International Tax Reform = Negative for Equities…?
Several clients have asked how fundamental reforms relating to international tax rules will impact equities. In our view, under the current international tax system, countries competed to attract MNEs to their countries to establish operations and create jobs. However, in the digital age, companies have become effective in shifting profits around, from the regions where they do business to those where they will pay the lowest taxes (jurisdictions considered tax havens).
In the past week, the Organisation for Economic Co-operation and Development (OECD) published their report: “Statement on a Two-Pillar Solution to Address the Tax Challenges Arising from the Digitalisation of the Economy” highlighting that 136 countries equating to more than 90% of global GDP have agreed to tax reforms. The OECD noted “the global minimum tax agreement does not seek to eliminate tax competition… [it] will ensure a fairer distribution of profits and taxing rights among countries with respect to the largest and most profitable multinational enterprises. It will re-allocate some taxing rights over MNEs from their home countries to the markets where they have business activities and earn profits, regardless of whether firms have a physical presence there”.
The new reforms are designed to curtail tax evasion and ensure companies pay at least some of their taxes where they do business, rather than where they choose to have their headquarters. Countries are aiming to sign a multilateral convention during 2022, with effective implementation in 2023.
- The details. The key details to the reforms include:
(1) Pillar One: “taxing rights on more than US$125bn of profit are expected to be reallocated to market jurisdictions each year. Developing country revenue gains are expected to be greater than those in more advanced economies, as a proportion of existing revenues”.
(2) Pillar Two: “introduces a global minimum corporate tax rate set at 15%. The new minimum tax rate will apply to companies with revenue above €750m and is estimated to generate around US$150bn in additional global tax revenues annually”.
- Implications for equities – Our thoughts. We must highlight we are not making any political statements about these reforms but rather their impact on equity valuations. The reforms specifically target “multinational enterprises with global sales above €20bn and profitability above 10%… with 25% of profit above the 10% threshold to be reallocated to market jurisdictions”. These reforms exclude mining companies, shipping, regulated financial services and pension funds.If we reflect upon traditional valuation methodologies inform us that the worth or intrinsic value of a company as the sum of its future earnings, then the new reforms which increase taxation payments and hence decrease company earnings going forward, then this should consequentially result in lower valuations and intrinsic value. Whilst we acknowledge the reforms should be negative to company earnings and hence valuations, the extent of materiality is unquantifiable with the level of current disclosures from companies and their subsidiaries. Hence, we are currently seeking guidance from company management teams to appropriately assess the impact.