Tax at Osgoode Hall Law School

 

Reports of a Global Minimum Tax

It is much reported today that the G7 Finance Ministers agreed to implement a global corporate minimum tax. The Communiqué and a supporting commitment to developing beneficial ownership registries can be found by clicking the hyperlinks. (Also see here an html-friendly version of the Communiqué).

This note does not speak about beneficial ownership. Canada made this commitment concerning the Canada Business Corporations Act some time ago, and made a further commitment in the recent April 19, 2021 Federal Budget to enhanced standards in line with initiatives spear-headed by the Organisation for Economic Co-operation and Development (OECD) arising most recently as an element of its ongoing Base Erosion and Profit Shifting project (BEPS, initiated in its current incarnation in 2012 and continuing as its Pillars One and Two GloBE Global anti-Base Erosion initiative.)

In fact, the global minimum tax "cart" is very much ahead of, what in fact, is probably a much more slow-moving "horse." Let’s look a little more closely – and critically - at what the Ministers actually said. What they said is just as much evident in what they did not say, but implied. According to the oft spoken quip that “the devil is in the details”, there’s not any detail here, and in international tax relations there’s much that is bedeviling. The lemming like “enthusiasm”, even hunger in the international tax conversation and by the commercial press for momentous “stories” might create a different impression. That’s why it’s good to reflect, to question, to evaluate with an informed critical mind, even if sympathetic to the “problem” of “undertaxed” diverted income which seemingly is the Ministers’ target.

 

What the G7 Minister’s Said

Paragraph 16 of the much reported on June 5, 2021 G7 FINANCE MINISTERS & CENTRAL BANK GOVERNORS COMMUNIQUÉ issued today says the following:

 

“Shaping a Safe and Prosperous Future for All

16. We strongly support the efforts underway through the G20/OECD Inclusive Framework to address the tax challenges arising from globalisation and the digitalisation of the economy and to adopt a global minimum tax. We commit to reaching an equitable solution on the allocation of taxing rights, with market countries awarded taxing rights on at least 20% of profit exceeding a 10% margin for the largest and most profitable multinational enterprises. We will provide for appropriate coordination between the application of the new international tax rules and the removal of all Digital Services Taxes, and other relevant similar measures, on all companies. We also commit to a global minimum tax of at least 15% on a country by country basis. We agree on the importance of progressing agreement in parallel on both Pillars and look forward to reaching an agreement at the July meeting of G20 Finance Ministers and Central Bank Governors.”

 

That's it. All of it.

 

Interpreting What the G7 Minister’s Said – What Does What They Said “Mean”?

What did the Ministers actually commit to?

 

• They reiterated their support “to address the tax challenges arising from globalisation and the digitalisation of the economy”. That is not new. It or a variation of it in equally brief terms has been in all Finance Ministers’ and First Ministers’ communiqué from the earliest states of BEPS. Being supportive and up-ending domestic tax and related legal regimes in a co-ordinated, consistent, and enduring way are much different things. We are still at the support stage.

 

• They ostensibly committed “to adopt a global minimum tax”. That would indeed be momentous if that is in fact what they had done. But, there is that devilish detail rearing its head again. Let’s look a little more closely.

 

• They committed “to reaching an equitable solution on the allocation of taxing rights, with market countries awarded taxing rights on at least 20% of profit exceeding a 10% margin for the largest and most profitable multinational enterprises.” What does this really mean? Essentially, its another supportive commitment agreeing to agree.

 

• Agree to what? A solution, but a solution that does not yet exist, to allocate taxing rights.

 

• To what end? To allocate some measure of profits as a measure of the contribution to profitability associated with market, that is, with customers in countries who buy products and consume services: “to reaching an equitable solution on the allocation of taxing rights, with market countries awarded taxing rights on at least 20% of profit exceeding a 10% margin for the largest and most profitable multinational enterprises.”

