companies and Microsoft, if enacted, they may end up benefiting these companies by making taxes more certain and less complex.
4. Hear a Lot, but Expect Little
It’s always important to keep numbers in context. Ireland’s corporate tax rate is only 2.5 percentage points lower than the global minimum. Hundreds of sovereign and independent countries must coordinate tax strategy. And, altogether, analysis from the University of California, Berkeley suggests these efforts could raise an additional $60.8 billion in revenue for the U.S., or 28% of current tax revenue.
Attorney Robert Kiggins, the tax practice chair at Culhane Meadows, notes that investment funds, pensions, government entities, international organizations and nonprofits will not be affected, but it all depends on how terms will be defined.
As the plan passes through the legislative process, expect lobbyists from firms and industry groups to influence the bill and carve out exemptions for their clients.
According to Severino, “This proposal seems like more bark than bite, but we will have to see how it unfolds.”
Kiggins emphasizes that these firms will be especially well-advised and move quickly to remain compliant and savvy. Importantly, Mossina says that taxes and regulations respond to broad industry trends and practices, which companies themselves remain largely in control of.
At the end of the day, investors should know that the race to the bottom has now become a slow hike back up. Barton believes that the talks should serve as a warning to all companies that “taxes are going up.”
Takeaway
Global leaders seek to prevent large corporations from skipping out on tax day, helping raise money for public investment through standardizing the global tax code.
The proposal centers around two pillars that call for a global minimum corporate tax rate of 15% and require companies to pay income tax where they sell goods and services. Though it indirectly targets tech firms, these companies largely report to support the bill.
With this proposal, experts believe the devil will be in the details — and the final details are a long way off. Still, this global policy may represent a shift in the relationships between major governments and large corporations.
“I wouldn’t underestimate the attempt here to do something multilateral,” Barton says. “Coming together and trying to unify certain aspects of the global tax system … that’s a big deal.”
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4 Things to Know About a Global Minimum Corporate Tax Rate originally appeared on usnews.com
