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The G7 Tax Plan: OECD rocket fuel or just another step on a long road?

  • Global
  • Tax planning and consultancy

23-06-2021

If the OECD want to speak to an IP lawyer, they should click here. In the past couple of months they have seen their hard graft over long years to formulate their international tax reform blueprints for “Pillar 1” economic nexus taxation and a “Pillar 2” global minimum tax rebranded as first Joe Biden’s international tax reform proposals and now as the G7 tax plan.

The G7 tax plan has in particular received a very high level of publicity, not necessarily commensurate with the brief, high-level statement issued by the G7 finance ministers last week. While the G7 statement, like Biden’s earlier proposals (and clearly based on Biden’s proposals), suggests some differences to the OECD proposals published at the end of 2020, it basically reflects the position reached by the OECD. What is significant is the public commitment, particularly from the US, to progressing the OECD reforms, which frankly had stalled under the previous US administration.

So what is the roadmap from here, what tax changes can multinational businesses expect and when? Set out below is a brief overview of the G7 and Biden tax proposals and their interaction with the OECD proposals, a “best guess” timetable for implementation of the reforms (if political momentum can be expanded globally and maintained) and comment from our international tax experts on the potential implications of these reforms.

What is clear is that despite the strong political statements from the G7, there is still likely to be a long road to travel to finalise the design of these reforms, obtain broad international consensus and then implement such reforms at a domestic level globally.

The tax plan – an overview 

It is an overstatement to call the G7 announcement a “tax plan” – it was in fact a surprisingly short statement (150 words) of very broad and high-level principles. In summary, the statement:

  • expressed support for the OECD initiatives in this area;
  • stated a commitment to an equitable solution on the allocation of taxing rights to countries in which customers are based, with taxing rights to be awarded on at least 20% of profits exceeding a 10% margin for the largest and most profitable multinational enterprises (an economic nexus basis of taxation);
  • removal of all domestic digital services taxes and other similar measures if the above allocation rules are implemented; and
  • stated a commitment to a global minimum tax of at least 15% on a country by country basis.

The G7 statement bore close similarities to a widely leaked internal presentation from the US Treasury on the Biden Administration’s position regarding the OECD proposals in this area, as supplemented by a May 20, 2021 Readout from the U.S. Treasury Department, which broadly stated that:

  • the OECD Pillar 1 proposals on an economic nexus basis of taxation (see below) should be limited to no more than 100 very large multinational enterprises whose total annual revenue and operating profit margin exceed a determined level
  • the OECD Pillar 2 proposals on a global minimum tax should be implemented at a minimum rate of 15%
  • relevant unilateral measures (unspecified but taken to include digital services and other similar taxes) should be eliminated

As observed above and recognised in both the G7 and Biden proposals, these tax plans are in fact political statements of support for the OECD proposals, albeit with some important departures or additional detail.

The OECD proposals, set out with typical OECD brevity in the combined 478 pages of the reports on the Blueprints of Pillar One and Pillar Two, are complex and we have addressed the detail of these proposals in other briefings (“Highlights on Pillar 1 and Pillar 2 Blueprints recently released by OECD” and “Taxing the digital economy – OECD update”). By way of a very brief summary:

  • Pillar 1 proposals

    • Pillar 1 proposes the reallocation of profits and taxing rights to market/customer jurisdictions in which a business has significant economic nexus but little or no traditional physical presence.
    • The proposals outlined a formula based apportionment approach, subject to size and economic presence thresholds.
    • The proposals are ringfenced to “automated digital services” businesses and “consumer-facing businesses”.
    • The proposals outlined the need for measures to prevent double taxation and proposals for implementing this reform on a global scale through multilateral tax treaties.
    • Significant detail, particular key details such as allocation formula, still needs to be determined.
  • Pillar 2 proposals

    • Pillar 2 proposes a global minimum tax regime pursuant to which a jurisdiction is granted additional taxing rights in respect of controlled related entities where the jurisdiction in which such entities are based does not impose tax or tax is only imposed below a certain minimum rate
    • Pillar 2 consists of a number of mechanisms to achieve this objective
    • Like Pillar 1, significant detail remains undetermined, in particular the tax rate to be used as a global minimum.

The G7 and Biden proposals develop or alter the OECD proposals in a number of key ways:

  • the G7 and Biden proposals appear to materially limit the scope and impact of the Pillar 1 proposals. It appears that the intention is to impose financial thresholds that will limit the proposals to only 100 of the largest multinational enterprises, as well as to remove the focus on digital and consumer facing business. Further, imposing a 10% profit margin threshold may also change the focus of these rules away from some of the digital businesses that were the original target of the rules;
  • the G7 and Biden proposals make clear statements on the applicable rate for the Pillar 2 global minimum tax proposals. The Biden Administration’s legislative proposal is 21%, although it appears that this has been reduced in negotiations to the 15% rate proposed in the in G7 statement.

