Who Will Tax Big Tech?

2019 was quite a year for debates on the international taxation system. Gaps in the current system allow wealthy individuals and multinational corporations to systematically employ tax havens and other financial mechanisms to reduce the level of taxes they pay. This scenario is aggravated by the case of the big digital services multinationals, called Big Tech, because, despite having impressive levels of profit, they pay extremely low taxes.

In response to this scenario, the Organization for Economic Co-operation and Development (OECD) drafted,  this year, a project to reform the international tax system – what has been called BEPS 2.0 – addressing the tax challenges posed by digitization of the economy. But what does this change mean? What is its size and potential impact? And above all, will it be able to reverse some of the inequalities that prevail today? 

In today’s post, we will tell you a little about why these initiatives become necessary, how the process of building them took place and try to point out some perspectives for next year.

How we got here

In 2018, Amazon, despite making more than $10 billion in profits in the United States, did not pay a penny in federal income tax. Shocking, these numbers are the extreme of a practice that has become quite commonplace. Scandals of this nature have already hit most multinationals in digital products and services. Apple, for example, was convicted in 2016 by the European Union for receiving illegal Irish tax benefits between 2004 and 2014, resulting in a fine of 13 billion Euros (plus interest), which at the time meant the largest fine ever paid by a company as a result of tax crimes. A recent British tax justice campaign, called the Fair Tax Mark, pointed out that over the past decade, the six major US digital services multinationals (Amazon, Facebook, Google, Netflix, Apple and Microsoft) have avoided paying 100 billion dollars through aggressive tax planning.

The architecture of the current international tax system was first developed in the 1920s under the League of Nations. At that time, the central concern that permeated the discussions was how to avoid double taxation. That is, that a person or a company was not subject to taxes on income that had already been taxed in another jurisdiction. This concern was particularly important for companies operating in more than one country, companies we know as transnational or multinational. In this context, the principle known today as arm’s length was established. 

The arm’s length principle provides that each subsidiary or subsidiary is to be understood, for tax purposes, as a separate company, and therefore subject to tax in accordance with local rules. These rules are the foundation behind the profit shifting phenomenon, whereby multinational corporations transfer their profits to jurisdictions where they have negligible economic presence but where they enjoy zero or extremely low taxes. This is accomplished by overvaluing products and services in branches that operate in low tax jurisdictions and undervaluing them in places where taxes are high. As a result, this practice gives the impression that profit is produced only in low tax jurisdictions. According to a recent research, more than 40% of multinational profits are transferred to tax havens. Some estimates show that the loss of tax revenue globally is around $500 billion a year, and this proportionally affects more developing countries.

The strengthening of the digital economy further weakens the existing system. Businesses of digital companies typically employ intangible assets, that is, that do not have a clear physical presence, such as patents, trademarks, algorithms, among others. Intangibility represents a major challenge for tax systems historically thought out on a territorial basis. By making it difficult to identify where taxes should be paid, the digital economy increases the erosion of countries’ tax base, as well as the transfer of profits to countries with reduced or zero taxes. 

This scenario has led to a series of efforts to tax Big Tech both through cooperation between countries and unilaterally, that is, through the uncoordinated action of a country. The most famous of the unilateral measures was the French, popularly called the GAFA tax, an acronym for Google, Amazon, Facebook and Apple. The measure would charge 3% on profits made on French territory and has ignited a great deal of tension in US-French relations. US President Donald Trump even spoke in retaliation, suggesting imposing tariffs on French wines, which French agriculture minister Didier Guillaume said was “completely imbecile.” Concerns about the high levels of conflict that unilateral measures could cause have reinforced the need to address this problem at the international level. But how – and on what principles – to reorganize the international tax system, especially in a conflicting arena like the tax one?

The current OECD initiative: who gets what?

