In early June, members of the G-7 reached an agreement that would establish a minimum global corporate tax rate of at least 15% on multinational corporations. The intent of the deal—which the group called “historic"—is to stop the so-called “race to the bottom” in the international corporate tax world.
Even though the news immediately made headlines, questions still linger about what it all means. Here’s what you need to know.
About the G7
G-7 is shorthand for the Group of Seven nations, a consortium of wealthy developed countries that have met regularly since the 1970s to discuss global economic concerns and initiatives. Today, the G-7 includes Canada, France, Germany, Italy, Japan, the U.K., and the U.S., but earlier iterations have been cleverly branded the Group of Five (G-5), Group of Six (G-6), and the Group of Eight (G-8).
Every year, the G-7 meets to discuss global trends and challenges. The economy clearly stands out at these meetings since the group constitutes about 40% of the world’s GDP.
Contentious Tax Strategies
Corporate taxation has been a key component of G-7 discussions for years. Specifically, countries like the U.S. have struggled with how—and at what rate—to tax multinational corporations. That hasn’t gotten any easier as globalization and technology have made it easier for companies to structure transactions to shift profits from high tax countries to lower tax countries. These strategies are often referred to as base erosion and profit shifting, or BEPS.
It’s important to note that these strategies aren’t necessarily illegal. In fact, companies who have utilized these schemes maintain that they haven’t done anything wrong: They’re simply taking advantage of ill-matched tax systems. It is, they argue, merely good tax planning.
Not everyone agrees.
The Organization for Economic Cooperation and Development, or OECD, has been clamoring for change for years. The OECD, which is made up of 38 member countries, including the U.S., believes that the current system allows multinational companies—those that can easily move their operations and property across borders—an unfair advantage over domestic businesses. More importantly, the OECD believes that when taxpayers see multinational corporations avoiding paying tax, even if it is done legally, it undermines all voluntary compliance.
Technology and the internet have further complicated things. Now, companies can sell products and create valuable intellectual property without an actual physical presence. That means that companies can more easily book income in lower-tax countries, raising fundamental questions about revenues and valuation.
In recent years, even those multinationals that have benefited from these schemes have signaled that they might be amenable to more consistency. Companies like Amazon, Facebook, and Google have spent years—and lots of money—fighting tax bills all over the world. Now, it looks like there may be a consensus for change.
Shortly after G7 Finance Ministers agreed in principle to a solution, Nick Clegg, the VP of Global Affairs for Facebook, tweeted:
Facebook has long called for reform of the global tax rules and we welcome the important progress made at the G7. Today’s agreement is a significant first step towards certainty for businesses and strengthening public confidence in the global tax system.— Nick Clegg (@nickclegg) June 5, 2021
Clegg added that the company recognized that this “could mean Facebook paying more tax, and in different places.”
Pillars One and Two
So what exactly is in the agreement?
For years, the challenges have been broken down into two sets of talking points, or pillars. You’ve probably heard them referred to as Pillars One and Two.
Pillar One focuses on where tax should be paid. You can think of it in terms of nexus—similar to the same kinds of discussions we have in the U.S. as between states. The critical question is: Who has the right to tax income even if there’s no physical presence?
Pillar Two examines the amount of tax to be paid, with an eye towards the disparate tax rates from country to country.
As part of the Pillar One agreement, large multinational companies will be required to pay tax in the countries where they operate, and not just where they have their headquarters. This is to prevent companies from opening headquarters in lower-tax countries simply to shift profits.
With respect to Pillar Two, there was an agreement to establish a global minimum corporate tax rate of 15%. The current corporate tax in the U.S. is 21%. In contrast, Ireland’s current corporate tax—where many U.S. companies like Apple have established headquarters—is just 12.5%.
And, there’s more. While not expressly calling them out, in an apparent effort to soothe rising tensions between U.S. tech companies and European countries, the agreement suggested that removing existing digital services taxes would be forthcoming. Those taxes—like the 3% tax imposed by France on digital services—have become increasing sources of controversy since they are typically calculated on revenue, rather than profit.
You can read the G-7 policy paper which memorializes the agreement here.
This isn’t a done deal. While some countries like Spain have signaled their support for the agreement, work remains.
The annual G-7 Summit is scheduled for mid-June, and tax will definitely be on the agenda. In addition to the member countries, representatives of the E.U. will be on hand for those discussions.
And later, in July, another group of nations called—wait for it—the G-20 will meet and discuss the agreement, and the tax deal is bound to be a tougher sell. The current G-20 members are: Argentina, Australia, Brazil, Canada, China, France, Germany, Japan, India, Indonesia, Italy, Mexico, Russia, South Africa, Saudi Arabia, South Korea, Turkey, the U.K, the U.S., and the E.U. G-20 nations account for more than 80% of the world’s GDP, 75% of global trade, and 60% of the world’s population. The G-20 leaders have met every year since 2010. (They met virtually in 2020.)
That pales, however, in comparison to what will undoubtedly be a fight in Congress. President Joe Biden has signaled that he wants to increase the top corporate tax rate in the U.S. to 28%, which could be a hard sell if the global minimum tax rate hits 15%. And, since Pillar One would change the rules for taxing corporate profits, it would likely require updating tax treaties: That’s a change only Congress can make.
Even with an agreement in principle, this is far from over. It’s not just about a 15% minimum tax rate. There are complexities involving in moving companies and countries away from the status quo. Remember: Simple is hard.