The Treasury hailed the new G7 agreement for a minimum level of corporate tax announced on Saturday as ‘seismic’. I’m always a bit suspicious when normally staid bodies resort to extravagant language. Normally the explanation is quite prosaic, like the inexperience of the weekend duty press officer. But sometimes extravagant language is used as a smokescreen to exaggerate the importance of deals that sound important but have few meaningful consequences.

It’s the second explanation that holds true on this occasion.

The agreement is to adopt a 15% minimum corporate tax rate, but one which only applies under a set of specific conditions. The rate will only apply to 20% of profits above a 10% margin and only on the overseas earnings of multinationals. If the local rate of tax is below 15%, then the host government can charge an additional tax to top up to 15%. The OECD think it will raise $50-60 billion in taxes – not even a thousandth of world GDP. Even that figure looks way too high and those who came up with the estimate say that other, additional measures will be needed to generate that much revenue.

In reality, we expect this policy will have little practical consequence for multinationals.

First, the 10% profit margin above which the taxes are levied would be a pipe dream for most. Even in the supposedly profitable subsector of e-commerce, Amazon’s margin is only 7.5% so it is unlikely to be affected. Therefore, very few companies will pay any extra tax.

Second, many multinationals are in the tech space, within which one emerging habit is to expense most development expenditures. This can be shown by the case of Uber, which in fact makes losses despite being widely regarded as successful. The effect of this is to hold profit margins down which will keep most below the 10% margin above which this tax applies. And it appears that most countries will now not proceed with their plans for a digital service tax.

Third, the agreement only applies to taxes on profits, which make up only a portion of all taxes paid by corporates. Most levies paid by corporates stem from the combination of sales taxes or VAT, property taxes, social contributions and, of course, the income tax earned by their employees. Corporate taxes, more accurately called profit taxes, amount to only a small proportion of GDP – the OECD average is 3.14%. The relatively small-scale burden of profit taxes is further exacerbated by the fact that they do not apply to the entire domain of profits. Dividends, for instance, would not be captured by the tax since they are subject to personal, not corporate, taxes. That the agreement only applies to profits means that the most prominent tax advantage open to tech giants – taking advantage of low VAT rates by supplying from VAT tax havens – remains unaffected.

Fourth, the scale of the tax is pretty low. Even a firm with a profit margin of 50% with earnings in Ireland, where the corporate tax rate is 12.5%, will only pay an additional tax of 0.5% of revenue or 1% of profits. This is not enough to create much corporate advantage.

Finally, the agreement leaves open the opportunity for governments which previously offered low tax regimes to offer incentives in other ways that lower the effective corporate tax rate.

So, given that the deal actually does pretty well nothing, why the overblown language?

Obviously, politicians like to be seen to be doing something and to claim credit where it is not due. And they normally like to come up with something seemingly far reaching to justify their taxpayer-financed junkets for which, of course, the Covid travel restrictions were lifted.

But there are more serious reasons for thinking that the measures agreed might have an effect eventually. It is meant to be part of a programme of fiscal coordination between countries to prevent companies playing governments off against each other. There will be more agreements on tax cooperation to follow. The trade union of Treasuries around the world loves nothing more than to set up a cartel to act against the multinationals that, in their view, hold them to ransom.

But you could argue that tax competition is the only factor keeping the tax authorities honest, with companies voting with their feet to prevent being exploited. This subsequently prevents the authorities, with their powers of tax enforcement, from overtaxing the business sector. The right role for tax competition is surely to limit the excesses but not to prevent companies from leaving countries where the corporate tax system is too burdensome.

Ultimately, time will tell how important the long-term impacts of this agreement will turn out as the follow-on agreements emerge. But, in the near future, this ‘seismic’ event will not make the earth move…

For more information please contact: Douglas McWilliams dmcwilliams@cebr.com phone: 07710 083652