G20 Countries Seek Never-Before-Seen Global Tax Reform in Ambitious Initiative
Introduction
Finance Ministers of the G20 countries have finalized a framework for the implementation of the most ambitious global tax reform since the beginning of the 20th Century. At least 8,000 companies across the globe are expected to be affected.
Efforts to implement a major tax reform at a global level have been taking place between the world’s top economies since the aftermath of the 2008 crisis. The latest world-wide reform took place in Paris in 2020 between 135 countries, at the Organization for Economic Cooperation and Development (OECD), whereby a blueprint for a two-pillar reform was introduced. On June, 5th 2021, the G7, comprised of Canada, France, Germany, Italy, Japan, the United Kingdom, the United States and the European Union, agreed in London to implement the ambitious two-pillar global tax reform mechanism. Developments were made in Venice between 8-11 July, whereby the Finance Ministers and Central Bank Governors of the G20 countries further endorsed the proposed deal. Interest has been expressed in finalizing said framework at the upcoming G20 Summit, to be held in Rome in October 2021. The historic agreement opens the way to further rises in tax rates in the near future.
Current Concerns
Under the current global taxation regime, generally, active business income is taxed where the business is located. As a larger fraction of global trade has shifted to activity between subsidiaries of the same company, as well as becoming increasingly cross-jurisdictional, companies have succeeded in transferring larger portions of their profits to subsidiaries in low-tax jurisdictions, i.e. tax havens.
Tax authorities worldwide therefore seek to collect hundreds of billions of dollars in tax revenue by targeting tax havens, tech giants, corporations holding their intellectual property in low-tax jurisdictions and, more generally, companies declaring profits outside their main place of business.
The ambitious new system agreed upon in London seeks to tackle this in two ways: Pillar One would affect global firms with at least a 10% profit margin, subjecting them to tax in the countries where they operate, rather than where they are registered, as is currently the case. Pillar Two proposes an additional principle of a 15% minimum rate of corporate income tax (CIT), to be implemented globally on a country-by-country basis.
Pillar One
Although the threshold for determining which companies would be subject to Pillar One is yet to be determined, the proposition currently stands as follows: “Large” global firms with at least a 10% profit margin would see at least 20% of all profits above that margin reallocated in order to be taxed in the countries where such profits are derived from. These changes would ensure that corporations operating in several jurisdictions (particularly those with a large online presence), will pay taxes in the countries where they operate and not only where they are headquartered. Countries would therefore get a new right of taxation over a share of profits generated in their jurisdictions by overseas-headquartered multinationals.
Pillar Two
Pillar Two is perhaps more ambitious and needs global unanimity, demanding that each country compensate and collect underpaid taxes by companies shifting profits to low-tax jurisdictions, and proposing that the country where the company is headquartered compensate for CIT revenues on the basis of the global minimum rate of 15%. That is to say, for example, if a company incorporated in Cyprus has operations in a country where taxes are lower than the 15% proposed rate, Cyprus would be required to impose an additional tax on said company to reach the minimum rate.
According to the initial G7 communiqué, the minimum rate would only apply to multinationals with revenues above a certain threshold, although the specificities of this threshold remain unknown. It is anticipated that the range of this threshold will be central to the discussions of the October G20 Summit.
Moving Forward
The thresholds that determine which companies will be affected under the scope of the new proposals will be key points of negotiation in order to make the two-pillar proposal a reality. Moreover, since the G7’s initial announcement, further dissention has come to light. The City of London, for example, has shown support for proposed exemptions from the 15% rate, including exemptions for financial services firms, and income derived from corporations’ substantive activities within a given jurisdiction. It is likely that further similar exemptions will be proposed in order to achieve international consensus on the application of the reforms.
How This Affects Your Business
Who will be affected (and to what extent) remains a question to be answered, although it is recommended for companies who fall broadly under the currently-construed conditions to keep an eye out for developments. Indeed, a number of important issues must be clarified before tax authorities understand exactly the proposed changes, as well as for corporations with cross-border interests to know how they will be affected. Notably, companies will have to watch out for how a multinational’s effective tax rate will be computed in each jurisdiction where it does business, a clear definition of which companies will be subject to the proposed formulary allocations of profits, and a the creation of a multilateral instrument to facilitate the implementation of the new approach. In any case, it is anticipated that companies will no longer be able to shift profits with the same ease as they have been accustomed to do so in recent years.
Luca Rayes Palacín
