G7 Pact on Tax - What does it mean?
16 June 2021
The G7 announcement on tax has made world headlines, but the agreement's substance falls well short of the PR.
It's not too surprising that seven countries whose corporation tax rate is already over 15% have been able to agree they would like large Multi-National Corporations (MNCs) to pay business tax on foreign earnings at least at that rate.
The run-up to the G7 Finance Ministers Summit in London saw the USA make the running despite the UK being in the Chair. US Treasury Secretary Janet Yellen initially declared her support for a global minimum corporation tax of 21%, coupled with a proposal to raise the US domestic corporation tax rate to 28%. The US has committed to funding a $6.0trn domestic, infrastructure and social welfare spending plan. And a global agreement on a minimum corporation tax would lessen the chances of US firm inversions and relocation of activities to lower-tax countries, paving the way for the Biden administration to pursue revenue-raising measures at home. However, pushback from several countries saw the US revise the proposed tax rate down to 15%.
A year’s-long effort to address the business tax impacts of the digitalisation of the global economy by the OECD's Inclusive Framework has been re-energised. Still, US concerns remain over the unfair targeting of its digital businesses, with the EU calling for a significant reallocation of taxing rights on corporations such as Google, Amazon, and Apple. Whilst conciliatory words have been expressed, both sides have reserved their position on this aspect of the deal, with EU countries deferring the withdrawal of their digital services taxes.
Levelling of tax rights
The OECD had proposed moving to more market sales-based taxing rights (known as Pillar I) and introducing a global minimum corporation tax at around 12.5% (Pillar II). The OECD proposals respond to changes brought about by the digital economy, where substantial profits arise with minimal market presence. And the locating of intellectual property rights into lower tax jurisdictions with extensive treaty networks can significantly reduce company tax bills.
Under the OECD plans, approximately 2,300 companies would have more of their profits assessed for tax in the countries where they make their sales, and these profits would be subject to a minimum rate of taxation. The proposals aimed to apportion taxing rights more evenly between countries and discourage profit shifting.
The US proposals pitched as a countermeasure to a race to the bottom on corporation tax rates impact the 100 largest multi-national companies, as determined by revenue and profit margin thresholds. The proposals concede changes in taxing rights to a more market-based system. Still, they are subject to a minimum corporation tax rate of 15%, now only slightly higher than initially envisaged by the OECD.
The G7 Communique doesn't provide for a new Global Tax Agreement but is instead a clear statement of political intent:
"We strongly support the efforts underway through the G20/OECD Inclusive Framework to address the tax challenges arising from globalisation and the digitalisation of the economy and to adopt a global minimum tax. We commit to reaching an equitable solution on the allocation of taxing rights, with market countries awarded taxing rights on at least 20% of profit exceeding a 10% margin for the largest and most profitable multi-national enterprises. We will provide for appropriate coordination between the application of the new international tax rules and the removal of all Digital Services Taxes, and other relevant similar measures, on all companies. We also commit to a global minimum tax of at least 15% on a country by country basis. We agree on the importance of progressing agreement in parallel on both Pillars and look forward to reaching an agreement at the July meeting of G20 Finance Ministers and Central Bank Governors."
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Progress and the implications for the British IFCs
So what does this mean for the OECD and G20 process and the implications for centres like the British IFCs?
The powers who decide the global tax agenda are the G20, including China, Russia, and Saudi Arabia. The rules developed by the OECD's Inclusive framework include a further 139 countries. This work will now progress, informed by the G7 Communique, and scheduled to report in time for the October G20.
It's essential to be clear that the headline rate of 15% doesn't mean that all countries must increase their rate to this level, but multi-national profits will be subject to a 15% minimum effective rate on foreign earnings. BUT only 20% of profits above a minimum threshold of 10% are up for reallocation to market-based taxation. Some gains may be reallocated and taxed by countries where sales conclude.
There has been media speculation that the G7 plan will limit small state IFCs such as the British Crown Dependencies and Overseas Territories (CDOTs), requiring them to overhaul their tax systems. Still, there is scant evidence to support such a view
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Focus of the US & OECD proposals
The US and OECD proposals target the most significant global trading companies without differentiation by sector, with US domestic and EU markets being the main focus. The changes made through the OECD Base Erosion and Profit shifting measures, the EU's economic substance requirements, and the US GILTI tax mean that British centres with limited treaty networks are already likely to be an unattractive proposition for hosting this kind of business.
As ready adopters of international standards, there is little doubt that the CDOTs will subscribe to any new global standard on corporation tax in their capacity as OECD Inclusive Framework members.
The CDOTs primary role is to package and distribute international investment capital taxed in the investor's hands. There is universal agreement between the major players, including the US and the OECD, that this activity should not be in scope. It supports wealth and job creation and will be a crucial enabler of pandemic recovery efforts.
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