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G7 backs global GILTI and mandatory binding arbitration

US tech companies can breathe a sigh of relief after G7 finance ministers agreed to back a global minimum tax rate with mandatory binding arbitration to reduce the dispute fallout.

Facing divisions among the OECD countries, the G7 agreed to the principle of a global minimum corporate tax rate, saying it would be the best way to reform international tax to deal with the challenges of the digital economy. The G7 finance ministers reached this compromise during two days of talks in Chantilly, France, on July 17-18.

Ministers agreed that “a minimum level of effective taxation, such as for example the US GILTI regime, would contribute to ensuring that companies pay their fair share of tax”.

The US global intangible low-taxed income (GILTI) rules came into force as a key part of the US tax reform designed to set a floor on tax planning through offshore structures. The GILTI rules are supposed to incentivise the repatriation of cash and other assets back to the US.

US businesses told TP Week in June that they could live with a global minimum rate because it could serve as a level playing field. Even though it may require a fundamental turn away from traditional TP norms like the arm’s-length principle.

Many companies were nervous the GILTI rules would hit them hard and create a competitive disadvantage for US multinational groups. Making GILTI the international norm is one way to eliminate this disadvantage.

Ministers also agreed to build an international dispute resolution mechanism “through mandatory arbitration”. This could go a long way to making sure the global rate does not send shockwaves of disputes around the world.

“The most efficient and effective changes are those made where the majority of countries act in a consistent and coherent manner,” said Tim Wach, managing director at Taxand.

“The G7 must avoid conflicting regimes across different countries and ones aimed at particular sectors of the global economy which are inherently inefficient and complex to craft and administer and with which to comply,” Wach said.

However, many details remain unsettled and the plan still has to be drafted. The global rate could be set at a low rate to placate critics, but few countries are willing to give up sovereignty when it comes to taxing rights and dispute resolution. Tax competition is not just a matter of lower rates, it’s ultimately about raising tax revenue.

The next step is for the OECD to reach an agreement on the details before the G20 can approve such a proposal in January 2020. It may have been easy for the G7 to reach a consensus on the principles, but as more countries are involved in the discussions it will get much harder to maintain consensus.

Challenges ahead

It is no coincidence that the G7 agreement was reached after the US clashed with several European countries over digital tax. France, Italy, Spain and the UK have all opted for special taxes for the high-tech sector, while the US has made it very clear this is unacceptable from its point of view.

“We feel very strongly that this should not just be geared at the US digital companies,” Steve Mnuchin, US Treasury secretary, told the press.

“Everyone here wants to reach an acceptable international solution,” Mnuchin said. “Creating certainty for global multinationals is very important.”

Mnuchin was optimistic about the G7 statement, though. He stressed there is more work to be done, but the meeting has achieved “significant progress” in addressing the concerns about taxing the digital economy.

“It’s a real advance for fairer tax for the 21st century,” said Bruno Le Maire, French finance minister. “It’s the first time that members of the G7 agree on this principle.”

The French government has made it clear the purpose of its digital services tax (DST) was to hasten an international agreement by forcing the OECD and other bodies to try to find a middle ground. Yet it is unlikely France will abandon the DST until there is a firm agreement in place.

At the same time, the Trump administration has launched an investigation into the French DST and this comes with the threat of retaliatory measures and possibly even going to the World Trade Organisation (WTO) to challenge France.

“The level of urgency has grown as politicians feel increasing pressure to take action, which raises the risks of inconsistent unilateral actions,” Wach said. “This is particularly the case with France and the UK charting their own courses on taxing digital activity.”

“Inconsistent independent approaches to taxation and trade wars are in the interest of neither governments nor taxpayers,” he added.

The US Council for International Business (USCIB) has been vocal in its concerns about the levy and its implications for American enterprise. The problems are twofold: the DST is not a tax on corporate profits, it’s a tax on revenue and such a levy would fall outside the tax treaty framework.

“Taxes on revenues are distortive,” said Carol Doran Klein, VP for tax policy at the USCIB. “The total tax may exceed company profit and misallocate profits to the market jurisdiction.”

“Any solution should be treaty compliant and designed to avoid controversy,” she added. “It should tax income based on where value is created by companies, including appropriate recognition of where intangibles are created.”

This is why a global minimum rate would be much easier for businesses to work with. However, if the G7 proposal fails, it is possible the unilateral measures will become permanent features of international tax competition.

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