G7 accord – a significant step towards global tax reform and what it means for Ireland

The recent G7 meeting saw finance ministers of the member nations give unequivocal backing to the two main elements of the new OECD/G20 framework on global tax reform, known colloquially as BEPS2 (an acronym for, ‘base erosion and profit sharing’). The G7 accord is significant, signifying a clear trajectory towards the most fundamental change in global corporate tax policy in decades and has been hailed as proof of the “revival of multilateralism”.

However, much is left to be decided and wider global negotiations will be conducted among the 139 countries at the OECD in Paris. The G7 agreement must also win the backing of the G20 group of nations, which will meet in Venice in July.

OECD/G20 proposals on global tax reform

BEPS2 sets out a framework to ensure multinationals pay their “fair share” of taxes wherever they do business. The BEPS2 roadmap is divided into two pillars.

Pillar One centres around achieving a unified approach to the reallocation of taxing rights in favour of large countries with big markets, overturning the long-established practice where profits are taxed only where companies have a physical presence. As currently proposed, any countries where the world’s largest and most profitable businesses have sales would have taxing rights over “at least 20 per cent of profit exceeding a 10 per cent margin”.

Pillar Two’s focus is on a global minimum taxation. It would introduce a minimum effective global corporate tax rate, which the G7 finance ministers agreed should be at least 15 per cent and applied “on a country-by country basis”. That means businesses cannot pay an average minimum rate by routing some profits through higher-tax countries and some through low-tax regimes.

The G7 consensus does not mean it is smooth sailing from here. While it instils momentum into a global discussion on tax, advanced small to medium-sized countries like Ireland, Luxembourg and the Netherlands will not easily cede to demands of big nations. However, if there is political agreement in July, the detailed measures will have to be drafted and implementation could take some time – it took countries an average of two years to ratify the original BEPS tax treaty amendments after proposals were agreed.

Implications for Ireland

Ireland’s 12.5 per cent corporation tax rate and Foreign Direct Investment (FDI) model has seen vast and outsized multinational investment in a tiny consumer market of 5 million, which has long vexed its European Union allies who see Dublin as depriving other countries of profits from multinationals.

BEPS2 has largely been viewed as a threat to Ireland’s FDI model. Pillar One proposals may see the Irish exchequer lose a proportion of its corporate tax base, which the Department of Finance has estimated could be more than €2.2 billion per annum, or close to one fifth of total corporate tax revenue.

Pillar Two causes the main concern for the Irish foreign direct investment (FDI) economy. Ireland’s 12.5 per cent corporate tax rate is one of the lowest in the world. A new 15 per cent minimum could potentially remove the incentive for companies to base their businesses in low-tax locations like Ireland.

Minister for Finance, Paschal Donohoe has insisted Ireland is committed to international tax changes and remarked upon the success of BEPS. Nevertheless, he is a strong defender of Ireland’s corporate tax rate, saying he will be “vigorously making the case for legitimate tax competition and for a rate of 12.5%”, and has emphasised that any agreement will have to meet the needs of small and medium-sized countries, “to offset the advantages of scale, location and an industrial heritage”.

The 12.5 per cent corporate tax rate has been hugely successful for Ireland to date. Its longevity thus far has provided certainty and consistency for businesses and supported the flow of FDI to Ireland, especially in the tech and pharmaceutical sectors.

Looking to the future

A multilateral approach to tax harmonisation is timely, and a unified consensus will help avoid future tax and trade wars at a time where the global economy is already suffering enormously as a result of the Covid-19 pandemic. A globally coordinated approach to tax will ensure a more equitable system that can help alleviate “race to the bottom” undercutting tactics.

FDI will continue to be an indispensable part of Ireland’s business model, and this disruption to the global tax regime could be harnessed as an opportunity for positive action and green investment in a post-Covid world. As posited by Gerard Brady, Chief Economist at Ibec, the Irish Government has an opportunity to react proactively to the changes by “significantly strengthening other areas of our FDI regime”.

The Government has already made strides in recent years in progressing greener, socially minded initiatives, such as its Rural Development Policy and the Climate Action Plan. More meaningful investment in thus far underfunded sectors like education, innovation, housing and infrastructure would enable Ireland to remain an attractive stronghold for FDI investment based more dominantly on a skills-base and quality of life.