2021 has been dubbed the reopening reflation year, and as such cyclical stocks have mostly outperformed big tech. Will a Global Minimum tax put a top in FAANG?
What is happening with a global tax?
The G7 group of nations are banding together around US Treasury Secretary Janet Yellen's proposal to ensure companies pay taxes where they operate and to have a global minimum corporation tax. The number put forward so far is 15%.
When us Europeans are used to seeing up to half our earnings disappear from our pay checks, 15% might not sound like a lot – but there are some things to consider:
- Some big corporations (as well as wealthy individuals) have in some years paid no tax, so then 15% suddenly seems a lot higher.
- Some nations are a bit hesitant – Switzerland and the UK want some exemptions - so it needs to be low to bring them onboard
- The deal should not penalise poorer countries that have used a lower tax rates to attract foreign investment
- It is the oldest ‘tax trick’ in the book – start low and you can always raise it later. The US Federal Income tax started out at 1%!
Why set a global minimum tax?
US Treasury Secretary Janet Yellen described a “race to the bottom” in attempts by big corporations to legally avoid taxes.
One of the means of doing so was to shift jurisdictions to other countries. So instead of paying taxes where the profits were earned, the profits were transferred to sub-divisions in other countries with little or no corporation tax.
Naturally as the corporate world searched around for the best tax bargains, some countries – notably Ireland and the Netherlands lowered their corporate tax rates significantly and reportedly cut so-called ‘sweetheart tax deals’ for the biggest companies. Having a global minimum tax is intended to dissuade this kind of behaviour from corporations and countries.
The G7 countries having a minimum corporate tax rate won’t make much difference since corporate tax rates are mostly higher in those countries. The difference will come once other countries come onboard later. The next step would be the G20, then possibly the OECD with 125 member countries, then the RoW.
How will stocks be affected by a global minimum tax?
Big tech companies as well as healthcare companies are at the tip of the spear in tax avoidance – and naturally could be hardest hit were a deal to get done.
Stock prices are (supposed to be) based on a discounted forward earnings model. Higher taxes mean lower earnings which means a lower share price. So that’s obviously bad for big tech investors and owners of FAANG stocks – Facebook, Apple, Amazon and Google (Alphabet).
Here’s why it might not be so bad:
1) It would not make much difference anyway
We probably need to accept that were this deal agreed at the G7 to be implemented, tech companies would pay a higher tax rate than they do now. But, it’s not likely to be by much. Goldman Sachs has calculated that it would only represent a 1-2% downside to consensus 2022 earnings per share estimates on average. For low-taxed industries like technology and healthcare, it could be more like 5% downside.
Still, if you are investing in growth and these companies have been reporting double digit sales growth for years, it probably does not damage the investment case.
2) It avoids a much worse ‘digital sales tax'
Part of the motivation for the US making the proposal was to dissuade other countries, mostly the UK and Europe from instituting a ‘digital tax’ aimed at big Tech companies. The below chart shows what some of the biggest American companies paid in UK tax as a percentage of turnover.
The idea of tying taxes to sales rather than profit is something Big Tech and other big corporations will have wanted to avoid at all cost. Amazon especially is known for having made billions in revenues but having razor thin operating margins because all the money is ploughed back into the company. Even this tax deal in theory wouldn’t affect Amazon because it is aimed at companies with a 10% profit margin, Amazon’s was 7.9% in 2020. Though officials have said Amazon would be affected by whatever is agreed.
The high sales / low profit model has been good for Jeff Bezos, Mark Zuckerburg and the other billionaire tech founders as well as shareholders because instead of the profits being taxed as dividends, the firms focus on growing sales, which attracts growth investors, pushing share prices up and boosting their wealth anyway.
3) It likely won't happen anytime soon
These are ‘proposals’ by the G7, which as a group has influence but no actual taxation authority. The clearest example is the United States, where a 50/50 split in the US Congress means Republicans, who favour lower tax rates in general, could kill the deal.
Even if the assumption is made that eventually these proposals make it into law, it will need to be ratified and implemented with domestic tax policy across the 140 countries that will be negotiating in talks led by the OEC. That process could go well beyond short-term investment horizons of the next 12-24 months.