The US is home to eight of the world’s top 10 largest companies, including six with a market capitalisation in excess of US$1 trillion. And that just scratches the surface of the corporate titans that have their headquarters in the US. The nation gets plenty of advantages from the success of these homegrown giants, which generate over US$5 trillion in value per year and support around 30 million jobs, at last count.
But an appropriate level of tax from these multinationals can be challenging – despite repeated efforts by presidents, Congress and the tax authorities. Most recently, the US Internal Revenue Service demanded Microsoft pay US$28.9bn in back taxes, which the authorities say were avoided by routing profits to Puerto Rico, Singapore and Dublin from 2004 to 2013. The software giant disputes this interpretation and years of legal wrangling likely lie ahead.
Government debt has surged by almost 50% since the start of the Covid-19 pandemic to around US$34.5 trillion
Trump’s sweeping reform
The conflict has highlighted the difficulty even the world’s largest nation faces in collecting revenue from global companies. A sweeping tax reform, implemented by the Trump administration in 2018, was intended to boost the tax take from US multinationals, reducing the incentive to shift profits to lower tax jurisdictions such as Ireland.
But it has become clear that this effort was only partially successful at best. And opposition from Republicans is preventing the US from ratifying an OECD deal between 140 nations to apply a minimum 15% tax rate on corporate profits, which came into force at the start of this year.
So, why have efforts to tax multinationals fallen short? And could the OECD deal mark a turning point?
High stakes
The stakes are especially high for the US at present. Government debt has surged by almost 50% since the start of the Covid-19 pandemic to around US$34.5 trillion – US$11 trillion higher than in March 2020. And US politicians show no signs of tightening the belt. The annual deficit is forecast to reach 5.6% this year, according to the bipartisan Congressional Budget Office. That’s the kind of level of borrowing more typical during a deep recession – not during a period of solid growth and low unemployment, as at present.
Despite the US financial and economic strength, this fiscal trajectory raises the risk that investors will eventually demand higher rates to lend to Uncle Sam. That makes efforts to raise tax revenue even more crucial in coming years – including from the nation’s largest companies.
‘The 2018 act didn’t stop the problem of top US multinationals practising very aggressive tax-avoidance behaviour’
A major recent effort to make sure that this happened was the Tax Cuts and Jobs Act, which came into effect in January 2018. The legislation was partly inspired by reports that US multinationals had hoarded around US$2.6 trillion in cash overseas, enabling them to delay payment of the 35% tax rate they would have faced by bringing funds back to the US. The Trump administration argued that the return of these funds would not only boost tax revenue but encourage companies to invest and hire more in their home base.
The 2018 overhaul of the tax code lowered the overall corporate income tax rate to 21% and offered a one-time 15.5% tax rate on the repatriation of cash, or 8% on non-cash or illiquid assets. Initially, this appeared to have achieved its goals, with US companies bringing back more than US$1 trillion, according to data from the Commerce Department.
‘The act did create a window of opportunity to bring cash home,’ says Jason Ward, principal analyst at the Centre for International Corporate Tax Accountability and Research. ‘But it didn’t stop the problem of top US multinationals practising very aggressive tax-avoidance behaviour.’ Indeed, a study published a year after the law was passed found cash reserves held by US companies had actually increased by around 48% following the reform, due ‘almost exclusively to a rise in foreign cash’.
Profit shifting
Nor have multilaterals abandoned the practice of artificially shifting profits to low tax jurisdictions, including by placing intellectual property in places like Ireland. ‘Even after the 2018 cut in the US tax rate, there has remained a strong incentive to book profits outside in more competitive jurisdictions,’ says Matthew Gardner, senior fellow at the Institute on Taxation and Economic Policy.
‘As long as intellectual property is highly mobile, even small differences in tax rates will be sufficient – especially for tech and pharmaceutical companies – to shift profits offshore. The post-2017 US tax regime left that in place.’
The effective tax rate of such multinational giants has gone from around 21% prior to the reform (versus a headline tax rate of 35%) down to around 12% (compared with a headline rate of 21%), according to calculations by Gardner.
This has been a problem not just for the US, but globally. A race to the bottom on corporate tax, as nations competed to host top multinationals, threatened to undercut the ability of leading nations to extract funds from leading companies.
‘The bulk of OECD members realised that tax avoidance by multinationals can only be remedied by international collaboration’
This is where the OECD deal, which has been operational for only a matter of months, has the potential to change the dynamic. ‘The arrangement is cleverly designed,’ says Ward.
‘If one country taxes a multinational at below the 15% minimum, other parties to the agreement can apply for a top-up tax to bring the total up to 15%,’ he explains. ‘This should eliminate the incentive for countries to compete with each to implement the lowest rate, along with the incentive for companies to devise elaborate structures to book profits in such nations.’
Biden his time
While the Biden administration was a driving force behind this global initiative, opposition in Congress is preventing the US from officially signing up. Even so, top US multinationals will be among the most affected. And the US now has a powerful incentive to join the agreement. By refusing to do so, the US loses its ability to collect the 15% top-up tax.
‘We do not even get to look at this undertaxed income unless we join this club,’ says Gardner. ‘The bulk of OECD member nations realised that tax avoidance by multinationals is a collective harm that can only be remedied by international collaboration. US politicians need to realise that they can’t solve this problem alone.’
Of course, both companies and countries are adroit at finding loopholes. Nations could compensate multinationals for the higher nominal tax rates through other perks, such as breaks on employment taxes.
Taxing multinationals will always be a challenge, says Thomas Brosy, a senior research associate at the Urban-Brookings Tax Policy Center in Washington, DC. ‘The largest of these multinationals have a disproportionate negotiating power,’ he says. ‘They have very complex layered structures that complicate enforcement by specific countries.’
As a result, it is perhaps such global deals – rather than changes to national rules – that have the best potential to ensure that multinationals are taxed at levels that voters might deem appropriate.
