Is G7’s Global CIT unfavorable for Poland? Biden, OECD and tax havens

There is a cult phrase in Twin Peaks: “The owls are not what they seem.” The same can be said about the global CIT proposed for multinational corporations. At the G7 summit in June, the minimum 15% rate of this tax was adopted, prompting comments that the era of tax havens and tax avoidance by multinational corporations is coming to an end. The reality, however, is more complex. Developing countries, with a large share of CIT in their tax revenues, emphasize that the beneficiaries of the proposed solutions are the richest countries that do not have to compete using their tax thresholds.

One of the main tax challenges that countries have been facing for several years is the taxation of digital giants, such as Google, Amazon, and Facebook. The specific modus operandi of such companies, involving business without physical presence – where the primary asset and source of profit is data – allows them to pay taxes in jurisdictions other than those they sell and earn actual income in. At the same time, they resort to tax optimization typical for international corporations, including manipulating transfer prices and using intangible assets in the transfer of profits, which allows minimizing the tax base.

As a result of these practices, countries around the world record loss of revenues up to $ 430 billion lower each year. The ones to lose the most are Germany and the UK. Their CIT revenues are reduced each year by 26% and 25%, respectively. On the other hand, EU tax havens – e.g. Ireland and the Netherlands – have revenues that are 67% and 39% higher, respectively.

The path towards poorer big-techs and richer countries

Since 2017, work has been underway within the G20 and the OECD to tighten the international tax system. With the persistence of the most affected countries, two solutions were presented in 2019 intended to revolutionize the international tax system. If both of them were implemented, the total global revenues would oscillate around USD 103 billion. (4% CIT).

The first of them (the so-called Pillar I) allows the taxation of profits of international corporations operating in consumer goods (CFB – Consumer-Facing Business) and automated digital services (ADS – Automated Digital Services) with the sales location of a given service (the so-called tax re-allocation of sales). Part of their income will ultimately go to the countries they do business in, regardless of the declared tax residence. With this change, the revenues of states could increase to USD 12 billion annually, which accounts for 0.5% of global CIT revenues.

As part of the second solution (Pillar II), a minimum global effective CIT rate was to be established. According to initial proposals, the minimum 12.5% threshold was to apply to international companies involved in intangible business activities with their global annual revenues exceeding EUR 750 million. Under this arrangement, all revenues of qualifying corporations would be taxed with an effective tax rate of at least 12.5%. Its implementation would avoid the prisoner’s dilemma – capital would have nowhere to run away to, as all countries would have the same tax threshold.

Negotiations on a new tax stalled in 2020. It was partly due to the US administration under President Trump, which demanded a halt to work on a tribute largely aimed at American companies. At the same time, the pandemic reality restricted the possibility of conducting (mainly behind-the-scenes) negotiations.

The situation changed dramatically with Joe Biden’s takeover of power. One of the main sources of funding for the programs he announced in early 2021 – post-Covid support for the economy and infrastructure – is to be increased tax revenues from companies, primarily the largest corporations transferring profits outside the United States and paying low taxes in tax havens.

The American president came out in April this year with a proposal based on the assumption that all multinational corporations would pay the tax if they exceeded a certain level of annual revenues. The American administration informally suggests that the tax indicated by the OECD is way too low. The new one could be up to USD 20 billion. In effect, the minimum 21% CIT would cover only the 100 largest multinational corporations, regardless of the nature of their operations.

A groundbreaking agreement?

There was a breakthrough during the summit of G7 finance ministers held in London at the beginning of June this year. The curt communiqué published by the British Presidency shows that the Group’s states have reached an agreement on the taxation of the largest multinational corporations. The consensus reached seems to be a product of the OECD and the American administration’s proposals. Countries agree to adopt both pillars at the same time while resigning from unilateral solutions concerning taxation of digital companies (digital service tax).

The first pillar provisions have been maintained: the largest multinational corporations with profit margins above 10% will have to share at least 20% of their global income among the countries where they sell their services and products.

The global minimum CIT rate would be 15% and would be charged on a country-by-country basis. As a result of accepting such a solution, there is no need for unanimity in accepting this idea and raising the corporate tax rate to 15% by all states. For example: if a Polish corporation books income taxed with the 5% rate in Ireland, Poland will be able to collect an additional 10% until the adopted 15% rate is reached. This would apply to income booked by Polish corporations in all countries around the world.

What is also important is what was missing in the G7 communiqué. It does not say whether the minimum tax rate will be nominal or effective. The former informs about the official tax rates in force in a given country, while the latter refers to the actual level of taxation, incl. after deducting tax allowances or tax exemptions. The lack of this information prevents a more accurate calculation of how much corporations will have to pay. The leaks show that the goal of the G7 countries is to implement an effective rate. This would tie the hands of poorer countries: Southern and Eastern Europe, Central Asia, and Africa, which often offered lower tax rates to attract foreign investments.

It is equally important to clarify which companies would be taxed. This is about the aforementioned rate, the revenue threshold, and the specification of the companies affected. The G7 communiqué does not contain any information about any exemptions provided for in the OECD proposal. According to it, companies operating in a given country were to be excluded from the taxation (the so-called substance curve-out). This measure was supposed to tax intangible assets and focus it on corporations using subsidiaries to distribute profits and reduce taxation artificially.

