U.S. Treasury Secretary Janet Yellen
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The global tax deal that the G-7 nations reached over the weekend isn’t like pulling an emergency brake that brings a runaway train to a screeching halt. Its effects will be slight for most companies, and won’t be felt for some time.
But the pair of proposals—a system that taxes companies in line with where they operate and a 15% minimum corporate tax rate—can eventually make it tougher for multinational corporations to shift their revenues to tax havens and reduce their tax bills.
The immediate impact, though, won’t be significant, given the relatively low 15% rate and plenty of details left to be figured out. Still, a shift away from a global tax system that pits countries against each other in a race to the bottom to attract businesses could mean higher overall corporate taxes down the road.
Higher corporate taxes, in turn, usually pull down markets because they eat into companies’ earnings. To know how much, though, investors should understand the global package agreed to by Treasury Secretary Janet Yellen and her counterparts in Canada, France, Germany, Italy, Japan, and the U.K. The deal next goes before the Group of 20 and then a coalition of 137 countries convened by the Organization for Economic Cooperation and Development, or OECD.
Jefferies strategist Sean Darby breaks down the G-7 agreement:
“Firstly, multinationals will pay at least a 15% global minimum corporate tax rate in each country they operate from,” he wrote “Secondly, …taxes would apply to any global company with at least a 10% profit margin. Thereafter, 20% of any profit above that would be allocated and taxed in the countries where they operate from.”
To be clear, the G-7 proposals are international agreements that represent a big step forward in how countries are approaching taxation of multinational corporations. But nations have their own tax laws, which will take years for lawmakers to draft, negotiate, and pass—and could look very different from the G7’s proposals. Republicans in the U.S. are currently opposed to corporate tax hikes, for example.
The X Factor of each country needing to pass its own legislation to implement the G-7 agreement explains why an immediate impact from last weekend’s proposals won’t be felt. Then, couple that with the 15% minimum corporate tax rate, which simply isn’t all that high.
Earlier this year, Goldman Sachs’ David Kostin calculated that a 15% minimum rate would be a $1 drag on S&P 500 earnings per share in 2022. That’s not much compared with other corporate tax hikes currently being envisioned by Democratic policy makers in Washington.
Today, the U.S. tax corporate rate is 21%, cut from 35% in 2017 by a Republican-led Congress. Lifting the statutory corporate tax rate from 21% to 28%—halfway between the current rate and the pre-2018 rate—would shave $8 from the index’s forecasted earnings of $203 per share next year. And two other Biden administration proposals, a doubling of the Global Intangible Low Tax Income rate to 21% and additional Social Security payroll taxes, could each eat $5 of S&P 500 earnings in 2022 if enacted, using Kostin’s math.
But a global agreement on a 15% minimum rate has broader implications than just subtracting a buck from S&P 500 earnings—if it would put international jostling behind and encourage countries to raise corporate tax rates across the board, in the estimation of two analysts at Gavekal Research.
“By overcoming long standing prejudices about national tax sovereignty in favor of supranational cooperation, the deal reduces international tax competition,” wrote Yanmei Xie and Udith Sikand. “In the long run, this is only likely to mean higher effective corporate tax rates.”
Companies with significant revenues attributable to intangible assets will be most impacted by the G7’s proposals. That means big internet and pharmaceutical companies, in particular, according to Jefferies’ Darby.
It’s currently easy for a company that provides digital services like Facebook (ticker: FB) or Google-parent Alphabet (GOOGL) to register a corporate headquarters in a low-tax jurisdiction like Ireland, and shift its overseas profits there given a relative lack of physical presence in the countries in which it generates revenue.
Ditto for a pharma company that registers its patents in one country but sells drugs globally. That’s in contrast to a manufacturing company that employs workers in a factory and sells physical goods in that country, which can’t pull off such a tax-avoiding maneuver.
Goldman Sachs’ Kostin screened for S&P 500 companies that generate at least 50% of their income outside of the U.S. and have foreign effective tax rates of less than 15%, yielding 30 names with the vast majority in the technology or healthcare industries.
Lots Of Foreign Profits, Low Foreign Tax Rates
Source: Goldman Sachs
Take semiconductor designer Nvidia (NVDA). The company generates 67% of its income from abroad, per Kostin’s estimates, and pays an effective tax rate of 4% on those profits. Nvidia’s overall effective tax rate in its latest fiscal year was 1.7%, according to the company, while its net income margin was 26%. It paid $77 million in taxes on net income of more than $4.3 billion.
“Our effective tax rate for fiscal years 2021 and 2020 was lower than the U.S. federal statutory rate of 21% due primarily to income earned in jurisdictions, including the British Virgin Islands, Israel, and Hong Kong, where the tax rate was lower than the U.S. federal statutory tax rate, recognition of U.S. federal research tax credits, and excess tax benefits related to stock-based compensation,” Nvidia wrote in its latest annual report.
Nvidia’s tax bill would stand to rise under the G7’s proposals, allowing countries to levy higher rates on the company on the business it does within their borders, regardless of the foreign entity it ultimately passes those profits through.
The screen also includes tech heavyweights Apple (AAPL), Electronic Arts (EA), Adobe (ADBE), Oracle (ORCL), and eBay (EBAY), plus payments giant Visa (V). Pharma giant Amgen (AMGN) and medical device makers Cooper Companies (COO), Edwards Lifesciences (EW), and Stryker (SYK) all make the list as well.
It’s unlikely that investors will ding their stocks based on the latest G-7 moves. But those could just be a precursor to more punitive corporate tax measures to come.
Write to Nicholas Jasinski at [email protected]
