February 2022

By Mathilde Defarges


For the better part of a decade, G20 countries have grappled with how to effectively adapt their tax systems to the global digital economy. As early as 2015, these countries, led by a vocal group of large European Union (EU) member states, asked the Organization for Economic Co-operation and Development (OECD) to come up with a plan to halt domestic tax base erosion and profit shifting due to mismatches between different tax systems. After years of stalling, the OECD process has produced an agreement that has been largely accepted around the world. However, several hurdles still need to be cleared before the agreement is adopted at the EU level and then fully transcribed into national laws of the Member-States of the EU.

 

A thorny issue

 

In the EU, several of the larger member states have long been frustrated by the fact that the taxes they perceive from multinational digital giants are far below what could be expected given the significant profits these companies derive from users based in Europe. France, Germany, Italy and Spain nudged the European Commission to put forward two proposals in 2018.

The first initiative aimed to redistribute part of the corporate tax paid by companies deriving profits from users residing in EU member states – away from countries in which those companies were incorporated and toward countries in which the users resided. The second initiative sought to create a new “digital services tax” on types of activ11ities not previously covered by European tax codes, such as selling online advertising space or selling user-generated data. These proposals eventually failed to make it into European law, owing to the opposition of smaller member states who derived a competitive advantage from their tax systems.

In addition, given that the majority of large multinational corporations active in Europe’s digital sector are based in the United States, Washington saw the 2018 EU proposals as discriminatory against American companies. The Trump administration imposed retaliatory tariffs on countries who adopted digital services taxes and ensured that the OECD process stalled. All this changed under the Biden administration. In April 2021, the United States revised its position on the OECD process and expressed support for a global minimum corporate tax rate of “at least 15%.” Thanks to this more constructive approach, Washington convinced EU member states to drop their digital services tax plans in favor of a multilaterally-negotiated OECD solution.

 

Progress at last

 

By October 2021, 136 countries around the world had agreed to reform the international tax system through a two-pillar solution. Pillar One planned for a portion of the profits of large multinational companies to be redistributed among countries from whose markets/users those profits are derived. Large multinational companies were defined as having a revenue exceeding 20 billion euros (almost 23 billion USD) and profitability above 10%. Pillar Two introduced a global minimum corporate tax rate set at 15% for multinational companies with a revenue exceeding 750 million euros (almost 860 million USD).

On 22 December 2021, the European Commission proposed a legal text to implement Pillar Two, the 15% global minimum corporate tax, inside the EU. To make it into law, this text still has to be unanimously approved by all 26 member states. France currently holds the presidency of the European Council where the negotiations are taking place, and the adoption of this text is a top priority for Paris. The current timeline for the process aims to have the EU-wide 15% minimum corporate tax rate enter into force in 2023.

 

Disagreement inside the EU

 

However, several of the smaller member states, whose lower corporate tax rates are a major competitive advantage, are still dragging their feet. In January 2022, Estonia, Hungary, and Poland expressed concerns that the Biden administration could fail to find the Congressional support needed to implement Pillar Two in the United States. They asked to tie the implementation of the minimum corporate tax rate to that of the tax redistribution arrangement envisaged under Pillar One. With the European Commission’s proposal for the implementation of Pillar One planned for release in July 2022, tying both pillars together would allow those countries to delay the negotiations around the global minimum corporate tax rate for several months.

While Estonia, Hungary, and Poland are the only ones asking for the two pillars to be connected, other member states are skeptical about the EU’s ambitious timeline. The Czech Republic, Bulgaria, Malta, Slovenia, and Sweden have all expressed concerns over their ability to implement the 15% tax into national law at such short notice. The skeptics’ ranks are sure to grow should Congress further delay the Biden administration’s efforts to implement the OECD agreement in the United States.

Acknowledging these internal disagreements, it is important to recognize that the vast majority of the EU’s member states now support the idea of a global minimum corporate tax rate. At the end of the day, everyone stands to benefit from Pillars One and Two, and The EU stands to finally receive an increased share of the profits derived from users residing on its territory.