Giant companies that pay little tax will compete on a more level playing field. Now we have to make the new rules work
Last modified on Thu 10 Jun 2021 05.25 EDT
A decade ago, a series of scandals rumbled through the corporate tax world, as we all learned how big companies often paid little tax. Amazon, Google and Starbucks were hauled before parliament to explain why their tax bills were so low. What was truly shocking wasn’t the way they had broken the law, but the fact that they hadn’t. The global corporate tax system was incredibly leaky. International agreements to ensure no double taxation were, and are, actually leading to double non-taxation of company profits.
Large companies routinely avoid paying their fair share of taxes by “shifting” their profits to low-tax countries. This has led to a dramatic decline in the amount of tax governments collect from corporations. What’s more, profit shifting gives multinational companies a huge advantage over smaller ones: instead of competing to offer a better service, they just can keep costs low by paying less in tax. How is your local coffee shop, paying the 19% corporate tax rate on its profit, supposed to compete with the likes of Starbucks, which paid minimal tax despite large sales?
This problem wasn’t new a decade ago, but it might soon be solved. Last week, after a meeting of the G7 finance ministers in London, the chancellor, Rishi Sunak, breathlessly announced a “historic agreement” on corporate tax. The deal comes in two parts. First, a minimum tax on worldwide profits, with a rate of “at least 15%”. The US badly wants this, to fund the Biden administration’s spending plans. In exchange, the US is willing to agree to a small slice of profits from big companies being shared across other countries where they operate. The details are yet to be ironed out, but the idea is that companies such as Amazon should pay some tax where their customers are.
Many have described the deal as a return to multilateralism, after four years of an isolationist Trump presidency. That may be partly right. Part of the push to agree the deal at the G7 is that China is not represented, and the US has been keen to isolate China economically. But coming to an agreement at all has been achieved less through global cooperation, and more through hardnosed threats and negotiation.
In 2013, soon after those scandals of a decade ago, the OECD group of wealthy countries started a review with the snore-inducing name “base erosion and profit shifting” (or BEPS to those in the know). The idea was to create a new international agreement that would end the corporate tax “race to the bottom”. It failed to do this.
Instead, the current agreement was reached because countries started to go it alone and introduce digital taxes on some of the tech giants. These companies are based in the US, and the Biden administration made no secret that it was unhappy about these taxes, threatening tariffs in retaliation. The deal announced at the G7 includes an agreement that countries will remove such digital taxes.
So will the new system work? As ever with tax issues, it is complicated. There are problems for both “pillars” of the deal – the minimum rate and revenue sharing.
First, the minimum tax rate. The US proposal was initially 21%, before being quickly knocked down to 15%. In Europe, France (among others) is also pushing for a higher rate. The UK should join this push. Sunak made a big show of a planned increase in corporation tax to 25% by 2023 in March. If companies have the choice between paying 25% on profits when booked in the UK, or 15% on profits booked elsewhere, it is clear which they will prefer.
The details of how the minimum rate will operate are also crucial. While tax rates are fairly straightforward to understand, the definition of profit can be fiendishly complicated. Different countries have their own rules for whether and how, say, investing in a new factory reduces a company’s taxable profits. Clarity and consistency is going to be the difficult bit, so that profit is measured in the same way everywhere, but it isn’t going to attract the same attention.
Second, the definition of which companies are captured under the revenue-sharing arrangements may leave out some companies that inspired this whole thing. The current proposal requires, among other things, companies to have a profit margin above 10%. Amazon would not meet this test. There are discussions of how to fix this, including treating Amazon Web Services – which is very profitable – separately from the rest of Amazon, but it highlights again that details are important. And whatever deal is reached, we should expect companies to respond in ways that suit them: they will continue to be “fully compliant with all local laws and regulations in the countries where [they] operate” as Microsoft recently put it, but that doesn’t mean they’ll want to pay more tax.
If this deal goes ahead, there will be losers and winners. The tax havens that have for so long relied on providing “professional services” to the companies that nominally locate there will lose out: Bermuda and the Channel Islands will seem a lot less attractive to companies once their low tax rates are no longer available. The deal is also not great for poorer countries, which are unlikely to get much tax from a revenue-sharing deal based around where sales are made.
What about the UK? Although we’ll get a small slice of tech company profits, it seems likely that this will be less than we would have got from those companies under a digital services tax. The other parts of the deal – the minimum tax and potentially bringing more companies into the tax-sharing agreement than are covered by the digital taxes – mean that the overall effect will still probably be higher tax revenues. The recently launched EU Tax Observatory has crunched the numbers for EU countries, and looking at similarly sized economies – France and Germany – suggests the UK stands to gain roughly £2.5-5bn from the deal, while losing £400m from removing its digital tax.
Nevertheless, the deal is important for the UK. Although the money raised is small compared with total tax receipts of more than £700bn, the minimum tax will – if it can be made to work – start to level the playing field between large and small companies. Just as tax havens will be less able to compete by offering low tax rates, large companies will find it harder to compete by paying less tax and undercutting the local competition. This is an important goal, and the UK should support it wholeheartedly.
Arun Advani is assistant professor of economics at the University of Warwick. Lucie Gadenne is associate professor of economics at the University of Warwick
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