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In early June, ahead of this past weekend’s Group of Seven leaders’ meeting, the G7 finance ministers got together and reached a breakthrough agreement on corporate taxation in the digital age.

The G7 finance heads, Chrystia Freeland among them, said they “strongly support” continuing work “to address the tax challenges arising from globalization and the digitization of the economy and to adopt a global minimum tax.” The G7 leaders’ summit reiterated the endorsement: “We need a tax system that is fair across the world.”

The steps that G7 countries are pledging to take could have a huge impact on the future of corporate taxation. They aim to reduce the ability of multinationals to use legal and accounting techniques to lower tax bills by shuffling profits and expenses out of countries such as Canada.

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Two years ago, more than 100 countries, working through the Organization for Economic Co-operation and Development, agreed on a road map for this reform. The G7 announcement is the next step. The plan has two pillars.

The first pillar aims to tax companies in the countries where they are actually doing business and generating revenues. The main focus is large internet companies.

After a me-first pandemic, G7 leaders feel the need for some defensive globalism

Prior to the G7 meeting, countries such as France introduced a 3-per-cent digital services tax; Canada is planning the same as of next January, which is expected to bring in $3.4-billion over five years. The G7 finance ministers have now agreed to support the replacement of those levies with “taxing rights” that countries could apply to “the largest and most profitable multinational enterprises” that sell products and services within their borders.

The second pillar proposes a minimum global corporate tax rate of 15 per cent. That’s a lower rate that is in place in every G7 country, so this is not about raising business tax rates domestically. Instead, it aims to smoke out the use of tax havens by multinationals, particularly internet giants.

When people hear the phrase “tax havens,” places such as the Cayman Islands most often jump to mind. But countries such as the Netherlands, Luxembourg, Singapore and Ireland are regularly mined by multinational companies. With accounting gymnastics that are easiest for tech companies with limited physical assets, profits can be minimized in countries where sales are made, and increased in other jurisdictions, where tax rates are lower. It is notable that Amazon has an office in Luxembourg City and Dublin is Google’s European headquarters.

This shuffling of money for tax purposes is what the International Monetary Fund calls “phantom investments.” These now account for as much as 40 per cent of global foreign direct investment – at least on paper.

The IMF says that Luxembourg, home to a mere 600,000 people, or roughly the population of London, Ont., is host to more than US$4-trillion in foreign direct investment. That’s more than China and as much as the United States. How can that be?

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It’s possible because most of those Luxembourg investments are only real in a legal and accounting sense. Trillions of dollars have not actually been invested in factories, stores and jobs in one tiny country.

The tax dollars at stake are significant. The OECD in 2019 cited its research suggesting that implementing the two pillars could recover lost corporate taxes of as much as US$240-billion a year. The IMF, also in 2019, suggested the figure could be as high as US$600-billion.

While the G7 has now endorsed a way forward, validating years of work, there is still a lot that remains to be done. Attention turns to a G20 finance ministers meeting in Venice in early July, where debate will be difficult. And although U.S. Treasury Secretary Janet Yellen has been key in pushing things forward, winning approval in the U.S. Congress is far from certain. As for the European Union, while its biggest member states are on board, low-tax Ireland is not.

Though reaching a final deal will not be easy, and could take months or years, it’s remarkable that the G7 was able to come to an agreement on basic principles. Even Facebook and Google are publicly supportive of the process, with Facebook acknowledging its tax bill could rise.

It was a century ago when rules for how to tax corporations doing business across borders were first agreed through the League of Nations. Times change. To level the playing field, it’s time to write some new rules.

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