In early 2019, the OECD established a work plan aimed at establishing a new international taxation system, addressing the challenges that the digital economy presents. At each stage, proposals and questions related to the institutional architecture of such a system were presented and submitted to public consultations, receiving opinions from governments, civil society and companies. These proposals have no binding effect, so they must be screened by national decision-making authorities. The current OECD reform proposal, which aims to reach consensus by the end of 2020, has two pillars: 

1. Pillar 1 concerns the creation of potential profit reallocation solutions between the different subsidiaries and branches of the same multinational. In this sense, it proposes the creation of a new nexus, establishing where taxes should be paid and on what basis. 
2. Pillar 2, also called the Globe mechanism, seeks to compel multinationals to pay a minimum of taxes globally. In this sense, the second pillar seeks to establish a minimum level of corporate taxation that would have to be adopted by all countries.

It is important to note that this type of initiative is particularly sensitive, since a country’s system and tax base are often understood as a very important sovereign space. Still, talking about the tax system means talking about redistribution, that is, reallocating money from one hand to another. Redistributive efforts are often marked by high levels of conflict. In this regard, there have been efforts within the OECD to build the so-called Inclusive Forum, which currently has 137 member countries. The idea is that the construction of space with higher levels of inclusiveness may lead to more agreed upon and potentially fairer solutions. 

Initiatives for inclusion, however, have been widely criticized as being limited by activist groups such as the Tax Justice Network, who point out that reform proposals like the G24 have been overlooked. The G24 initiative, a group of 28 developing countries, proposed a unitary approach, summing the profits of each multinational company globally and then fractioning across countries from a formula of significant economic presence. The Significant Economic Presence, in the G24 proposal, would include both productive activities and sales. This has very important impacts because, as a recent study showed, different formulas for dividing profits by country have very different redistributive impacts. Developing countries have fewer users, but often have a certain level of productive activity: in this sense, preliminary analysis indicates that the inclusion of employment, as well as sales, is very important for the initiative to have positive impacts on the collection of developing countries. development. It is important to point out that the current system is a strong mechanism for promoting inequality. In the words of Professor Jayati Ghosh of the Independent Commission for the Reform of International Corporate Taxation (ICRIT), the global tax system is “an update, to the 21st century, of the colonial system”. And in general, building institutions does not only mean solving technical problems, as they carry different conceptions of justice.

Towards 2020: Where are we standing

In the first week of December 2019, when the two-pillar public consultation process had already taken place, the US announced two measures that made the OECD reform process even more fragile. Firstly the USTR, the US Trade Representative, stated that unilateral measures by France were discriminatory against US technology companies, and accordingly proposed tariffs of up to 100% on imported French products. 

On the other hand, US Treasury Secretary Steven Mnuchin announced in a letter that he had serious concerns about the reform model and the abandonment of the Arm’s Length principles. In this regard, he stated that Pillar 1 could incorporate the idea of a safe harbor. While the idea of a ‘safe haven’ has generated a lot of confusion, it seems to mean that US companies, including Big Tech, could refrain from joining the new system without incurring illegality. If this were to happen, it would undermine the already fragile OECD reform proposal. 

Recent developments have created a scenario of stallement as, on the one hand, the US has opposed unilateral measures, reaffirming the multilateral framework as the only one qualified to deal with this problem. On the other hand, Secretary Mnuchin’s recent criticism casts doubt on the extent to which the US is indeed willing to commit to what is now the OECD’s main reform proposal. 

Alex Cobham of the Tax Justice Network has stated three possible future scenarios: i) limited retirement; ii) process collapse; and iii) resetting the negotiations. According to the expert, recent US movements appear to indicate a weakening of the former and a strengthening of the latter. The demand for more inclusive forums also includes choosing the arena for reform proposals: Cobham argues that demands for shifting the scope of OECD discussions to a UN forum have become more vocal. 

In short, the end of 2019 implied the incorporation of new layers of complexity into a conflict that already has to spare. The scenario is complex, but, on the other hand, it is a process that is unlikely to come back. 2020 will be the key year to see if reforms will be successful, and specifically which reforms will be successful.

The views and opinions expressed in this article are those of the authors.
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