 

• How will the profits be measured? What accounting conventions will apply? Will those profits be evaluated on a pre- or post- tax basis? We can know with reasonably certainty that 20% of profits after accounting for a 10% profit margin is not 20% of profits, but something less at least by the measure of those profits that is 10%. That may be a reasonably small amount, or it may be fairly sizable to the extent that the “market intangible”, to use a familiar but familiarly imprecise transfer pricing notion, is “high”. But it is important to not that the target here is the value of a market and not all “intangibles” notably technology – related intangibles.

 

• What about the other 80% of profits? Where do they “go”. Presumptively, they are not related to market presence. If they were, they would be in the 20%. If they are not allocated to market jurisdictions, presumably they migrate to their “natural home”, the headquarters or home or parent jurisdiction. In effect the agreement is to allow for a modest allocation of income referable to a commercial market “presence” in the form of business custom. But not the rest. Effectively, the transfer pricing puzzle is solved with an effective abandonment of the arm’s length principle in favour of a formulaic or fractional “profit split," by necessary implication of the jurisdiction(s) of the corporate home – and the 80:20 rule where the 20 is both a market allocation and in fact less than 20. The result interestingly is consistent with what the International Chamber of Commerce recommended in the early 1920s: a profit split defaulting to a single sales factor formula for multinational corporate income. It is also consistent with Mitchel B. Carroll’s observations, in his League of Nations work in the 1930s, to the effect that the intellectual home of a multinational enterprise, the source of and closest nexus for its “intangibles” in today’s terms, was naturally associated with the parent or home jurisdiction of the multinational enterprises and not its more limited function branch or subsidiary manifestations in market countries. It is also interesting to wonder if applying the 20% (less, actually) market profit allocation, the result would be much different than what conventional transfer pricing analysis would assign as a suitable allocation, on average, to market jurisdictions. , More about this in a moment because when the proposed 15% rate is considered, this implication becomes even more interesting.

 

• Even if the questions about accounting conventions and pre- or post-tax income measurement are resolved, what income? This is the question mostly addressed by Pillar One but Pillar Two is also relevant. Isn’t this the “old” transfer pricing question in different garb? In order to allocate income referable to markets to the market jurisdictions, it is necessary to measure it. The tax applies to the allocated income; from its earliest origins in the 1930s’ work of Mitchell B. Carroll for the League of Nations. The fact of the matter is that there is no universal notion of “source” which in any event is a legal and not a geographic or economic notion even though empirical observations about how business ins conducted, i.e., where and to what effect, feed the law-based notions that inform any country’s tax system’s connotation of “source”. So, to answer the BEPS riddles, to answer the Pillars riddles, and now to inform “minimum tax”, we have to know definitively how much income gets allocated where. The Communiqué does not offer insight on this, except to offer continuing encouragement to the ongoing OECD efforts grounded in the Pillars for which there is no international consensus. It is notable in this regard that the US has said that its support for a global minimum tax depends on the Pillar One rules not affecting its multinational enterprises adversely. To this point is the last agreement to agree: "We agree on the importance of progressing agreement in parallel on both Pillars and look forward to reaching an agreement at the July meeting of G20 Finance Ministers and Central Bank Governors."

 

• Now the rate, 15% on whatever is the measure of the allocated income, which is 20% of profits above a 10% profit margin. First, to get it out of the way, even though commentators and governments are preoccupied with tax rates as if they demonstrate commitment to robust taxation, informed commentators know that tax rates by themselves are not meaningful. Headline tax rate? Effective tax rate? Marginal effective tax rate? Tax actually paid expressed as a rate?

