The G7 Tax Proposal — What it Means for Big Tech

Published on July 29, 2021 by Jeetendra Prakash and Mohit Choudhary

• Big tech companies (combined cash balance: >USD580bn 1) have paid lower taxes by incorporating in tax havens where corporate tax rates range from 0% to 17% as opposed to tax rates of more than 20% in the countries in which they were initially founded.
• Apple, Facebook, Twitter and Microsoft have their international headquarters registered in Dublin, Ireland, where the tax rate is 12.5%. Effective tax rates for Amazon, Facebook and Apple were only 11.8%, 12.2% and 14.4%, respectively 2, in FY 2020 — much lower than the 21% corporate tax rate in the US.
• G20 countries asked Organization for Economic Co-operation and Development (OECD) nations to address this disparity in 2013–15. Base Erosion and Profit Shifting (BEPS) strategies were subsequently introduced to ensure uniformity and certainty in the international tax system.
• In June 2021, the G7 countries agreed to tax the top 100 companies globally, irrespective of the place of incorporation, and are looking at setting up a framework to check tax arbitrage.

Need to change archaic tax laws

Taxing traditional business models is relatively simple, as an entity’s taxability could be linked to its physical presence in a country. However, in a highly digitalised era, the taxability of tech companies is blurred significantly, as revenue generation and value-add do not necessitate a physical presence in the country of operation.

A study by the IMF estimates that tax havens cost governments USD500–600bn per annum, mostly in corporate tax revenue. To put this in perspective, 55 corporations in the US paid no federal taxes in 2020, according to the Institute on Taxation and Economic Policy.

To prevent tax erosion, the UK, India, Italy, Spain, France and other European countries have unilaterally started levying a Digital Service Tax (DST) on non-resident digital service providers by taxing 2–3% of the revenue earned from domestic users.

The G7 corporate tax deal — the background and details

The Biden administration seems to be working its way back to the global centre stage, as evidenced by a softened stance on global minimum taxes to push the G7 tax deal. The (domestic) corporate tax cuts introduced by the previous administration cannot be reversed in isolation; hence, the US is focused on developing a multilateral agreement to resolve the digital and other international tax issues with other countries.

On 5 June 2021, the G7 countries (the US, the UK, Germany, Canada, France, Italy and Japan) agreed to create tax reforms aimed at multinational companies that bypass taxes through tax haves and remove the DST. Removing the DST would make the tax structure uniform internationally.

The deal is based on two pillars:

Implications

• An additional USD275bn 3of tax revenue could be earned under the proposed minimum corporate tax rate — 61% of this would accrue to the G7 nations; the US would earn 50% of this.
• With limited tax arbitrage, capital could flow back to (or accumulate in) the countries where the multinationals have a strong business presence.
• In the long term, measures such as infrastructure, favourable regulation and rule of law, and quality of workforce would be the key factors attracting foreign direct investment (FDI).

Conclusion and key takeaways

• Timing and the way forward: The backing of the G7 nations has provided a definitive step towards reforming the international tax structure. The tax proposal will be discussed next at the G20 meeting in October 2021.
• Tech companies: In the current form, the impact on tech companies is not significant. For instance, the top 15 companies in the US are subject to an effective tax rate of c.14% 4. Under the new tax reform, we estimate that the effective tax rate will increase by 300–400bps 5, as some of the tax increase will be offset by the withdrawal of the DST. The minimum tax rate of 15% is only marginally higher than Ireland’s current tax rate of 12.5%.

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Originally published at https://www.acuitykp.com.

About the Authors

Jeetendra Prakash, Assistant Director, Investment Research, has over 10 years of work experience in investment research, with a focus on oil and gas and real estate. He currently supports a large European asset manager. The process involves research on potential acquisitions of real estate assets and also supports a distressed debt fund. In addition, he is also actively involved in training and quality control of deliverables. He holds an MBA and a bachelor’s degree in Commerce.

Mohit Choudhary, Delivery Lead, has over 5 years of experience in investment research with a focus on cable, media and mining sectors. He currently supports a large European buy-side client. The work involves analysis of highly leveraged companies and theme-based research. He has cleared CFA level 3 exam and is a bachelor of commerce.