International tax reform – now it’s time to get excited!

In my previous blog, I couldn’t get too excited about the G7’s announcement on 5 June that agreement in principle had been reached on some key aspects of international tax reform because there was so little detail and an agreement between 7 seemed a drop in the ocean when another 130+ jurisdictions also need to agree. But it certainly paved the way for significant progress by the Inclusive Framework of the OECD. On 1 July, a statement was published by the OECD setting out areas of agreement between 130 of the member jurisdictions – and this is something I can get excited about!

Notably, Ireland and Hungary are among the 9 countries which did not agree with the statement, both being opposed to the global minimum rate of tax as low-tax jurisdictions with more to lose than gain. 

The proposals will now be put to the G20 Finance Ministers on 9-10 July and the aim is still for a detailed implementation plan to be finalised by October 2021 in time for the G20 summit, although work on the application of the arm’s length principle to in-country baseline marketing and distribution activities will not be completed until the end of 2022.

There’s a lot packed in to the 5-page statement, but I would like to draw attention to the inclusion in the statement of two important points which had been included in the OECD blueprints but did not appear in the G7 agreement:

• An exclusion from the new taxing right for regulated financial institutions – this is something UK Chancellor Rishi Sunak promised to fight for and is important politically, but also from a practical and technical perspective, as applying the new taxing right to financial institutions was fraught with difficulties and with little to be gained.
• A formulaic substance carve-out from the global minimum rate of tax rules – this is similar to, but at a lower rate than, the equivalent carve-out in the US GILTI rules (although the Biden administration has proposed to repeal that carve-out).

How much additional tax will result from the new taxing right?

Whereas the G7 agreement referred to a taxing right of at least 20% of profit exceeding a 10% profit margin for the largest MNEs, the statement refers to between 20% and 30% of profit exceeding a 10% profit margin for MNEs with global turnover above EUR 20 billion. It will be interesting to see from the impact assessments (when they become available) how much extra tax would be allocated to market jurisdictions depending on where this percentage ends up -  although it has become increasingly clear since discussions began that the amount of tax is not as important as the political message. 

What about the EU’s proposed digital levy?

Consistent with the G7 agreement, the statement provides that all Digital Services Taxes and other “relevant similar measures” on all companies will be removed. Tension hangs over the EU digital levy due to be announced on 14 July. The EU is expected to argue that the levy is not a relevant similar measure but will operate more like VAT. But this argument is unlikely to satisfy the US. The fact that the EU wants a new digital levy alongside the OECD proposals does show, however, concerns that something more is still required to properly tax the digital sector.

Is it realistic for the new rules to be effective as soon as 2023?

With so many jurisdictions now on board, even though there are still technical, practical and political issues to resolve, it looks like international tax reform will happen and will progress quickly. As we have seen from the BEPS project, complexity does not seem to prevent countries from rushing ahead to implement measures and then ironing out any issues later, as the UK has done (and continues to do!) with the hybrid mismatch rules. So businesses may have to put up with some uncertainty and double taxation until the new rules bed down.

But the concerns I raised in my earlier blog about implementation still stand – in particular the logistics of the US passing the relevant legislation - so aiming for these fundamental changes to international tax rules to come into effect in 2023 seems ambitious.