India, the U.S., and other countries with hundreds of millions of consumers and large import markets could rake in a bigger share of multinational tax revenue under a plan to change global tax rules.
The Organization for Economic Cooperation and Development plan, green-lighted by Group of 20 finance ministers at a June 9 meeting in Japan, aims to rewrite how multinationals are taxed amid growing concerns that the world’s biggest companies, especially tech giants, aren’t paying enough tax or aren’t paying it in the right countries. Countries like France, the U.K., and Italy have already launched unilateral efforts to tax the digital activity of companies like Facebook Inc. and Alphabet Inc.'s Google.
The OECD outlined two approaches: a global minimum tax and new rules to give more tax revenue to “market” jurisdictions where a company’s consumers are located. The organization is now working on an impact assessment that would give 129 countries—who must agree to a revamp by the end of 2020—a clearer idea of who would win and lose under the proposals. The analysis should be completed in October, the OECD said in a June 11 webcast.
“The devil’s in the details, but here the details might be worth billions,” said Stefano Giuliano, a partner at CMS Adonnino Ascoli & Cavasola in Rome. “Changing one tiny feature of any proposal might cause billions to move from one country to another.”
The OECD’s blueprint already gives a hint of how countries will carve up corporate taxes.
The biggest winners under the new plan would likely be market jurisdictions like India.
Despite having billions of consumers, India doesn’t get a very big bite of multinationals’ corporate profits under traditional tax rules that allocate the bulk of taxable profits to the jurisdiction where a company locates important functions, assets, or risks. But the new rules would change that.
“If you define winning as gaining more tax revenue, then India has a lot of opportunity for different scenarios to result in higher tax revenue,” said Daniel Bunn, director of global projects at the Tax Foundation—though the details of the profit reallocation could affect businesses’ location decisions in a way that could also ultimately impact countries’ tax revenue, he added.
Other countries with large—and growing—populations of consumers could stand to gain from this proposal, Bunn said—like China, Mexico, and other Latin American nations, and any developing country that is “moving into a position where it’s purchasing higher-value goods,” he said.
“That question of how profit is allocated to market countries I think is the key question, and the key to restoring stability to the international tax system,” Brian Jenn, Treasury’s deputy international tax counsel, said June 3 at a U.S. Council for International Business/OECD International Tax Conference in Washington.
The result of that reallocation won’t be clear for many countries until the OECD plan is finalized.
Some European countries are a market for U.S. digital services companies, but an exporter for other types of goods or services they sell into Asia, Pascal Saint-Amans, director of the OECD’s Center for Tax Policy and Administration, said on a May 23 call with reporters.
For example, France is a market country for U.S. digital services companies that sell to French users, but an exporter of luxury brand products.
That’s why the U.S. is pushing for a solution that focuses on companies with valuable marketing intangibles instead of only digital companies, said Marlies de Ruiter, global international tax services policy leader at EY in the Netherlands.
The net outcome for most countries—including the U.S.—will depend on how the plan is ultimately designed, including what type and how much of a company’s profits it reallocates.
The U.S. may be a large importer with a large market—so it would stand to gain under a market-focused profit reallocation—but it’s also home to many highly profitable, intellectual property-heavy companies, said Will Morris, chair of the Business at OECD Committee on Taxation and Fiscal Policy and deputy global tax policy leader at PwC in Washington.
If the plan ultimately targets only highly profitable companies, or only profits from intangibles, the U.S. could lose revenue, Morris said.
Reallocation will take taxable profits away from the countries where IP and products are designed, developed, and made—particularly affecting export-heavy nations like Germany and Sweden.
A February study commissioned by the Confederation of Swedish Enterprise estimated that foreign residual—or above-normal—profits make up about 18% to 21% of Nordic countries’ tax revenue, and about 17% of Germany’s. “If the marketing intangibles approach is introduced, the bulk of this corporate tax revenue would be allocated to other countries,” the report said.
But the extent of the damage will depend on how the new rules are designed, de Ruiter said. If the threshold for “above-normal” profits is high enough, many companies’ profits could end up relatively unaffected. For example, companies with valuable intangibles may be high-margin, but companies with low margins or high manufacturing costs might not make enough profit to have their profits reallocated, she said.
The global minimum tax could let exporting countries like Germany make back some of the revenue it would lose under a profit reallocation—described as the “first pillar” of the OECD plan—if the countries can collect additional tax from the foreign entities of companies headquartered there. But whether they can do so would depend on how the tax is designed.
But revenue gains might not be substantial if other countries raise their tax rates, so there is little or nothing for the headquarters country to charge in a “top up” tax, de Ruiter said. “More importantly, it will take away some of the tax arbitrage incentives and level the playing field more. “
Countries giving up revenue will need something else back in return: tax certainty, or some guarantee that what they see as revenue-grabbing practices, such as overly aggressive audits, will stop.
“How much certainty can be ensured by the emerging economies, which will probably get more taxing rights, and how do you bargain more taxing rights in exchange for tax certainty?” Saint-Amans said at the June 3 event.
The minimum tax rules would also likely hurt very low-tax jurisdictions, Saint-Amans said May 23.
The OECD’s years-long project to crack down on base erosion and profit shifting (BEPS) already shut down many of the tax incentives that jurisdictions like the Cayman Islands used to attract businesses.
Under minimum tax rules, “they’ll likely be hit very hard,” particularly when their economies rely heavily on services connected to creating tax efficiencies, de Ruiter said. A global minimum tax would lower a company’s incentive to locate to a low-tax jurisdiction.
That blow could be softened if the minimum tax rate applied to a company’s “blended” effective global tax rate, rather than the rate that each of its entities pays, she said. That’s because a company could still partially structure into a very low-tax jurisdiction to lower its overall rate.
To Be Determined
Countries like Ireland and Luxembourg have attracted the regional or world headquarters of tech giants like Facebook and Amazon Inc. They offer incentives such as educated workforces and business-friendly infrastructure, with tax as an important part of the package: Ireland has a 12.5% corporate income tax rate.
Reallocating profits to market jurisdictions would likely take a bite out these countries’ tax revenue because they don’t have big enough populations to win under a reallocation to markets, Giuliano said. And if a minimum tax rate—described as the “second pillar” of the OECD plans—lands above 12.5%, it would be a big problem for Ireland.
“The Irish situation on pillar two will be tricky,” Bunn said. “If the rate becomes the minimum or something close to it, then it gets to questions of Ireland’s competitive advantage for attracting mobile tax bases, which is something they’ve relied on a good deal.”
A minimum tax could actually allow a very low-tax hub country to collect more revenue, if it raises its tax rate to meet a minimum threshold, Morris said.
Even if they are at the minimum rate, these hubs could still be more attractive than larger countries with higher tax rates, he said, meaning they could see increased revenue from higher rates while still remaining competitive.
“So a result of the minimum tax proposals could in fact be that some of those hub countries end up collecting more tax as a result, and larger countries don’t,” Morris said.
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