In June 2021 at the annual G7 summit in Cornwall, major western powers committed themselves to the idea of a global minimum corporate tax. This shift is part of a longer-standing endeavour by the OECD to prevent international tax avoidance called the Base Erosion and Profit Shifting (BEPS) initiative.
The BEPS initiative has two main pillars. The first one seeks to implement a principle for taxation of corporate revenues based on location of sale rather than place of manufacturing. The second one is the aforementioned global minimum corporate tax, currently proposed to be 15%.
How do these developments impact the special services and consultancy sector? How are these firms likely to react in response?
At first sight, the BEPS initaitive looks not just reasonable, but also long anticipated. Aggressive tax planning has become rampant among multinationals, with Big Tech being the worst perpetrator. The effective tax rate paid by the Silicon Six in the US (GAMMAN: Google, Apple, Microsoft, Meta, Amazon, and Netflix) amounted to less than half of the official US federal tax rate in 2019. Thus, the issue of global tax reform is ripe for discussion.
The BEPS initiative should put an end to some of the most egregious forms of tax avoidance. According to Pillar One, companies of a certain size that generate a certain level of profits will have a portion of their profits taxed in the jurisdictions where they generate sales rather than where products are manufactured. This will prevent the most blatant forms of profit shifting. For example, when a shell company located in a low tax jurisdiction has no business operations other than being the formal owner of valuable intellectual property, and collecting royalty fees for it. This should make the international tax system both simpler and fairer.
Another hot topic is the taxation of digital services. In this arena the application of the Pillar One principle would lead to more reasonable outcomes. One can fairly argue that the value created by Facebook’s European operations happens where its users engage with its applications, instead of at its Ireland office where it manages bookkeeping. Therefore, continuing to tax all corporate profits in Ireland would seem unfair. Pillar One could also offer a solution to the poor customer service record of social media giants. The main reason that these firms refuse to open local customer service centres is that having a permanent establishment in a given country would entail tax residency.
Although implementing Pillar One will make it easier to tax digital services, its one-size-fits-all approach could produce unfair outcomes in other industries. For example, an auto manufacturer may decide to locate in Hungary because of its 9% corporate tax rate. However, taxing each car based on the location of the car dealership where it is sold instead of the location of the factory would be absurd. Therefore, there are valid criticisms of the BEPS initiative. Instead of specifying its scope based only on revenues and profit margins, it should also evaluate a company’s business profile in a more holistic manner.
Another downside of the BEPS initiative is that it will reduce the ability of poorer countries to lure international investment by offering a more favourable corporate tax regime. As a result, Pillar Two of the BEPS initiative, which mandates a global minimum tax, is often opposed. What the US laments as a ‘race to the bottom’ in corporate tax environments might instead be viewed as the natural outcome of free competition, which ultimately benefits consumers.
Some commentators have gone so far as to characterise the compulsory tax rate of 15% as an international tax cartel. By enforcing this cartel, economically dominant countries would be able to limit the potential of developing countries to become internationally competitive, while simultaneously benefiting from the sheer size of their consumer markets.
The BEPS initiative is likely to have an overall negative impact on the tax consultancy sector, although it may also create new opportunities for tax advisors. Tax services are one of the three major service lines of the Big4, producing approximately one-fifth of the group’s revenues in 2021. The changes proposed by Pillar Two of the BEPS initiative will eliminate much of this revenue source by making international tax planning much more uniform and thus less lucrative. Pillar One, however, offers the potential to tackle illegitimate profit shifting schemes while not reducing the freedom of countries to engage in tax competition, and so it may open up new horizons for tax advisors.
The international community should seek to modify Pillar One to apply the ‘location-of-sale principle’ based on actual value creation. This would help to differentiate mere shell companies from actual manufacturing or R&D centres that make a real economic contribution.
Such an arrangement would be more difficult to enforce, since a nuanced application of the Pillar One rule would be more complicated. However, this is where the BEPS initiative could offer new professional opportunities for tax consultants. Although estimating value creation is likely to be difficult, this has been the main purpose of transfer pricing studies over the last few decades. Transfer pricing specialists utilise highly advanced models, such as the profit-split method, to assess contributions to economic value creation.
The bottom line
Fighting against blatant profit-shifting schemes and other egregious forms of tax avoidance does not necessarily need to result in the downfall of tax consultancy. If special services firms, governments, and international organisations engage in constructive dialogue instead of defensive antagonism, the policies of the BEPS initiative can be fairer for small sized countries, while at the same time creating new opportunities for the tax advisory profession.
Bence Borbély is a Hungarian first-year History and Politics student at the University of Cambridge whose professional fields of interest are management consultancy, public policy-making, politics and international relations.
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