The supporters of the solution proposed by the OECD are countries with a significant share of industrial production in GDP and attracting capital with pro-investment incentives, e.g. Poland. They emphasize the need to maintain the sovereignty of tax decisions concerning tangible economic activity conducted on domestic soil. In their opinion, the American proposal – probably accepted by the G7 countries – contradicts the original idea of solutions negotiated at the Organization’s forum.

Will Poland lose on the deal?

The details of the tax agreement are still being processed, but at this stage, it is possible to indicate at least theoretical beneficiaries of individual solutions concerning the two pillars proposed by the OECD.

The greatest benefits of adopting the first pillar – enabling countries to tax large enterprises where they sell, and not only where they book profits – will be enjoyed by countries with a large consumer base (including the largest EU countries and the United Kingdom). They will increase their budget revenues at the expense of countries with low tax rates (Ireland, Switzerland), where corporate profits are being booked.

The second pillar will bring the most influence to the United States. Those are primarily American companies, often from the digital sector, that resort to shifting profits to tax havens. Its supporters also included the largest EU economies, suffering significant losses in this respect.

Precise estimation of the budgetary consequences of the agreement is impossible due to the lack of key elements of the agreement, but preliminary estimates indicate that adopting a minimum effective CIT rate of 15% should allow for an annual increase in global CIT revenues by up to USD 275 billion, of which Poland can get from USD 800 million up to USD 4.5 billion. However, higher revenues would be associated with the adoption of a higher effective tax rate than originally assumed and a broad tax base. In the long run, this could result in a reduction in the competitiveness of the Polish economy due to the limited possibilities of using instruments lowering the nominal tax rate and applying minimum tax rates to all economic activities.

An equally important consequence of adopting the developed solutions would be the end of tax havens. Implementing a minimum tax rate by a critical mass of large economies and accounting for it at the level of individual countries (country-by-country) would render the functioning of tax havens meaningless. The transfer of profits to countries with low tax rates will no longer be reasonable since companies will be forced to pay the tax surcharge at their place of business anyway.

Lots of questions

The preliminary agreement concluded within the G7 is an important step, but the final agreement is still a long way off. There is no consensus on the minimum rate of global CIT in the international arena. The compromise worked out by the G7 was accepted by the states that are the greatest supporters of the proposed changes. They were even supporters of even more far-reaching changes – after all, Joe Biden originally proposed a higher rate, and the French Minister of Finance, Bruno Le Maire, specifies the 15% rate as a starting point for further negotiations. Threatening the possibility of a higher rate should lead to the acceptance of the solution developed by more liberal and poorer countries.

On the other side of the negotiating table, there are tax havens that benefit the most from the current tax system. They are headed by Ireland, which has a 12.5% CIT rate, where almost all global high-techs operating in the EU have their headquarters and tax residences. The Irish Finance Minister has already commented on the G7 agreement, stating euphemistically yet bluntly that any global deal must include smaller nations. Similar voices are also heard from Hungary and Cyprus. Developing countries with a large share of CIT in tax revenues are this group’s accidental allies. They emphasize that the beneficiaries of the proposed solutions are primarily the richest, well-established countries that do not have to compete using their tax thresholds.

The third group includes countries that support the proposed changes, but want to introduce specific provisions. This group includes Poland, which opts for the OECD proposal to exclude companies that operate in a given country from taxation and adopt a nominal tax rate.

The next rounds of global negotiations are scheduled in the coming weeks. In July, talks will be continued at the G20 and OECD forums. The future of the solutions described depends on reaching a consensus in these bodies: while the minimum CIT rate does not require unanimous approval, a global agreement is necessary for the effectiveness of the first pillar – the right to tax part of sales profits in a given country.

Even after reaching a compromise, national ratification shall be required for the agreement to enter into force. This may pose particular problems in the European Union and the United States. There are voices of criticism of Joe Biden’s ideas from Congress. Republicans have already announced that they will not agree to an increase in the tax burden on corporations, and Democrats – often associated with Silicon Valley companies – want to amend the solutions proposed by the American president.

The European Commission announced the intention to implement tax solutions at the EU level to maintain their uniformity. However, this will require unanimity and acceptance of the agreement by all member states. Having reached a global agreement, the Commission will need at least six months to prepare the bill. Brussels-based legislators expect that negotiations in the legislative draft will not start until mid-2023 and it’s hard to say when the final text of the agreement would be accepted by all EU countries.

The more so as the experience to date in the implementation of international tax law on domestic soil does not give rise to optimism. OECD statistics show that the average time between the adoption of a solution at the global forum (BEPS/OECD) and its implementation at the local level is approx. two years. Therefore, the entry into force of the solutions described above should not be expected before 2026-2027.

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Nothing is decided yet on the global minimum CIT. The agreement concluded by the G7 countries, which reflects their interests, will now be confronted with the position of countries with different development needs and different logic of conducting economic policy. In the coming months, we can expect numerous reports from the frontline: breaking negotiations, forming new alliances or returning to talks.

Polish version is available here.