The G7 countries struck a long-awaited tax agreement this weekend. What’s next?

The G7 countries – the UK, the US, Canada, Japan, Germany, Italy, and France – struck a historic agreement this weekend which aims to tackle tax avoidance by multinational corporations and paves the way to introduce a global minimum tax rate.

So what’s been agreed – and what will actually change under the agreement?

The deal creates a global minimum tax rate of 15%

“In London today, my finance counterparts and I have come to a historic agreement on global tax reform requiring the largest multinational tech giants to pay their fair share of tax in the UK”, UK chancellor Rishi Sunak said on Twitter.

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The agreement is divided into two pillars. The first pillar applies to global firms who have a minimum profit margin of 10%. A 20% tax would apply to profit above the 10% margin, and would take effect in the countries where the companies make sales.

The second pillar is a 15% global minimum corporate tax rate, designed to discourage big companies from declaring profits in tax havens, to reduce the size of their tax bill.

Agreeing on a global corporate tax rate is seen to be a win for US president Joe Biden who has been lobbying for companies to pay a greater share of taxes (partly to fund his ambitious US spending plans). His administration first proposed a universal model for taxing global companies based on their volume of sales rather than profits back in April.

That said, prior to the agreement, the US had been pushing for the global minimum tax rate to be 21% – 15% is quite a bit lower than it might have been.

The logic behind taxing sales is simple: it is much easier to shift profits around the world than sales. So taxing sales makes it easier to correctly calculate a company’s actual liabilities from country to country. According to The Guardian, for example, Amazon paid no corporation tax in Europe last year, headquartered as it is in Luxembourg, despite having sales income of around £38bn in the region. Such instances have put companies’ tax planning and use of regulatory arbitrage under scrutiny.

Ireland, long seen as a tax haven hub due to its low corporation rate of 12.5%, appeared to welcome the G7 proposals. Paschal Donohoe, Ireland’s finance minister, told Reuters he is optimistic that the proposal – if realised – would not hurt the country’s economy as multinationals are “well embedded” in the country’s physical infrastructure.

What does this mean for investors?

There are still several hurdles to clear before the proposal becomes reality. And of course, these sorts of agreements are rarely watertight.

The deal requires global agreement and the legislation must be approved in the US Congress, points out the Financial Times – it may not be easy to get it passed by the Republican Party. For now, the first milestone the G7 must hit is wooing the G20 group of nations, which is due to meet in Venice in July. So any effects on investors are likely to be limited for a while.

Meanwhile, it won’t necessarily cover some of the companies it’s been viewed as targeting. For example, Amazon still won’t necessarily pay it, despite US Treasury secretary Janet Yellen’s assurances to the contrary, because the company’s profit margin last year was only 6.3% – partly because it reinvests so heavily in expanding its operations.

However, while the G7 proposal may be in its infancy, the direction of travel is clear: countries are spending more money. To justify that, they have to raise the taxes from somewhere. In the past decade, we’ve seen the banks being fined, partly to cover the costs of the financial crisis.

Now, the cost of Covid-19 is demanding contributions. And right now, big multinational companies – and tech businesses in particular – are the ones that politicians have in their sights.

The end result remains to be seen. And higher costs for companies in the form of higher taxes may well be passed on, either in the form of higher cost of goods, or lower wages than otherwise would be the case. But one thing is clear: the political risk of investing in these companies has gone up.