A tax deal for the digital age – are we ready for this?

Marina Barata (Master's in Law)

1. The deal

On October 8, 2021, the world woke up with the news that the OECD/G20 has agreed a two-pillar solution to address the tax challenges arising from the digitalisation of the economy, marking the first rewriting of international tax rules in a generation.

We might as well talk about a Generational Achievement.

The framework updates key elements of the century-old international tax system, which is no longer fit for purpose in a globalised and digitalised 21st century economy.  The two-pillar package – the outcome of negotiations coordinated by the OECD for much of the last decade – aims to ensure that large Multinational Enterprises[1] (MNEs) pay tax where they operate and earn profits, while adding much-needed certainty and stability to the international tax system. The proposal established a 15% global minimum tax, starting in 2023, and was designed to discourage tax-motivated profit shifting and base erosion by digital corporations that operate worldwide.

Pillar 1 aims to adapt the international rules on the taxation of corporate profits to reflect the changing nature of business models, including the ability of companies to do business without a physical presence. It will give market jurisdictions a right to tax part of the profits of certain non-resident businesses by providing for a reallocation of a portion of these global profits among the jurisdictions where the group has customers or users, using an agreed formula.

Pillar 2 will set a floor to excessive tax competition by ensuring that multinational businesses are subject to a certain minimum level of tax on all of their profits each year. The globalisation of economies and intensification of the use of intangible assets in global value chains have enabled certain multinational companies to shift profits to low-tax jurisdictions. Pillar 2 will enable jurisdictions to top up the amount of tax paid by large multinationals to a minimum effective level, while leaving individual countries free to decide on the features of their own tax systems. Such a minimum effective taxation of businesses profit will limit tax avoidance opportunities.

Both pillars of the global agreement are in line with the European Commission’s vision for a business taxation framework for the 21st century. Their objectives are complementary and a solution on both is needed as part of the global discussions.

Of the 140 countries engaged in the negotiations, 136 signed on to the new outline. Holdouts were Kenya, Nigeria, Pakistan, and Sri Lanka. Ireland, Estonia, and Hungary all recently gave their approval after initially staying out of the agreement in July. Ireland, the low-tax European headquarters for blue chip companies including Apple, Google and Facebook, declined to sign up to the initial deal in July, objecting to a proposed rate of “at least” 15%.

An updated text dropped the “at least” clearing the way for Ireland to accept this agreement. Also, Ireland can maintain the 12.5% rate for firms with annual turnover below 750 million euros and keep tax incentives for research and development.

2. Implementation – are we talking years?

Once agreed and translated into a multilateral convention, the application of Pillar 1 will be mandatory for participating countries. A global corporate minimum tax, including the OECD plan, would not be self-implementing. Each country would have to incorporate the rate and rules into its own tax system. The OECD agreement envisions implementation of the new rules in 2023. Because the plan requires many countries to amend their tax laws, this timing may be overly optimistic.

In order to ensure its consistent implementation in all EU Member States, including those that are not members of the OECD and do not participate in the Inclusive Framework, the European Commission will propose a Directive for the implementation of Pillar 1 in the EU.

But the thing is, the European Commission wants to go beyond the OECD agreement, stating that the lack of a common corporate tax system in the Single Market acts as a drag on competitiveness, and proposes a new framework for income taxation for businesses in Europe (Business in Europe: Framework for Income Taxation or BEFIT). BEFIT will ensure that businesses in the Single Market can operate without any undue tax barriers. At the same time, it will ensure that the existence of mismatches between corporate tax systems in the EU does not undermine the ability of Member States to raise revenue to fund national spending priorities.[2]

Having this in mind, there is no time like the present to revisit the idea of tax harmonisation.

First and foremost, harmonisation does not necessarily mean legislative unification or adjustment, as this concerns the total elimination of disparities, with Regulations being the vehicle par excellence, and where States significantly give up their fiscal sovereignty.

Tax harmonisation represents a rational compromise between the need to eliminate tax disparities between Member States and to protect their legislative or judicial autonomy, where the proportion of the national and the supranational component varies according to the desired level of harmonisation.

When we talk about the need for tax harmonisation within the European Union, the intention is merely to prevent States from distorting competition by defining the structural elements of tax systems, such as tax incidence and rates, thus interfering in and disrupting the construction of the Single Market in an adverse way.

A minimum standard of taxing powers should be transferred to the European Union, consisting of rules fixing the limits of tax incidence and rates, and general and common principles for all Member States. A standard beyond which the States remain free to compete fiscally among themselves, competition which to a certain extent can be considered beneficial, but does not lead to significant distortions of competition, undermining the construction of the Single Market.

Tax harmonisation should be a means and not an end in itself, a means of achieving the truly European integration we are so yearning for and working towards.

Changes in international tax law that have (slowly) been made, as they are being developed and consolidated, will tend to lead to a markedly supranational law. Or at least that is what we hope for. And this is where the European Union will be ready to take a bow as a supranational entity with harmonisation privileges.

We cannot speak of the need for tax harmonisation within the European Union without reflecting on why it has progressed poorly and half-heartedly. In other words, the impediments of the European Union’s legislative bodies in what concerns taxation remains mainly due the unanimity rule on tax matters. It is understandable that the States, who have given up the monetary and exchange policy, withdraw into the fiscal sovereignty left open to them, hanging on to the unanimity rule when adopting tax measures, giving them a real right of veto on this matter. Not to mention that they are very cautious in accepting new areas of tax harmonisation or in further developing existing ones.

However, understanding the reasons for this status quo does not mean accepting its damaging consequences, as this implies that tax harmonisation is left basically in the hands of the market due to tax competition, which will lead to a lowering of corporate tax rates without eliminating the differences that are maintained or even increased in each of the increasingly complex national tax systems.

The economic competition among countries should be influenced more by the comparative quality and strength of their infrastructure and the skill of their workforce, rather than its lower tax jurisdictions.

This international agreement is expected to become the basis for creating a real European Union tax law that promotes the elimination of barriers between Member States, while encouraging fair and healthy competition, thus stimulating the consolidation of a true Single Market.

[1] A multinational corporation or multinational enterprise has facilities and other assets in at least one country other than its home country. A multinational company generally has offices and/or factories in different countries and a centralized head office where they coordinate global management. Some authorities consider any company with a foreign branch to be a multinational corporation; others limit the definition to only those companies that derive at least a quarter of their revenues outside of their home country. There are four categories of multinationals: i) A decentralized corporation with a strong presence in its home country; ii) A global, centralized corporation that acquires cost advantage where cheap resources are available; iii) A global company that builds on the parent corporation’s research and development (R&D); v) A transnational enterprise that uses all three categories.

[2] https://ec.europa.eu/taxation_customs/system/files/2021-05/communication_on_business_taxation_for_the_21st_century.pdf , page 12

Picture credits: stevepb.

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