The way forward from here is less clear. First, wider consensus from the G20 and then the 139 members of the OECD Inclusive Framework engaged in these proposals is needed for the broad principles of the G7 and Biden proposals. This will not be easy in itself, as some jurisdictions may lose out from the narrowing of the Pillar 1 proposals and others may not be happy with the minimum tax rate proposal.

After that, as the full 478 pages of the OECD Blueprints demonstrate, there is a lot of detail still to settle and then ultimately implement on a global scale. Some of the key issues still to determine include:

  • the Pillar 1 financial thresholds and profit margins for application of the rules and allocation of profit;
  • profit margin is a particularly key issue, with an important question being whether businesses with both high and low margin operations will have to apply a blended approach or segregate operations to be assessed individually;
  • what constitutes significant economic presence in a jurisdiction in order to have nexus;
  • which business areas will be exempt from the Pillar 1 rules. For example, a key question is whether financial services businesses will be exempt;
  • the final rate for the global minimum tax;
  • the method for implementation of these changes – a multilateral treaty has been proposed;
  • the scope and timing of the repeal of existing or proposed digital services and similar taxes.

“Best guess” roadmap

Below is a timetable roadmap for the potential implementation of the proposals, assuming broad political consensus is achieved quickly on the proposals. Other than a couple of known initial dates, this roadmap represents a “best guess” in relation to a process that has already taken six years since the publication of the original OECD BEPS Action 1 report in 2015.

Eversheds Sutherland comment

Germany

The G7 has agreed on three general taxation principles. These principles clearly set the guideline for the discussion on the OECD level, the Inclusive Framework. The outcome of the discussions show that the German minimum tax rate of 25% is not in line with the international consensus. The relevant minimum tax rate for German companies under the cfc rules should be lowered from 25% to 15%. Furthermore the decisions of the G7 clearly indicate that even in the area of digital economy the allocation of taxation rights requires a sufficient nexus. Against the backdrop of this the Federal Ministry of Finance should reconsidered whether it is in line with international principles of taxation to request a taxation right on royalties simply based on the fact that IP registered with a domestic registers without having any further link to the German jurisdiction. It is clear that the G7 only agreed on certain general principles and that the transformation of the resolutions into a legal framework will probably takes a couple of years. But it is another important step on a long way to the equitable allocation of taxation rights

Ireland

While the G7 finance ministers have reached an agreement in relation to a number of key elements of the global tax reform agenda set out in the OECD BEPS 2.0 plan, this is by no means the end of the road, and any agreement will not be binding unless consensus is achieved among the wider G20 group and the remaining 139 OECD countries. A key focus for Ireland in any negotiations will be the proposed 15% minimum rate of tax. Ireland will remain committed to working towards agreement at OECD level, however Ireland’s position remains that any agreement must be sustainable, ambitious and equitable, and must cater for all countries, small and large, developed and developing. The Irish 12.5% rate of corporation tax has become a symbol of stability and certainty for businesses investing in Ireland, enduring for more than 20 years, and is an important feature of Ireland’s offering. However, while important, the tax rate is by no means the only attraction of Ireland. Other non-tax factors, including a highly-skilled work force, a common law legal system and the ability to serve global markets as an EU jurisdiction, also contribute to Ireland’s attractiveness for businesses, and will become even more important features as the global tax landscape continues to evolve.

Italy

During the last G7, several general tax principles have been agreed. However, it is clear that the announcement which will have more impact is the 15% global minimum tax.

Italian corporate income tax is levied at 24%, higher than the proposed 15%, therefore Italy is already compliant. However, the application of the global minimum tax can benefit Italy.

For instance, if the internationally agreed minimum tax rate is 15% and an Italian company has an effective tax rate of 12,5% on the profits it records in Ireland, then Italy would impose an additional tax of 2,5% on these profits to reach the effective rate of 15%. Therefore, Italy would collect extra taxes so that its multinationals pay at least 15% in taxes on the profits they book in each country.

According to the Tax Observatory of the European Union, Italy could gain until Euro 2.7 billion of tax revenues from the application of such global tax rate to its multinationals.

With reference to Italian Digital Service Tax (“DST”), Italian Minister of Economy communicated that payments made for Italian DST for 2020 are Euro 233 million against the estimated Euro 700 million.

Therefore, the abolition of Italian DST will not have a material impact.

Switzerland

Currently, 18 out of 26 Swiss cantons apply a total effective tax rate for corporates below 15% (including federal, cantonal and municipal taxes). The various discussions regarding the introduction of a globally applicable minimum tax rate put these cantons, e.g. Zug, Geneva, Schwyz, Vaud etc. in the spotlight. As in previous similar situations, the Federal Finance Minister and the respective Cantonal Finance Ministers are working on solutions to amend Swiss tax law to comply with global requirements. In the past and only under specific circumstances, Switzerland has used an incentive driven regional economic policy. Should cantons be obliged to increase their tax rates to avoid seeing companies to leave the canton or even the country, one of the scenarios is to use the additional tax income, which is currently not needed to keep the cantonal finances healthy, to introduce such incentive regime (e.g. for employments created, for R&D developments, for specific investments, etc.). This incentive regime will be in line with the incentive regimes applied in most other countries, such as the G7 and G20. Another scenario currently discussed is the introduction of financial statements used for tax purposes only, which differ from the financial statements based on commercial law. Consequently, this would result in higher statutory tax rates combined with certain adjustments in the determination of the tax base at cantonal and municipal level. Finally, for a country with a small domestic market and a relatively low number of consumers, shifting tax powers from the country of a corporation's headquarters to those jurisdictions where the larger number of end consumers reside may affect Switzerland’s tax base more than the introduction of a Global Minimum Tax.

