A LOOPHOLE LESS

Recovery of the global economy hit by the coronavirus pandemic is progressing at a steady pace. This is the conclusion made by the G20 leaders, who gathered in Rome at the end of October to discuss joint actions during the pandemic, measures to eliminate its consequences, as well as plans to curb the growing global warming.

But this meeting will likely be remembered for adopting the new rules of the international tax system, which had remained unchanged in the past hundred years.

Lower and lower

Active development of digital technologies has long required urgent measures to change the rules governing, among other things, economic relations. The sphere of taxation is no exception.

Over the past thirty years, there has been a debate about whether the international (corporate) income tax rules developed over a century ago were suitable in the modern global economy. They once helped eliminate double taxation by stimulating global trade. However, new business models do not fit the existing rules. In addition, modern technology makes it easy to evade taxation by moving profits to jurisdictions with lower tax rates.

For example, fiscal authorities in many countries are unsuccessfully trying to find ways to tax digital giants like Facebook and Google, which make money in almost all corners of the world, but are not accountable to local jurisdictions, since they do not have representation there. It's hard to fight alone. And coordinating your actions is even more difficult. After all, the right to tax is the essence of any sovereign power.

However, there is nothing to blame transnational corporations for. Indeed, instead of jointly solving the common problem of avoiding tax obligations, countries compete with each other to provide these companies with the greatest possible favourable conditions so that they register their headquarters in their jurisdictions. It made sense in the past when the companies could settle in the country, set up a factory and created jobs, hence giving something in return for those favourable conditions. But the giants of the new digital era have learned to simply move profits virtually from the regions where they do business to those where they will pay the lowest taxes.

Back in the early 1980s, according to the Tax Foundation, the average global corporate tax rate was 40%. By 2020, this figure dropped to 22.57%. The highest rate is in the Comoros (50%). The only industrialised country in this top twenty is France (32.02%). And the first three countries with the smallest corporate tax rates are Barbados (5.5%), Uzbekistan (7.5%), and Turkmenistan (8.5%).

However, this does not mean that large companies immediately rush to open their offices in these countries. Location, infrastructure, legal security, and other conditions play an important role in the choice. Therefore, companies such as Google, Microsoft, Amazon, Apple, Facebook and so on opened their offices in Ireland, where the tax rate is 12.5%. As a result, corporate tax revenues in this country increased from €4 billion in 2013 to €12 billion in 2020.

Higher and higher

An uncontrolled global competition to lower the corporate tax rates sooner or later may well lead to its complete zeroing, which becomes increasingly visible due to many loopholes in national jurisdictions. Moreover, we all understand the unfairness of such a privileged position for large transnational corporations amid the growing tax rates and risks for smaller businesses. In addition, the COVID-19 pandemic demonstrated how the world's largest digital corporations continue to profit even at the tough times for the global economy.

Profit growth over the past two years for big tech companies like Facebook, Amazon, Netflix, Alphabet, Google, Apple, and Microsoft has been staggering. Amazon's stock value has risen 62% over the past year, with the business valued at $1.7 trillion, up $650 million from a year ago. Apple shares rose 70% over the same period increasing the company’s capitalisation value over $1 trillion up to $2.3 trillion.

Recent studies show no signs that this growth will slow.

Ireland got convinced

Back in 2012, the G20 summit decided to develop universal measures that can help countries eliminate tax loopholes that allow companies to manipulate profits. This was the task of the Organisation for Economic Cooperation and Development (OECD). However, all these efforts remained in vain for a long time, largely because of the reluctance of the US, the largest economy in the world and the homeland of the vast majority of global multinational companies, to actively participate in this process.

This position changed under the Biden administration, which in April 2021 called on the world's largest multinational companies to pay taxes to national governments based on their sales in each country. The US government proposed a formula according to which only the largest and most profitable companies in the world will be subject to the new rules. Washington also wanted to set a global minimum tax rate at 21%.

However, this high minimum level was opposed by countries such as Ireland and Hungary, which in 2017 sharply cut their tax rate from 19% to 9%, which is the lowest figure in the EU.

During discussions, the parties agreed on the wording ‘at least 15%’, which may mean an increase of the tax rate in the future. But after long and bitter disputes, mainly with Ireland, the final agreement was reached upon ‘exactly 15%.’

Additional billions

It seems that the nearly ten-year debate about what should be modern global fiscal policy has come to an end. The G20 summit approved a plan to be launched in 2023. Before that the parties will detail the treaty and ensure its approval by the national parliaments.

There are two parts to tax changes. The first part obliges the largest global companies with annual revenues of at least $20 billion to pay taxes in the countries in which they conduct their business and make profit regardless of the companies’ representative offices, branches or subsidiaries in the countries they operate. According to the agreed terms, this will distribute 25% of the residual profit in excess of 10% of the company's revenue. According to OECD estimates, this provision will allow for an additional distribution of about $125 billion annually between the national jurisdictions that will sign the agreement. As of today, the heads of 147 countries have expressed their consent.

The second part sets an international minimum corporate tax rate of 15% for companies with annual revenues of at least €750 million. Global Minimum Tax Agreement aims not to eliminate, but to harmonise the limitation of tax competition. This will allow countries to collectively receive an additional $150 billion in annual tax revenues.

Other benefits of this agreement are expected from the stabilisation of the international tax system as a whole.

An Amazon-sized loophole

Undoubtedly, this is a huge step forward in finding effective solutions for the global economy. Many economists believe that the threshold of 15% is too low and would be more effective at 21% or even 25%. However, it is not that simple. Even in this form, the agreement may not come into effect.

Although the G7 member states concluded a comprehensive agreement, the details of how to divide the revenues of large corporations into their constituent parts for taxation have not yet been agreed. Richard Murphy, a professor at Sheffield University, believes that the 10% profit threshold seems unconvincing due to different business models from different companies. According to Murphy, different approaches to reporting profits in each country will allow companies to transfer profits to their unprofitable structures to make it remain below the 10% threshold.

There is an Amazon-sized loophole in the clauses of the agreement dealing with the excess profits tax, the Guardian reported.

Amazon is one of the largest businesses in the world, with sales reaching $386 billion (2020). In Europe, sales of Amazon’s Luxembourg-based subsidiary reached €44 billion. At the same time, the company paid... zero corporate tax. The overall profitability of the company in 2020 was 6.3%. This is because, according to the documents, most of the profits are reinvested in the business.

According to Alex Cobham, executive director of the Tax Justice Network, “if the OECD cannot solve the Amazon problem, it will not only fail to meet the public demand for justice, but it will show other large multinationals how to get around these tax reforms.”

Perhaps, this is not the greatest difficulty of the agreement in question.

Although the conclusion of the agreement was possible thanks to the United States, it can effectively make it void as well. In fact, the initiator of negotiations was the Democratic president Joe Biden, while his Republican counterpart was categorically against the deal. The part of the agreement dealing with the division of the (mostly American) companies’ income around the world must be ratified by the Senate majority (two-thirds of the votes). These are the rules as far as international treaties are concerned. Democrats don't have that many votes. However, the US Treasury Secretary Janet Yellen believes that the next year the presidential administration will find a way to join the agreement.

Everyone is waiting

Everyone understands the importance of a global tax agreement. In addition, many other global problems need to be solved too, including those related to climate change.

According to the head of OECD, Matthias Kormann, the experience on international taxation will come in handy when setting up a comprehensive pricing system for carbon and other hazardous emissions.