Changing Corporate Taxes

At the World Economic Forum meeting, governments altered the way their companies are taxed.

On the sidelines of the World Economic Forum meeting in Davos in January, the US and France were able to hammer out a truce on Paris’s plans to slap a tax on the profits of internet companies that have sales in France. What the US didn’t reckon with is that the truce only whetted the appetite of governments around the world to begin taxing all multinationals on their local profits, not just digital firms.

France, which announced the 3% tax on profits of companies like Google and Facebook, backed down following a threat from US President Donald Trump to impose retaliatory tariffs on $2.4 billion of French exports to the US, such as champagne and cheese.

US Treasury Secretary Steven Mnuchin met with French Finance Minister Bruno Le Maire at the Davos conference; and the two men agreed to suspend action while an international tax agreement is negotiated at the Organization for Economic Cooperation and Development (OECD), a rich-nation think tank with headquarters in Paris. But a number of other countries, including Britain, Austria and Italy, later said they planned to go ahead with their own taxes on digital companies, most of which are American.

While the US government is unalterably opposed to efforts to place new taxes on American multinationals, not all the companies share that sentiment. Facebook CEO Mark Zuckerberg told a security conference in Germany in February that Facebook is ready to pay its share.

“I understand that there’s frustration about how tech companies are taxed in Europe,” Zuckerberg said, adding that he was glad the OECD is proposing new alternatives. “And we accept that may mean we have to pay more tax and pay it in different places under a new framework.”

Such positive pronouncements from Big Tech, coupled with a coordinated political campaign by Europeans, are likely to mean multinationals will end up paying tax in many new jurisdictions, possibly as early as next year.

While France and other countries initially wanted to tax only digital firms, the mandate is now much wider. “It’s gotten bigger than that now,” says Scott A. Hodge, president of the conservative-leaning Tax Foundation, a Washington, DC-based nonprofit. “Where it started as aimed at just the digital, it’s now potentially impacting everyone.”

Pressure to force multinationals to pay taxes on their overseas profits has been growing since the US adopted Trump’s Tax Cuts and Jobs Act in 2017, which forced American multinationals to pay taxes on the estimated $2 trillion they had stashed in subsidiaries in countries with low corporate taxes like Ireland and the Netherlands. The International Monetary Fund says in a 2019 report that profit shifting by US multinationals has risen from 5%-10% of gross profits in the 1990s to about 25%-30% today.

While all companies that have sales in Europe must pay value-added tax to the local governments, there has never been a coordinated effort to force multinationals to pay taxes on their profits locally. Most companies simply pay corporate taxes to the government where they are headquartered.

Toder, Urban-Brookings Tax Policy Center: Shifting profits to tax havens has been going on for a long time, and there is a consensus that this is no longer appropriate.

But that has dramatically changed with the advent of internet firms that have little or no physical presence in a country—such as Google, which sells online ads. Another huge issue is so-called intangible assets, which include things like intellectual property, patents and software copyrights. Multinationals such as pharma companies have in the past transferred these intangible assets to subsidiaries in low-tax countries to escape paying tax in both the country of origin and the country where the profits are earned.

The OECD has stepped forward with a two-pronged plan that would require companies to pay tax on their profits in the countries where their sales and employees are located, as well as what it terms a “global minimum tax” on excess profits, which it has not defined. David Bradbury, head of the OECD’s tax policy and statistics office, told a news conference February 13 that preliminary estimates suggested that the combined approach would raise about $100 billion annually in new taxes, which he said would be evenly spread across high-, middle- and low-income nations.

While European governments are the main moving force behind the proposals, they are also keenly aware they have multinationals themselves that will be affected by these rules.

“Failure to reach a consensus-based solution will lead to unilateral measures and greater uncertainty,” Bradbury warned, in an apparent swipe at the US, which has insisted the OECD proposals have a so-called safe harbor provision that would make them optional for every company. France’s Le Maire has said the US proposal is unacceptable.

“I think the OECD is concerned that countries like France and Germany were seeing revenue from companies like Google disappearing and being reported in countries like Ireland,” says Thomas Horst, an economist who specializes in international tax matters and managing director of consulting firm Horst Frisch. “They’re saying, ‘Wait a minute—that’s profit we should be taxing,’ but traditional tax rules were working against them.”

In the past, taxes usually have been based on the company’s country of residence, known as an origin tax. But the OECD proposal is based on where sales are taking place, which Eric Toder, a tax specialist and codirector of the Urban-Brookings Tax Policy Center, calls a “destination tax.”

“I think there is a consensus that multinationals have been shifting profits,” Toder says. “The system of transfer pricing, which is supposed to ensure that profits are assigned to the place where the activity takes place, doesn’t work very well when you’re dealing with intellectual property. Shifting profits to tax havens has been going on for a long time, and there is a consensus that this is no longer appropriate.”

Toder says the OECD proposal for a global minimum tax sounds similar to the tax on repatriated profits Congress imposed on US multinationals in 2017, the “global intangible low-taxed income” provision, which has the unfortunate acronym of Gilti. Now US companies have to pay tax on their overseas profits, while European firms have no such requirement. The tax bill also cut the maximum corporate rate from 35% to 21%, in the hope companies would bring jobs back to the US.

Tech giants Microsoft, Qualcomm and Google have announced that, as a result of Gilti, they are bringing their intellectual property back to the US. Microsoft says the shift resulted in a $2.6 billion tax benefit in the fourth quarter of 2019, while Qualcomm says the foreign subsidiary’s low-tax basis would carry over to the US parent. Apple disclosed it was paying the US government $38 billion on its accumulated profits overseas as a result of the new tax law, in payments divided over eight years.

The OECD proposals would mean it is no longer important where the profits originate, because the basis of the tax is the destination country where the excess profits are assigned. “Now there is a question if they do that: whether there might be other schemes and games companies can play on the destination margin,” Toder says. That might include having independent marketing companies sell into third countries and pay very little tax, because the marketing firms are so small and each company is likely to get an exemption for the first tranche of its profits, he concluded.