 

• To continue and simplify with the information we have, let’s assume that the reallocated income is the profit margin, some measure of revenue above relevant costs (the Communiqué does not foresee what are relevant costs any more than it anticipates the appropriate convention for measuring “income”). Let’s do the math: tax rate x applicable profit margin = 15% x (90% of 20% of corporate profits) = 15% x 18% = 2.7%. The minimum tax rate on market – oriented allocated market jurisdiction profits is 2.7%. Even if we made the less refined assumption that the 15% tax rate would apply to 20% of the profits, still that is an effective 3% rate. That looks a lot like the order of magnitude of “Digital Services Taxes” that are meant to be replaced by this global minimum corporate income tax: “We will provide for appropriate coordination between the application of the new international tax rules and the removal of all Digital Services Taxes, and other relevant similar measures, on all companies.” It seems that the minimum tax formulation is simply a more palatable ( to the US) expression of the DST. As a close friend observed to me today when speaking about these issues with me, likely a DST is a non-starter in the US, as such, but an income tax that mimics it has a much better chance. Not that a DST is not an income tax; I think it is. But getting rid of the label may assist the political sales effort that will be necessary to make any of this happen. No doubt this is why countries with DST’s are reluctant to let them go until their replacement is in place and also why those countries would be relatively indifferent to the rebranding of their DSTs. It also should not be lost that the renunciation of DSTs is for “all companies," whereas the global minimum tax is intended to apply only to the largest among them. A net gain it seems for those who oppose DSTs as such. This line of thinking is all the more fascinating if one notes that many if not most headline corporate income tax rates exceed 15% (though on a combined federal – provincial basis, some Canadian tax rates would come close, though likely not for the kinds of corporations that seemingly would be affected by the "new regime"). The implication is that as corporate income tax matter, there is little to gain or lose by agreeing to the 15% rate, subject of course how it is determined and to what measure of income according to what source conventions it applies.

 

• Putting all this together it is indeed interesting to wonder whether the global minimum tax is what it purports to be or whether its effect, in the image of global fairness and equity, will simply entrench in a different way the allocation of the lion’s share of corporate group income to parent or headquarters jurisdictions or their intermediate jurisdiction “designates” through the function of those jurisdictions controlled foreign corporation and related rules.

 

There is More to This

I have a few other observations:

 

• The G7 is a limited group of highly developed countries. It is not the G20, and it is not the Inclusive Framework. It has no legal authority. This proposal cannot work without universal and consistently universal, enduring legislative implementation in countries’ tax regimes with suitable bridging provisions to typical elements of those regimes associated, for example, with how the income of controlled foreign corporations is taxed, transfer pricing, foreign tax recognition/credit and the like. More is required, much more than a mere endorsement of continuing international collaboration and outlook. That’s not be a naysayer but engrafting on existing legal systems the same super-tax regime with the same effects taking account of existing tax regimes, in ways that make countries verifiably accountable to each other, is not easy and, I would guess, not something that happens soon. And, whatever the international impetus, this will need the enthusiastic consistent support of and actual adoption without material outliers  by the United States, and China and India among other countries that are not G7 countries but are members of the OECD led Inclusive Framework, essentially to confine their share of market income the way this proposal seems to envisage. In other words, are the kinds and degrees of universal, consistent, permanent adoption possible, and even if so, what are the implications for countries’ fiscal and tax policy if later their circumstances change, and they wish to recant – what is the exit strategy as one might ask in a corporate planning context?

 

• This proposal amounts, as noted earlier, to a simplified global formulary or fractional apportionment system, still though without solving for transfer pricing’s bane of how to allocate “income” and in that connection to determine the “source” of income.

 

• A key question with any tax is incidence. Assuming that this minimum tax applies to the largest of the large in “customer facing” and “digital” business settings, how is the tax passed on according to the old adage that “people pay taxes?

 

• It is hard to avoid questions about how US multinational businesses and the US Congress will react to this. Without the US, as not only a supporter but bound with its international contemporaries to the same terms, which likely require significant domestic legislative changes for participating countries even if something in the nature of a multilateral instrument emerges. Will the US’s and other countries’ political processes permit these changes any time soon even if the details are worked out, essentially on common terms, with the attendant necessary attention to general law, i.e., the private law that underpins tax law, and to the rest of domestic tax law, and for that matter tax treaty commitments?

 

That little paragraph in the Communiqué yields a lot to think about.

 

- Professor Scott Wilkie (Distinguished Professor of Practice, Osgoode Hall Law School)