New Global Tax Pact Hits Developing Nations Below the Belt

"Historic" and “hypocritical” were the farthest opposite ends of the contradictory description of a landmark global corporate tax deal hammered out by the Organisation for Economic Co-operation and Development (OECD) on October 8 after years of prolonged and fraught negotiations.

The group of 140 nations of OECD/G20 Base Erosion and Profit-Shifting Project, with the exception of Pakistan, Sri Lanka, Nigeria and Kenya, signed the Statement on the Two-Pillar Solution to Address the Tax Challenges Arising from the Digitalisation of the Economy to ensure that multinational enterprises pay 15% corporate tax in their jurisdictions.

The 15% tax rate, which will be charged from big companies with annual revenue of more than $866 million even if they sell their goods and services in these countries without physical presence, is much below the average 23.5% charged in most industrialised nations.

Representing more than 90% of the global GDP, the deal is expected to end the use of tax sanctuaries, like Panama, Cayman Islands, British Virgin Islands and Ireland among others, by multinational companies (MNCs) to pay either negligible or no corporate tax, and reallocate more than $125 billion of profit earned by about 100 such MNCs to countries worldwide. This is estimated to generate $150 billion in additional global tax revenues annually.

‘Historic’ or ‘dangerous’ victory

Hailing the deal, US President Joe Biden said that a “strong global minimum tax will finally even the playing field for American workers and taxpayers along with the rest of the world”. US treasury secretary Janet Yellen said that the entire global economy has “decided to end the race to the bottom on corporate taxation”.

OECD secretary general Mathias Cornmann said, “Today’s agreement will make our international tax arrangements fairer and work better” while European Commission president Ursula von der Leyen called it a “historic moment” as “all companies have to pay their fair share” from now.

Criticism followed with the deal described as “hypocritical”, “shameless” and “dangerous”. Oxfam said that the tax agreement, which it alleged was “written” by the tax havens themselves, was “shameful and dangerous capitulation to the low-tax model of nations like Ireland”. Oxfam’s tax policy lead Susana Ruiz said that the tax deal “was meant to end tax havens for good; instead, it was written by them”. 

For example, Ireland, which earlier charged 12.5% corporate tax, prompting tech titans Apple and Google and social media giant Facebook to set up their European headquarters there, joined the pact at the eleventh hour on Thursday. Dublin came on board after the text of the initial agreement was revised at its insistence to replace “at least, 15%” with “15%”.

The deal, which has “practically no teeth”, is a “mockery of fairness that robs pandemic-ravaged developing countries of badly needed revenue for hospitals and teachers and better jobs”, the British charitable organisation said in a press release.

Two pillars of the pact

According to the two-pillar deal, taxing rights on more than $100 billion of profit are expected to be reallocated to market jurisdictions every year under pillar one.

“In-scope companies are the multinational enterprises (MNEs) with global turnover above €20 billion and profitability above 10% (i.e. profit before tax/revenue) with the turnover threshold to be reduced to €10 billion contingent on successful implementation, including of tax certainty on amount A, with the relevant review beginning seven years after the agreement comes into force, and the review being completed,” states pillar one. Extractives and regulated financial services will be excluded.

Under pillar one, 20-30% of residual profit defined as profit in excess of 10% of revenue of such companies will be allocated to market jurisdictions. Basically, the tax will apply to a company’s profit margins of more than 10%. This, according to the OECD, “will ensure a fairer distribution of profits and taxing rights among countries with respect to the largest MNEs, including digital companies”.

Pillar two introduces a global minimum corporate tax rate of 15% on companies with annual revenue of more than $866 million, or €750 million, putting a floor on tax competition.

The OECD claims that the pact “will provide much-needed support to governments needing to raise necessary revenues to repair their budgets and their balance sheets while investing in essential public services, infrastructure and the measures necessary to help optimise the strength and the quality of the post-COVID recovery”.

However, the ‘Carve-outs’ clause permits such MNCs to pay less than 15% tax in tax havens where they have several employees and tangible assets, like factories, machinery and other equipment.  The rule “provides for a formulaic substance carve-out that will exclude an amount of income that is, at least, 5% (in the transition period of five years, at least, 7.5%) of the carrying value of tangible assets”.

The clause ensures that only excess income accruing from intangible assets that can be easily shifted to tax havens, not tangible assets, are taxed.

In May, Pascal Saint-Amans, Director, Centre for Tax Policy and Administration, OECD, said, “At the global level, I think it’s not realistic to think that we could move ahead without some form of carve-out which would recognise the activities, the substance.” OECD was already working on some form of carve-out “to recognise that a number of countries want to incentivise research and development (R&D) and that should be recognised without emptying the objective of pillar two”, he added.

Taking advantage of this clause, such MNCs can avoid paying 15% tax in offshore jurisdictions by hiring more employees and increasing their tangible assets. Extra employees could be hired in the name of R&D and more tangible assets acquired, which will reduce the tax percentage. In nutshell, companies can devise new ways to avoid paying 15% tax.

