President Donald Trumps proposed border adjustment isnt the only big tax risk right now. The entire global taxation system is in transition, and its not entirely clear how it will play out. But instead of just looking to Washington for clues, multinational corporations are also keeping a close eye on Brussels, where the European Commission has jumped into an ongoing reform process and in the process is making taxation a much larger risk than usual. Im hearing about tax on every earnings call, says Diane Jaffee, a senior portfolio manager at TCW Group. Tax is one of the top issues affecting stocks right now.
Ordering Ireland to collect another $14 billion or so in taxes from Apple was not the first example, and probably wont be the last. The EC is the executive branch of the European Union. Before the 2016 Apple ruling, it ordered Starbucks and Fiat in 2015 to pay roughly $25 million more in taxes in 2015. Investigations into Luxembourgs tax deals with McDonalds, Amazon.com, and the French energy company Engie are also ongoing. These probes werent part of the plan: Global leaders picked other organizations to lead tax reform, and the ECs abrupt involvement is one reason why tax reform is suddenly controversial. States are now fighting each other over tax reform as well as clashing with international organizations they formally control.
The tax reform narrative starts with the 200708 financial crisis, which sapped state revenues. World leaders agreed at a Group of 20 summit in 2012 to ask the Organization for Economic Cooperation and Development for a solution. A year later they approved the OECDs Action Plan on Base Erosion and Profit Shifting (BEPS), a phased plan with future steps to come and open to any country that wanted to participate. One of two main outcomes so far is a commitment to stop offering tax incentives or customized deals to specific companies and instead competing for investment only by lowering headline rates. The second is that multinationals should pay taxes where they generate their profits or have real economic activity, rather than shifting income to holding companies in low-tax jurisdictions to reduce tax bills. That is what Apple was accused of doing in Ireland.
The plan gives tax inspectors new leverage to make sure profit declarations are aligned to real economic activity. Starting with the current tax cycle, multinationals with annual revenue of 750 million euros ($807.79 million) or more must share far more information with tax inspectors than before a complete picture of global operations, rather than just a view within the borders of a particular country. If tax inspectors arent convinced companies are following the rules, they can use the extra data to start auditing.
Multinationals dont like the new compliance burden, but the underlying concepts arent controversial. In Washington, for example, the tax reform mantra is Broaden the base, and lower the rate. And ending incentives and sweetheart deals is something the International Monetary Fund urges on countries that receive its technical advice. But politicians who approved the Action Plan havent stuck with the script. Some have introduced new tax policies that contradict its principles, such as the U.K.s version of Irelands low-tax regime for patents. After objections from other countries however, the U.K., Ireland, and others changed the rules to comply with the OECD plan.
The EU joined the fray in 2013 with what it calls state aid investigations. There are just seven of them either completed or ongoing, but the impact has been significant enough to elicit a lengthy objection from former Treasury secretary Jack Lew to EC President Jean-Claude Juncker. The EU applies the OECDs new rules about profit shifting retroactively, and, as Lew wrote in his letter, all but two of the companies involved are American. The explanation for that traces back to the current U.S. tax code. Corporate profits formally generated and held outside the U.S. arent taxed until they are repatriated, which has led to an estimated $2.6 trillion in untaxed American income beyond the reach of the IRS. The EU went after Apples billions because the U.S. wasnt taking it, TCWs Jaffee says.
The U.S. government can respond to the EU with tax reform of its own. Proposals from President Trump and Congress include a repatriation clause offering multinationals a one-time, low tax rate, which would take at least some of that income off the table. A common expectation is that companies will use that cash to finance a wave of share buybacks in 2017, because thats what happened the last time amnesty was offered, as part of the American Jobs Creation Act of 2004. But that offer expired after two years, and the next repatriation may not come with such a deadline. Companies could wait to find the most productive use of the funds in the U.S., says Cathy Koch, Americas tax policy leader for EY. That is, unless Brussels comes calling first.