Before the G7 Finance Ministers’ communiqué of 5 June announcing an agreement in principle (which was endorsed by the G7 leaders according to their communiqué of 13 June), the biggest news in international tax had been a renewed engagement of the US with the OECD’s reform project following the transition from the Trump to the Biden administration, as illustrated by the US Treasury’s suggested changes to make the OECD’s blueprints (see earlier post for details) work. The US proposed that Pillar 1 (new taxing right for market jurisdictions) should be simplified and its application limited to the 100 largest multinationals and that Pillar 2 (global minimum effective rate of tax) tweaked to align with proposed changes to the equivalent US rules (GILTI).
The announcement that the G7 Finance Ministers had reached agreement in principle on some key aspects of Pillars 1 and 2 was widely celebrated by politicians and the media, but it is clear that there are still practical, political and technical details to be thrashed out. And, as some of the things “agreed” are not aligned with the OECD’s blueprints, it may prove difficult to get the G20 and then the remainder of the 139 jurisdictions comprising the Inclusive Framework on board. I would suggest the UK Treasury press release was a bit premature with its description of the G7 agreement as “seismic” and “historic”. Perhaps those words should be reserved for when final global agreement is reached! But it certainly has added some momentum, and lots of media attention, to the international tax reform agenda.
What was agreed?
- Multinational firms with at least a 10% profit margin will be subject to the new taxing right on at least 20% of profit exceeding the 10% profit margin.
- All digital services taxes and other relevant similar measures on all companies are to be removed (even for companies which are not caught by Pillar 1).
- The global minimum rate of tax will be at least 15% and will be applied on a country-by-country basis.
- Both measures will progress in parallel as a package.
What is left unresolved?
Starting with Pillar 1, it was initially reported that Amazon would not be caught because of its below-10% operating profit margin. This was, however, swiftly followed by reports that different activities and business lines would be looked at separately which, in the case of Amazon, would mean that its cloud computing unit would, after all, be caught. From the UK government’s perspective this should be a welcome development because the UK has said all along that the problem to be solved by Pillar 1 was that of taxing digitalised businesses fairly. So, narrowing of the scope of Pillar 1 so as to exclude companies commonly thought of as major digital players may have made it a rather difficult domestic sell. In terms of the administrability of the rules, it is, however, more likely to be bad news, given the likelihood of a further increase in complexity.
And what about banks? Although the OECD blueprint contemplated an exclusion from Pillar 1 for financial services, no such carve-out was agreed by the G7. The UK has announced that it will push for this at the G20 meeting in July, and France is supportive of this, but opposition is expected from the US.
On Pillar 2, the first open question is whether or not to include a substance-based carve-out. This is a key requirement for many jurisdictions and the blueprint had one, but the G7 did not agree one and the US intends to remove the one that’s currently included in the GILTI rules.
The substance-based carve-out controversy harks back to questions around the purpose of Pillar 2. Is its objective to eliminate tax competition? Or is it to tackle the remaining base erosion and profiting shifting (BEPS) risks that the BEPS project left unresolved? The G7 leaders appear to think the former (their communiqué refers to “reversing a 40-year race to the bottom”), but the OECD’s starting point was certainly the latter.
The substance-based carve-out is likely to be a key battle ground, in particular in discussions with smaller and developing countries seeking to use tax incentives to attract genuine investment. It will also be crucial to the level of support that can be expected for a higher minimum tax rate.
The G7 agreed that the minimum effective tax rate should be “at least 15%”, and France has already indicated it wants to push for a higher rate, whereas a rate of 12.5% was previously the focus of the OECD-led discussions. Especially without a substance-based carve-out, a higher rate will be a hard sell for jurisdictions such as Ireland which rely on a low corporation tax rate to attract investment. China is also concerned about a minimum tax rate and wants a carve-out for tax incentives to attract high tech industries and R&D. The UK would also benefit from this as the patent box rate is 10%.
What does the G7 agreement mean in practice?
Although there is political momentum and a desire for reform to happen sooner rather than later, there are concerns about how long it will take to get everything agreed and implemented in each jurisdiction, including in the US where passing legislation may prove challenging.
Is it realistic to require the removal of all digital services taxes and equivalent measures? This will be a hard sell for jurisdictions, such as India, which have had such measures for a while and been enjoying the revenue from them, particularly if the revenue that they will received under Pillar 1 will be lower (which is not unlikely given that the scope of Pillar 1 is much narrower than that of the many unilateral measures that have been put in place). And where does this leave the EU Commission’s proposal for an EU-wide digital levy compatible with WTO rules and sitting alongside the OECD’s project, which is supposed to be published on 14 July? Will this be sufficiently different from digital services taxes and “similar measures” to survive?
There is still a long way to travel towards global agreement with the next key dates being:
- 30 June for a meeting of the OECD’s Inclusive Framework
- 9-10 July for a meeting of the G20 Finance Ministers
The expectation is that an outline of a deal might come in July, followed by an agreement on a final package in October. It remains to be seen, however, which jurisdictions will reach the final destination and who will be left behind. And, if some jurisdictions are left behind, will there still be a critical mass to achieve the “tax peace” that Pascal Saint-Amans is hoping for to end the digital services tax wars?