FOR YEARS Governments have grumbled, simmered and raged as multinational corporations shifted their profits out of the reach of tax collectors and put them in tax havens. the OECD, a club composed mainly of rich countries, estimated in 2015 that avoidance deprives public coffers of 100 to 240 billion dollars, or 4 to 10% of global corporate tax revenues per year. Today, the tax fallout of covid-19 adds urgency to governments’ efforts to recover money, especially in America, where President Joe Biden plans to raise taxes on corporate profits, including foreign income.
Mr. Biden’s proposals will make their way through Congress. Finance ministers of the gSeven group of countries are likely to discuss global tax reform when they meet in London on June 4-5. And later this summer, 139 countries will discuss changing the tax system for multinational corporations. The confluence of political change in America and a global push to increase tax revenue to pay for the pandemic means some optimism is in the air. The proposals under discussion may initially generate only a modest amount of income, but they still represent a major break with the past.
The foundations of the global corporate tax system were laid a century ago. He recognizes that overlapping taxes on the same bracket of profits can hold back trade and growth. As a result, taxing rights are first allocated to the place where the profits are produced (the “source”) and then to the place where the parent company is headquartered (or “resident”). A multinational based in America but with a subsidiary in Ireland, for example, usually pays taxes in both places. It doesn’t matter where the business sells. Payments between different legal subsidiaries of a company are recorded on an “arm’s length” basis, supposedly on terms equivalent to those found on the free market.
These principles, now embedded in thousands of bilateral tax treaties, have had two unintended consequences. First, they have encouraged governments to compete for investment and income by offering extremely low tax rates (see Figure 1). In 1985, the average statutory corporate tax rate worldwide was 49%; in 2018 it was 24%. Ireland has a legal rate of only 12.5%; Bermuda, 0%. Second, tax competition has encouraged companies to redirect their reported profits to low-tax places. In 2016, around $ 1 trillion in global profits went into “investment hubs.” These include the Cayman Islands, Ireland and Singapore, which apply an average effective tax rate of 5% on the profits of non-resident companies.
There is a huge gap between where the tax is paid and where an actual activity takes place. Analysis by the OECD suggests that multinationals report 25% of their profits in investment centers, although only 11% of their tangible assets and less than 5% of their workers are based there. Parents can allocate paper profits to affiliates in tax havens by asking them to own intellectual property which is then licensed to other affiliates in high tax locations. The problem seems to have worsened over time, perhaps because more and more companies are making money from intangible services, from software to streaming videos. The share of foreign profits of American multinationals recorded in tax havens has fallen from 30% 20 years ago to around 60% today. Most investors and bosses view corporate tax bills as a black box that only a few lawyers and tax professionals really understand.
One way to grasp the magnitude of the manipulation is to look at what would happen if there were a single common tax rate. A recent study by Thomas Torslov de Kraka, a Danish think tank, and Ludvig Wier and Gabriel Zucman of the University of California at Berkeley, attempted to quantify this. A staggering $ 670 billion in profit on paper, unrelated to things like factories, is believed to have shifted in 2016 – nearly 40% of multinational corporations’ foreign profits. The big western countries are losers from the current system: profits in America and France, for example, are depressed by about a fifth (see graph 2). In comparison, havens collect more income, in proportion to GDP, despite their lowest effective rates. Hong Kong collects a third of its corporate tax revenues by attracting profits from high tax countries; Ireland, more than half.
The rise of Silicon Valley fueled the blaze. Some governments are complaining about giant corporations serving customers without any physical presence in their country and without paying taxes. The problems posed by tech companies are in fact not new: pharmaceutical companies have long held mobile and hard-to-value intellectual property; exporters do not incur tax debts where they sell. Yet digital services have become a target. More than 40 governments, from France to India, levy or plan to levy digital services taxes on the revenues of companies such as Amazon, Google and Facebook.
The growing sense of lawlessness over how to tax Silicon Valley, the global desire to raise more tax revenue, and a more conciliatory White House mean the stage is set for a global deal. the OECD ‘This upcoming summit is not the first time it has attempted to orchestrate reforms – it helped push through changes to the transfer pricing regime in 2015. But this time, two more ambitious proposals are under discussion.
The first would be to reallocate taxing rights so that a share of the profits can be deducted depending, for example, on the location of a company’s sales. This right could be acquired even if the company had no physical presence in the country. Mr Biden’s negotiators proposed a reallocation that would apply to the 100 largest and most profitable companies in the world; in return, the Biden administration wants all taxes on digital services removed. The second element would apply a minimum corporate tax rate, putting a floor on the race to the bottom. The Biden administration is targeting an overall minimum tax rate on foreign income of 21%, applied separately to profits in each jurisdiction.
You say you want a revolution
Could these ideas form the basis of an eventual agreement? The profit redistribution proposal was widely welcomed by other large, wealthy economies. Yet there are still many possibilities for disagreement over the details. Evaluating the location of sales made by one company to another, if it then continues to make sales in a different country, is tricky. Some governments also still want to turn the screws on Amazon, Apple, Facebook, Google and others: the European Union seems to be preparing to move forward with a digital tax regardless of the outcome. OECD. This in turn could cause some US lawmakers to forgo global cooperation. Meanwhile, many tax havens can resist higher minimum tax rates that eliminate the advantage for companies to record profits there.
Accordingly, any agreement will involve compromises. The amount of profits reallocated to be more like economic reality could be capped. For example, the OECD ‘s blueprint takes the radical decision to look at companies as a whole, rather than breaking them down into subsidiaries. Yet most profits would remain taxed as is. The right to tax, say, 20% of profits above a usual rate of 10% of income would be reallocated according to a formula that could be based on sales. Meanwhile, the United States’ preferred 21% minimum rate is unlikely to be the subject of a broader deal, as countries sniff out fiscal sovereignty. A rate of 10 to 15% is much more realistic.
What difference would changes of this magnitude make? The reallocation plan, in its current form, aims to generate annual revenue of $ 5 billion to $ 12 billion. the OECD estimates that a minimum rate of 12.5% would raise $ 23 billion to $ 42 billion directly through the higher rate, and an additional $ 19 to $ 28 billion by reducing profit shifting. These figures are not particularly impressive, although they could allow governments to raise national tax rates without worrying so much about the danger of capital flight.
Yet an agreement on new principles could leave the door open for bolder changes later. Carlos Protto, one of the representatives of Argentina in theOECD talks, says focusing only on the largest multinationals helps build consensus now, but also notes that many countries expect the scope of any reform to eventually be broadened.
What if countries can’t get along? America will move forward with reforms to its domestic taxes, including provisions that could unilaterally increase the tax burden on U.S. subsidiaries of foreign companies that pay meager tax bills globally. Meanwhile, taxes on digital services could spread like wildfire, potentially leading to U.S. tariffs in retaliation. On May 10, the United States trade representative held a fourth day of hearings on retaliation against foreign taxes on digital services. Overhaul or not, tax bills will go up. ■
A version of this article was posted on May 10, 2021
This article appeared in the Finance & Economics section of the print edition under the title “The big carve-up”