The cat-and-mouse game of global corporate-tax optimization has been going on for decades amid successive failed efforts at reform. But this time looks likely to be different.
Over the weekend, finance ministers from the Group of Seven leading nations agreed on the outlines of a global tax deal, including a minimum tax of at least 15% and some reallocation of taxation rights. It raises the odds of a global accord later this summer that could cost multinational giants an additional $50 billion to $100 billion annually, according to the Organization for Economic Cooperation and Development.
Plenty of obstacles remain on the path to an international agreement and the history of tax reform might tempt some to assume nothing will change. Yet investors should prepare for higher tax bills whatever happens to the latest plan. If it fails to bite, digital service taxes will instead.
The seeds of the current situation can be traced back to a 1997 U.S. tax rule change. Meant to simplify filings, it also enabled companies to park foreign profits more easily in offshore subsidiaries and defer U.S. taxes until the money came home.
A spike in cross-border financing soon highlighted the loophole, but Congress blocked moves to close it. Although the 2004 Homeland Investment Act offered a time-limited tax break on repatriations of cash, the offshore pile soon began to grow again.
The costs of the 2008 financial crisis and falling tax revenues pushed reform up the international agenda, particularly in Europe. Leaders of the world’s 20 largest economies launched a global crackdown on aggressive tax avoidance in 2013. Most of the 15-point action plan was eventually delivered. However, U.S. resistance stalled the crucial first point: tackling the tax challenge arising from digital services.
In European nations struggling with austerity, there was a public backlash against U.S. giants paying minimal local corporate tax despite significant domestic sales. That the arrangements were legal—optimizing U.S. rules in combination with deals from the likes of Ireland, Luxembourg or the Netherlands—only increased the pressure.
European Union officials mounted a crackdown, finding that some tax deals breached the bloc’s rules. But the moves to levy billions of dollars in back taxes were appealed, and some have been overturned. Frustrated with slow reform progress, a number of countries proposed new digital service taxes or DSTs on U.S. tech giant’s local revenues.
Then along came the 2017 U.S. tax overhaul. It taxed U.S. companies’ offshore cash—by then totaling $2 trillion—and sought to discourage future profit shifting by lowering the U.S. corporate rate and applying a minimum tax to some overseas earnings.
U.S. changes also prompted Treasury officials to rejoin global reform efforts and many nations suspended their DSTs in hopes of a deal. Progress stalled after a domestic impact assessment left the U.S. with cold feet and prompted the Trump administration to threaten a retaliatory tariff against France’s DST. Reform limped on as more DSTs were created and more tariffs threatened.
With President Biden’s clear endorsement, though, a bargain finally appears within reach. Washington will get a global minimum tax rate to reduce companies’ incentives to shift their headquarters abroad and Europe will get new taxing rights.
While history offers scope for doubt, with an army of accountants and lawyers ready to chart the least costly way through any new rules, it is hard to see corporate tax rates moving any way but upward. Officials have learned from the decades of failure and politicians need higher revenues to pay for their renewed interest in fiscal policy. If all else fails, they will fall back on their DSTs.
Write to Rochelle Toplensky at email@example.com
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