The G7 plan of the world's most economically powerful countries to introduce a minimum corporate tax rate for global companies will allow countries to supplement their coffers with additional income, while raising many unanswered questions about how this will happen and when the new times will begin.
Ideas and discussions on how to tax cross-border - global - digital services have been going on for several years. There are countries that have already introduced some form of digital tax, such as Hungary, France and Austria.
Global giants without taxes
"There are several reasons for such a radical step. Namely, over the last 10 years, digital service delivery platforms have evolved at cosmic speeds and a one-off structure can successfully offer products (services) worldwide, not just in one market, and without physical presence in each country to make money and pay no local (consumer, market, land) taxes, while locating your legal address in low-tax (or even tax-free) territories and paying either a small corporate income tax inconsistent with its gigantic size, or even avoiding it altogether” explains Jānis Zelmenis, a partner at AS BDO Latvia. He recalls that for many years the world has been competing between countries to attract investors, where the main bait is low corporate tax rates.
"The minimum corporate income tax basically means ending the race - which promises a lower corporate income tax rate," says J. Zelmenis. According to him, the second important factor is the desire to make these big global players pay income tax in the country where consumers created it, which is similar to the value added tax payable in the country where the product or service is consumed. "Of course, it is a little surprising that the minimum income tax is not decided by the European Commission or the OECD, but by the leaders of the G7 (USA, Canada, Japan, Great Britain, France, Germany, Italy), thus confirming in a way that their leaders have topical issue of filling the state coffers with taxes,” evaluates J. Zelmenis. However, he is now looking forward to the next steps from the European Union bodies to materialize such an idea.
"Time will tell, but corporate income tax rates and conditions of application are still within the competence of EU member states, unlike, for example, value added tax and customs duty, also partly excise tax (minimum rates)," J. Zelmenis answers the question about possible reaction of EU member states. He recalls that in the EU it is Ireland, where the corporate tax rate is 12.5%, but under special conditions it can be as high as 2.5%, in Malta it is 35%, but the various instruments can provide an effective rate 5 %.
Other construction
J. Zelmenis believes that the proposed new order is revolutionary and will mark a new era in taxation. 'Global companies will first be taxed in their home country and claim a profit margin of at least 10%, while the remaining profits in excess of this 10% will be redistributed and taxed in the countries where they provide services and the taxes received will go to their budgets. It is possible that this condition may force companies to revalue their activities in the light of tax rates, thus choosing countries for trade in goods and services within the minimum corporate tax rate set by the tax regime. However, there will also be a second condition - to apply a global minimum corporate income tax rate of 15% to all countries in order to avoid that one country competes with each other,” J. Zelmenis analyzes the nuances of the tiered system. He points out that determining the size of the market in terms of population should lead to a situation where global companies make the largest payments to rich countries such as China and India, each with more than one billion inhabitants.
States have lost the lawsuits
"There have been lawsuits between the European Commission and major global companies over the level of tax payments in Europe. Favorable judgments have been made by companies that, under existing corporate tax laws, paid CIT not in the country where they made a profit, but in the country where the company had its registered office. Moreover, the OECD transfer pricing guidelines stipulate that the majority of profits (and, consequently, the right to tax these profits) belong to the country where the product (service) is created, the most valuable assets are located and the most significant risks associated with the creation of products are borne,” recalls AS Alise Berlinberga, Director of the Tax Department of BDO Latvia.
According to classical transfer pricing theory, the value of a product or service is created by human resources and the tangible and intangible assets used, the physical location of which can be easily determined. In the modern world, the value of digital services is based on data, but their physical location is elusive.
That is why the debate on how to force global players to pay taxes in the countries where they make a profit has grown.
"I think there will be another political debate within the EU, which should be followed by the development of a concrete regulation and its implementation in national legislation, and if everything goes at the current pace, the new regulation could be implemented in the next three to five years," Berlinberg. In her view, there should be a centralized solution for tax administration. "I can't imagine a situation where the Latvian tax administration writes an invoice to each of the global companies for the amount of tax payable or tries to collect a tax debt in the country of the legal address of the respective company," said A. Berlinberga.
Gray area effect
Although this global minimum income tax is currently intended to apply only to global digital service providers, Ms. Berlinberg admits that some EU Member States will oppose and provoke a debate on whether this discriminates against other areas, as in many areas the solution lies in the digital tool, which means a very blurred dividing line. “Is a company which provides management services or training at a distance considered taxable under the proposed new minimum income tax scheme? Who will answer, is it or not and according to what criteria?” A. Berlinberg points to the gray area of possible dispute. She draws attention to the peculiarities of Latvian corporate income tax - it is levied only on profits that are distributed as dividends, and not on profits as such. A. Berlinberg said the benefits would be for countries with a corporate tax rate below the G7's 15%. In addition, there are issues with, for example, Germany, where there is both federal and local corporate income tax, as well as other compensatory mechanisms. "Whether they are simply summed up or not, we will see this during the drafting of the directive," said A. Berlinberg. There is another aspect that can be challenging. Namely, if the CIT rate in the country where the company has its registered office is lower than 10%, then the offer gives the country where the company provides services or trades goods the right to restrict the taxpayer's access to the benefits provided for in the tax convention.
Time will tell
According to several surveyed entrepreneurs, this innovation should not, at least initially, affect companies operating in the classical economy, but the same conditions can be gradually extended to players and segments of a different caliber, thus fundamentally changing the current tax system. According to one of the respondents, we will count chickens in the autumn, because there is too little known and too many unknowns.
The article has been translated from Latvian. Source: Dienas Bizness