United Kingdom

The UK has taken a lead role in pushing forward the OECD proposals and has even implemented an interim digital services tax, both to tackle some of the tax issues for which the OECD is designing an international solution but also to incentivise progress with the OECD proposals. It is therefore not surprising to see the UK leading again with the other G7 nations on this issue. Although already unlikely, as signalled by the proposed increasing in UK corporate tax rates from 19% to 25%, the global minimum tax rate should further move the UK away from any potential “Singapore-on-Thames” model post-Brexit. In fact, the UK stands to benefit from the global minimum tax rate, although probably less so from the Pillar 1 proposals (particularly given that the UK DST would need to be repealed). One important open question for the UK is how financial services businesses will be treated under Pillar 1 – as the home to some of the largest financial institutions in the world, whether or not financial services businesses are excluded from the scope of Pillar 1 will be important to the attractiveness of the UK going forward.

United States

Although the G7 proposal is generally in line with the Biden proposals as to the global minimum tax, the current Biden domestic proposals do not address the allocation of taxing rights among jurisdictions. Implementation of the Biden proposals in the U.S. is expected to require additional legislation, including to ratify any multilateral instruments necessary to implement the proposals. This is reflected in the Biden Administration’s recent budget proposals, which include, among other things, refinements to the global intangible low-tax income (GILTI) minimum tax and repeal and replacement of the Base Erosion Anti-Abuse Tax (BEAT). In addition to an increase in the U.S. corporate tax rate from 21% to 28%, the administration has proposed increasing the GILTI rate to 21%, eliminating the exemption for the first 10% of return on tangible assets, and requiring computation on a country-by-country basis, which are generally consistent with OECD Pillar 2 (other than eliminating a return on tangible assets). The Administration also proposes repealing the foreign intangible income (FDII) deduction, which reduced the tax rate on a portion of U.S. corporations’ export income to 13.125%.

The Administration’s proposal would also repeal and replace the BEAT with the Stopping Harmful Inversions and Ending Low-tax Developments (SHIELD) regime, which would deny multinational corporations U.S. tax deductions by reference to payments to related parties that are subject to a rate of tax below the globally agreed minimum tax (or, if no globally agreed minimum tax rate is adopted, the tax rate on GILTI income, as modified by the Administration’s proposal). SHIELD appears to be intended to mirror similar OECD Pillar 2 backstop rules but surprisingly also applies to payments made to related parties that are not subject to a low rate of tax if the overall rate of tax of the group does not meet the agreed rate of minimum tax (21% under the domestic proposal in the absence of a global consensus). The Administration’s proposal would also impose a 15% minimum tax on corporate book income over $2B, create a new business credit equal to 10% of certain eligible expenses associated with onshoring jobs and investments into the U.S., and impose a 10% “offshoring penalty” on U.S. company offshore production profits or services for sales back into the U.S. The bill would also provide significantly increased funding for tax enforcement.

Negotiations with Congress are ongoing regarding the Administration’s tax proposals as well as the associated infrastructure bill. In particular, the Administration has indicated some flexibility on the corporate rate increase, widely believed to include a corporate rate of 25%. But, some members of Congress have expressed scepticism about the G7 proposal and implementation of those proposals in the United States is likely to need support from Congress. There is particular scepticism as to changing the allocation of taxing rights amongst jurisdictions since it is seen as primarily impacting U.S. based multinationals. There is also resistance among Republicans to dismantling their FDII, BEAT and GILTI regimes enacted in 2017. If no bipartisan solution can be found, Democrats will need to rely on all 50 Democratic Senators with Vice President Harris casting a tie-breaking vote to pass unilateral legislation under arcane budget reconciliation rules that impose limitations on what can be included. Another wild card is Senator Manchin, the Democratic Senator from West Virginia, who has publicly resisted relying on the budget reconciliation process at least for the infrastructure bill. Although Biden appears to have taken a global leadership role on these issues at the G7, it remains to be seen whether he can ultimately deliver on these commitments.

Next Steps

What should businesses do now in response to these recent developments? Well, as our expert commentators make clear, there is still potentially a long road to travel before these changes start to impact on taxpayers (if they are introduced at all). Multinational businesses should however pay close attention to the ongoing developments in this area and in particular carefully consider the potential implications of these changes when assessing expansion into new jurisdictions or cross-border corporate holding structures.

If you would like further guidance on the implications of the G7 Tax Plan to your business, please get in touch