67 Tax
67.1 Corporate Tax
Profit Shifting
OECD Process
There remain significant difficulties in the OECD process, with its two-pillar proposals. First, there is no common ground on ‘Pillar One’. This is the element which would go beyond the archaic arm’s length principle and introduce some element of formulary apportionment (that is, allocating a share of each multinational’s global profits to the places where they actually do business, in the form of sales and employment). The US (under Biden, as under Trump) wants Pillar One to apply to all businesses; the EU is focused on the big tech multinationals; and the OECD proposal to identify ‘consumer-facing’ businesses falls somewhere in between these.
As things stand, the OECD proposal is highly complex and would retain arm’s length pricing for most profits, and therefore result in relatively little reduction in profit shifting – making it largely unattractive for most countries. At the same time, the proposal would require global treaty change, meaning that it could very easily be blocked – including by the US Congress, regardless of whether the Biden administration had come around to support it.
‘Pillar Two’ contemplates a global minimum corporate tax rate. This has the potential to go a long way to stop profit shifting, not by making it harder to achieve but by making it much less rewarding – since multinationals would, in theory, end up being taxed at the minimum rate even if they managed to shift the profits to a zero rate jurisdiction.
Here again though, the current OECD proposals are highly complex, and have been very unambitious. And an argument about ‘rule order’ – in simple terms, whether the home country of a multinational goes first in levying any top-up tax, or the various host countries – has exposed the major distributional question. Despite some initial optimism, most non-OECD members have by now become thoroughly disillusioned with the process. An outcome that favours OECD members, despite lower-income countries bearing disproportionately high revenue losses due to profit shifting, would be unconscionable – but, sadly, not entirely unexpected.
Lastly, the insistence that the two pillars are inseparable, and must be delivered jointly, creates a hugely complicated contraption requiring great resources to move ahead, but with little certainty over any benefits.
Way Forward
Stepping out of the limitations of the OECD process, things very quickly start to look much brighter. This is for three main reasons.
First, the two pillars can be separated – and that means the unworkable and unambitious ‘Pillar One’ can be left behind, along with the requirement for global treaty change. Instead, a global minimum corporate tax can be taken forward by a coalition of the willing. (In fairness to the OECD secretariat, they have raised this possibility at times also, recognising the practical difficulties of their Pillar One.) With the US and Germany (and the European Commission) committed to a minimum tax, broad agreement on the shape could be reached relatively quickly.
Second, the OECD leadership’s longstanding insistence on a very low minimum rate of 12.5% can be set aside. The Biden administration has indicated a rate of 21%. The Independent Commission for the Reform of International Corporate Taxation has proposed 25% as an absolute minimum; while discussions among various groups of lower-income countries have suggested higher rates still, to ensure that they are not disadvantaged. Negotiating upwards from 21% – and with the possibility of different countries taking their own approaches as appropriate – would provide a quite different dynamic.
And third, the setting aside of Pillar One creates the possibility of pursuing a more ambitious approach to the minimum tax. Our proposal for the METR, or Minimum Effective Tax Rate for multinationals, does just this. We propose a method that builds on the technical efforts of the OECD secretariat, who have done sterling work in establishing various approaches to identify and to apportion taxable profits, but shifts the politics substantially.
METR
In effect, the METR combines the two pillars by identifying under-taxed profits, and then apportioning these for ‘top-up’ taxation on a formulary basis, according to the location of multinationals’ real activity. In this way, the METR cuts through any ‘rule order’ debates and instead treats all countries, home or host, on an equivalent basis.
Politically, the momentum for globally inclusive solutions at the UN, rather than the rich countries’ club at the OECD, will continue to grow – and especially if a one-sided minimum tax solution emerges from the OECD now. The FACTI panel report called for the negotiation of a UN tax convention, which would provide the basis for an intergovernmental body under UN auspices to set corporate tax rules in future – including a global minimum tax rate designed to benefit all.
That the US administration is now leading the push for an ambitious global minimum tax rate confirms this as the new norm. The decisions set to be made in the next couple of months, over technical design and political inclusion, will determine just how effective this can be in bringing an end – finally – to the decades-long race to the bottom in corporate tax.
With the confirmation of this new narrative, it seems likely that what is left undone in the OECD process will be resolved through a combination of unilateral and UN action.
The Missing Profits of Nations
Tørsløv Abstract
By exploiting new macroeconomic data known as foreign affiliates statistics, we show that affiliates of foreign multinational firms are an order of magnitude more profitable than local firms in a number of low-tax countries. Leveraging this differential profitability, we estimate that 36% of multinational profits are shifted to tax havens globally. U.S. multinationals shift twice as much profit as other multinationals relative to the size of their foreign earnings. We analyze how the location of corporate profits would change if shifted profits were reallocated to their source countries. Domestic profits would increase by about 20% in high-tax European Union countries, 10% in the United States, and 5% in developing countries, while they would fall by 55% in tax havens. We provide a new international database of GDP, trade balances, and factor shares corrected for profit shifting. In contrast to the picture painted by official statistics, our results suggest that the corporate capital share has increased not only in North America but also in high-tax European countries. Capital is making a comeback globally, but its rise is obscured by the tax avoidance strategies of multinational companies.