Maastricht Journal of Politics & Economics
2023: The Year to Achieve Fair Taxation in the EU
By Clarissa Bigasz Mascarenhas
Last month, after intense negotiations with Hungary, Estonia, Ireland, and Poland, the European Union (EU) announced the unanimous agreement on minimum taxation of multinationals. With this historical settlement, the EU assures to be among the first to implement the OECD’s Tax Reform. This agreement has the potential to bring equity, clarity and dependability to the global corporate tax system, but how does it aim on achieving this fairness?
On 8 October 2021, the Organization for Economic Co-operation and Development (OECD), responsible for stimulating economic progress and world trade, together with the G20 countries, achieved a milestone achievement when approximately 140 countries consented to an extensive international tax reform plan. This reform is based on two pillars. Pillar I focuses on a new system to allocate tax rights over large multinationals.
In other words, the goal is to stabilise the international tax system and prevent the implementation of domestic digital taxes, thus avoiding double taxation and providing legal certainty for all involved. Pillar II seeks to establish a global minimum effective tax rate of fiteen per cent to promote increased fairness in the international tax system.
This approach would address the issues of digitalisation and intangible asset transfer, both of which have caused problems for international taxation. Furthermore, this measure would ensure that all countries are contributing their fair share of taxes.
Two months later, the European Commission put forth a suggestion for a directive that would implement Pillar II in a manner that is in compliance with EU legislation. However, the path to reach ‘fair taxation’ was not easy due to the unanimous consent principle, necessary for any change in EU tax legislation.
Initially, Hungary, Estonia, Ireland, and Poland expressed reluctance to the OECD-proposed deal. Their main concern was that the OECD's proposed agreement must be tailored to the needs of all countries, both large and small. Furthermore, Hungary, Estonia, Ireland, and Poland viewed their competitive corporate tax rates as a vital component for maintaining their economic presence among the world's most powerful economies.
For this reason, the disagreement between the four dissident countries and the rest of the EU put the Commission in a difficult spot, particularly because the Commission had to find a way to present a unified European front on the global stage.
Consequently, the unanimity requirement has resulted in a, to this day, heterogeneous tax system throughout the bloc, with different regulations and rates existing within the framework of a single market without borders.
Nevertheless, after securing certain guarantees, such as the ten-year transitional period, Hungary, Estonia, Ireland and later on, Poland gave their ‘yes’ to pursue the implementation of the directive. The acceptance can be considered a major step in halting the long-term competition between countries around the world and reducing corporate taxes in an attempt to attract multinational organizations.
First of all, the Tax Reform Act has been celebrated as a significant measure to stop the long-standing trend of countries competing to lower their corporate taxes in order to attract multinational corporations. The implementation of such a system could bring about a more equitable, transparent, and reliable international corporate taxation system, which is why it is called the ‘Fair’ Tax Agreement.
For instance, the EU deal entails a substance carve-out rule that will initially exclude a percentage of companies’ tangible assets and payroll costs. The addition of this rule to the agreement is intended to reduce the amount of taxes lost from erosion and profit shifting, as large corporations would not be as likely to transfer their financial operations to regions of free or low taxation, such as Bermuda or the Cayman Islands.
At the same time, the European Commissioner for the economy, Paolo Gentiloni, has stressed the importance of minimal taxation in managing the difficulties associated with a globalised economy. The intense tax competition, that has been ruling the world, has had a negative impact on many governments, leaving their fiscal resources inadequate to address the increased demands of climate, energy, and public welfare expenses.
Furthermore, the OECD projects that Pillar II could produce approximately 141 billion euros in tax revenue annually on a worldwide scale. A share of this additional income can be especially beneficial to the EU member states’ governments recovery efforts related to the Covid-19 pandemic.
One of the major warnings that surround the implementation of the minimum tax rate of fifteen per cent is that the ‘substance carve-out’ clause may reduce the reform's overall economic impact.
As a result, the rule could backfire its inicial purpose and create a ‘new type of competition’ between countries, as large firms could still find beneficial to move their offices and jobs to tax havens in order to secure a portion of their profits.
The 2021 study from the EU Tax Observatory warns about this loophole and emphasizes that “from an economic perspective, carve-outs are driven by the aim of combating the artificial shifting of profits as a priority”.
In other words, the proposed taxation system does not effectively address the case of companies which are shifting their operations to areas with lower tax rates. In fact, it provides them with an incentive to move their capital and employment to locations with minimal taxation, which impacts directly the projected Pilar II revenue gains.
In principle, by reaching this agreement, the EU calls for fair taxation for the largest groups of corporations and multinationals. With the adoption of Pillar II, all companies with a combined annual turnover of at least 750 million euros will be obliged to pay a corporate tax that cannot be lower than fifteen per cent.
Additionally, French President Macron defends this milestone as an important step toward reaching tax justice and the ability to tax any economic actor with the minimum wage, as some of companies were still not taxed in the EU.
The member states now have until the end of 2023 to incorporate the directive into national legislation, resulting in the EU maintaining to be the leading example to reach fair taxation by adhering to Pillar II of the OECD Agreement.
Sources: Euronews, European Commission, European Council, German Federal Ministry of Finance, RFI, OECD, EU Tax Observatory.
Written by Clarissa Bigasz Mascarenhas