G7’s clampdown on tax havens the start of a long journey

Earlier in July, the Group of Seven (G7) finance ministers came to what has been referred to as a historic or a seismic agreement on global tax reform.

This agreement is pursuant to the Organisation for Economic Co-operation and Development’s (OECD) ongoing initiative towards reforming the worldwide tax system and reducing tax avoidance and evasion. There have been developments over the past few years, including the programme relating to base erosion and profit shifting and various initiatives that accompany this.

The Pillar One initiative is aimed primarily at large tech companies operating in the digital economy. It is easy to be located in a low-tax jurisdiction and provide services and products to customers in high-tax jurisdictions, without having any sort of discernible taxable presence in the latter and therefore not paying tax there.  

In recent years this has caused disgruntlement, including among advanced economies, such as in Western Europe. Some have gone so far as to introduce unilateral measures to extract taxes in these circumstances, such as the digital services tax in the UK.

The agreement reached should, in principle, eliminate the need for such unilateral action. Its focus is to ensure such companies do not merely pay tax where they are resident and have their head office, but also in the countries where they operate and from whose residents and citizens they derive their profit.  

The proposed rules will apply to global groups with a profit margin of at least 10%. Then, 20% of any profit above that margin will be reallocated to the countries in which the company operates, and be subject to tax in those countries. 

Under Pillar Two, every country will have to have a corporation tax of at least 15%. This will not go down well with a number of offshore jurisdictions where the tax rate is zero, including places such as the Channel Islands, Isle of Man, Liechtenstein, Cayman Islands, Seychelles and others.  

Having a headline rate of 15% is one thing; having an effective tax rate of 15% is another story. It does not take too much imagination to introduce provisions into tax laws that have the effect of reducing the headline rate of 15% to an effective rate of a couple of percent.

One can debate the appropriateness or otherwise of Pillars One and Two with respect to the inequities in the world economy and other considerations such as free trade. And one can debate whether these are populist moves or are seriously justified.  

But whatever view one takes of the matter, it is clear that in the case of Pillar One and Pillar Two, this is just the beginning of a long road. It is one thing to express a principle in a few lines, but it is another to put in place a comprehensive set of rules with all the necessary checks and balances and measures to prevent loopholes; one that can be adopted in a way that is sufficiently the same in each of the relevant countries and does not itself create tax competition among countries.

Then there is the challenge of ensuring the offshore jurisdictions that introduce the minimum corporation tax of 15% do so in a way that meets a minimum standard of acceptability to the large economies.

So does this mean tax havens are dead? Well, maybe their death sentence has been pronounced in their current form, but all a country has to do is make itself more attractive, fiscally speaking, than other countries, such that there will be a big saving of taxes, and it can continue to thrive in that sphere. 

• Mazansky is head of tax practice at Werksmans Attorneys.