In July, Oxfam tax policy lead Christian Hallum told CNBC that the OECD could increase activities in other types of tax havens with companies paying less than 15% tax. “I think what is important to understand on the minimum tax is that it is not a blanket 15% corporate tax that will apply everywhere. It does have exceptions.” The clause, according to Hallum, will result in new types of tax planning and “allow tax competition to continue far below 15%. “The basic incentive for shifting profits has not been erased by a 15% floor on corporate income tax.”

Besides, the deal will come into force in 2023 and that too with a grace period of 10 years. “At the last minute, a colossal 10-year grace period was slapped onto the global corporate tax of 15% and additional loopholes leave it with practically no teeth,” Ruiz said.

Oxfam estimated that the deal will affect only 69 MNCs, not 100, as claimed by the OECD. “Loopholes could let the likes of Amazon and ‘onshore’ secrecy jurisdictions like the city of London off the hook. Extractives and regulated financial services are excluded from the deal.”

Calling this deal ‘historic’ is hypocritical and does not hold up to even the most minor scrutiny. The tax devil is in the details, including a complex web of exemptions that could let big offenders like Amazon off the hook,” Ruiz said.

Michael Devereux, one of the authors of a report released by EconPol, the European Network for Economic and Fiscal Policy Research, in July put the number of European companies that will be affected lower, at 37. “Around 64% of the pillar one tax will be attributed to US-headquartered multinationals—only 37 European companies are likely to be affected. Reducing the revenue threshold for multinational companies from $20 billion to €750 million would increase the number of companies affected by a factor of 13,” he wrote.

Developing nations will be most affected

The big companies, which are mostly headquartered in the US, France and Germany, shift staggering amount of profit to countries that charge low taxes. French companies shift €34, German €46 billion and American €95 billion, according to France’s official Council of Economic Analysis.

The new tax rate could raise corporate tax revenues by €6bn-€15bn for each of France, Germany and the US. On the other hand, Nigeria would have received only 0.02% of its GDP in additional money each year had it signed the deal.

Out of the total allocation at $87 billion, EconPol said, around 45% ($39 billion) will be generated by technology companies with US tech biggies, like Apple, Microsoft, Alphabet, Intel, and Facebook, alone generating around $28 billion.

The statement of Martin Shanahan, the head of state investment agency IDA Ireland, said that Dublin “will continue to compete with largely the same jurisdictions” and that investment by MNCs account for one out of six Irish jobs shows how the deal will hardly affect the developed world. Ireland has always maintained that its low corporate tax rate is the not a factor in attracting investment.

For example, US online gifting platform Sendoso, which recently set up a European headquarters in Ireland, said that the low tax rate was not the main reason for the decision. According to the head of Ireland’s National Treasury Management Agency, digital payments giant Stripe never discussed the tax rate while planning to hire more in Ireland.

In a virtual debate organised by the Independent Commission for the Reform of International Corporate Taxation (ICRICT) on October 7, its members suggested a 25% global corporate tax rate to end the “harmful tax competition between countries” and reduce “the incentive for multinationals to shift profits to tax havens”.

Criticising the pact, the ICRICT said that the G-7 nations would gain the most, 60% of extra revenue generated by the new tax agreement, despite having only 10% of the global population. And 52 developing countries would receive a mere 0.02% of their collective GDP in additional annual tax revenue under pillar one, Oxfam said.

The debate participants, including Martín Guzmán, the economy minister of Argentina—part of the G-24—said that proposals of G-24 members “reflecting developing countries positions have been systematically excluded so far. An agreement cannot be sustainable if the concerns of the developing countries are not adequately addressed” and meaningful revenue not ensured for them.

A 25% global minimum corporate tax rate “would raise nearly $17 billion more for the world’s 38 poorest countries, home to 38.6% of the world’s population, than a mere 15%, Oxfam said. “The G-7 and EU will take home two-thirds of new cash that it [the deal] will bring in while the world’s poorest countries will recover less than 3% despite being home to more than a third of the world’s population,” Ruiz added.

In March, the United Nations panel on Financial Transparency, Accountability, and Integrity (FACTI) Panel said in a report that that the estimated private wealth in secrecy jurisdictions and tax havens countries is $7 trillion and 10% of the global GDP is held in offshore assets. Besides, illicit financial flow like corporate profit-shifting annually costs countries $500-$650 billion.

The report stated that the amount lost due to tax avoidance annually in India could cover hospital treatment of 55 million low-income patients. While Chad’s annual tax revenue loss of $343 million could build 38,000 classrooms.

Proposing a new global minimum corporate tax rate of 20%-30%, FACTI said while corporations would still be “free to look for other jurisdictions to register things like profit, a global minimum corporate tax would ensure that the entity would be subject to tax on its global income at the minimum rate regardless of where it was headquartered”.

“What could have been an historic agreement to end the era of tax havens is rapidly becoming a rich country stitch-up instead,” Ruiz said. Terming the deal appalling, Oxfam said that while the majority of the world struggles with scarce vaccine supply and worsening hunger and poverty, rich nations are grabbing for an ever-bigger slice of the pie”.

(Aninda Dey is an independent journalist. The views expressed are personal.)