Tax: Rewriting the Rules

The digitalization of the international economy has generated opportunities for companies to sell goods and services to anyone, anywhere. Change is afoot as current tax laws may not capture all relevant revenues, and digital services companies need guidance to ensure they remain compliant. A corporate minimum tax seems all but certain. The investment landscape is complicated, mainly due to various rates, rules and regulations across countries, and multinational companies have long since used creative ways to decrease their tax bill. While the corporate tax rate varies significantly around the world now, implementation of a universal tax would impose a fixed rate of 15%, requiring companies to pay at least that wherever they operate, not just where they are headquartered. Every day, 650 million online searches are carried out in the EU, demonstrating how much the internet has changed our lives. Yet, global corporate tax rules are more than a century old and are out of step with the boom in the digital economy. Both the way a business sells to a customer and the way customers buy has shifted and a revamp of taxes is long overdue. Countries have begun instilling unilateral digital services taxes—another country-specific move that complicates an already intricate landscape. With all the global uncertainty that Europe is facing with the COVID-19 pandemic and Brexit, there was a danger that the Organisation for Economic Co-operation and Development (OECD) global tax reforms – the other main risk to European business and economy – would be forced further down the corporate agenda.

However, originally proposed in 2019, finance leaders have now reached a global tax deal aimed at ending profit shifting, signalling a welcome return to a multilateral approach, following various scandals around the use of tax havens by global tech companies. Much of the focus of reform looked at the tax affairs of global technology giants such as Facebook, Amazon and Google. Europe has attracted healthy levels of foreign direct investment over the past 30 years, with the multinational community contributing significantly to its economic success, and Europe is now cooperating at both a political and corporate level. Governments worldwide are desperate to raise extra revenue to rebuild their pandemic-ravaged economies, and corporate taxation has become an obvious target after decades of decline. It is no secret that companies employ a litany of techniques, both domestic and international, to keep their tax bills low and with new business models emerging, the tax system must adapt. Over the past 35 years, the average corporate tax rate has been more than halved, falling from 49% in 1985 to 23% in 2019. New global tax requirements to combat low corporate tax rates present a fundamental change for multinationals, and with new rules are on the horizon, businesses must get ready. The deal encompasses a two-pillar approach outlined by the OECD and aims to tackle the challenges arising from an increasingly globalized and digital economy. Under Pillar One, the largest and most profitable multinational firms will be required to pay tax in the countries where they do business, rather than simply where the countries have headquarters or hold intangible property. The allocation formula set out is that a company gets an allowance of 10% of their revenues. Any profit above this is a “super-profit” and 20% of these super profits are reallocated to countries where they operate. Under Pillar Two, there will be a global minimum corporate tax rate of 15% operated on a country-by-country basis. The OECD estimated that the reforms should raise as much as £57bn in additional tax revenues annually. Advocates of the change say it will create a level playing field and protect vital tax revenue, while critics warn it will harm smaller economies and encourage countries who are not part of the agreement – namely, China and Russia – to use lower corporate tax rates to their advantage in global trade. Europe offers excellent conditions for taxation on capital gains, income and corporations, and multinational companies like Apple and Google have been able to legitimately decrease their global tax bills by taking advantage of these tax rates. Several critics have argued that the former global taxation system allowed big companies to save billions of pounds in tax bills and major digital companies are making money in multiple countries and only pay taxes at home. It’s true, global corporate tax rates have dropped in an international ‘how low can you go’ competition, allowing big multinationals to funnel profits through low-tax jurisdictions. Nonetheless, times and tax laws are changing. The COVID-19 pandemic and supply chain disruptions have already led companies to reconsider their global supply chain policies and business models. Innovative, contemporary companies nurture a ‘think global make local’ model – moving away from manufacturing items in low-cost countries and transporting

them elsewhere. The new tax rules might accelerate this change. Yet, some smaller countries whose low corporate tax rates have enticed scores of multinational companies are still fighting to maintain their national levies in a last-ditch attempt to stop the global minimum corporate tax rate from undermining their ability to woo international firms. For example, Ireland’s Deputy Prime Minister Leo Varadkar vowed that Dublin would defend the country’s current 12.5% rate. However, US Treasury Secretary Janet Yellen stated that all EU countries would agree to the upcoming deal, a potential ploy to persuade reticent EU governments to support it. The deal sees a substantial change to the existing global tax rules, namely unparalleled restrictions on the use of tax havens and a new system of allocating profit made by large multinationals between countries to ensure greater public transparency. It will also tackle the use of shell companies through new anti-tax avoidance measures. The Commission will also present practices to ensure fair taxation in the digital economy with a proposed digital levy which will serve as an EU own policy. The agreement charges an additional tax on some of the largest multinational companies, potentially forcing technology giants like Amazon, Facebook and Google as well as other big global businesses to pay taxes to countries based on where their goods or services are sold, irrespective of whether they have a physical presence in that country. Although largely applauded by tax campaigners and deemed a moment that would ‘change the world’ by G7 finance ministers, months and possibly years of discussions still need to occur before the rules become reality. It is time to rethink taxation in Europe, which currently has 27 different tax systems. The European Commission plans to use the OECD deal as a steppingstone to more unified rules for business taxation across the EU, driven by social trends like the COVID-19 pandemic, an ageing population, climate change and the transformation of the labour market. Alongside the global disruption in the world of corporate tax, the EU is scaling up tax cooperation. Business in Europe: Framework for Income Taxation (BEFIT) will support further administrative simplifications and minimise tax avoidance opportunities. Full details are promised by 2023. The lack of any immediate ruling makes planning a particularly complex process. Like the global effort to curb tax base erosion, BEFIT will combine multinational companies’ profits and parcel them out across EU countries. With so much shifting and little clarity, multinationals are in a muddle. How to prepare for changes that are almost certainly coming without any real idea about what those changes will be, all while trying to manage global tax compliance and recovering from a pandemic, is a hard ask. Still, the global corporate tax landscape is experiencing a major shift, and international business cannot afford to be caught by surprise. Uncertainty isn’t good for tax planning. Companies need some level of stability to make the correct commercial choices and remain compliant. European businesses that pinpoint which changes are most relevant to their business and where to take action can prepare effectively. As always when it comes to taxation, understanding, planning and implementing are key. It is important that firms have the right tools and technology in place and leverage the benefits of greater automation. Consultants like EY can help global businesses navigate this new landscape, build on opportunities and manage risk to produce growth. Businesses must rethink how their operations are being taxed internationally. This will result in strategic conversations that go further than the tax department, affecting the way businesses operate. As multinational companies adapt to new supply chain models, the ability to adjust to evolving tax laws is also critical. Companies that use technology and innovation to negotiate the changes within the business, while embarking on tax and trade planning, will benefit. The recent revisions will make the tax system fit for the digital age and make sure that the right companies pay the right tax in the right places. Tax will always be one of the most crucial factors for businesses when considering different business models, and if business models change, policy makers will modify their application of taxes to access different ways of generating income. It is time for European businesses to take a holistic approach to ensure their global operations are compliant in all jurisdictions in which they operate. Looking ahead, if the last year or two have demonstrated anything, it’s that businesses need to prepare for the unpreparable. European companies can get ready by watching developments, anticipating opportunities and developing various responses.