[Song Seungseop's Financial Light] Ireland Sandwich and Digital Tax

A tax avoidance method called the Double Irish with a Dutch Sandwich, which sandwiches the Netherlands between Ireland. Photo by ABC Australia

Are you familiar with the term ‘Double Irish with a Dutch Sandwich’? It sounds like a strange food name, but it is actually a phrase mocking the tax avoidance tactics of global corporations. These companies set up paper companies in two locations in Ireland and one in the Netherlands, using complex tax systems to attempt tax evasion.

This kind of tax avoidance is expected to decrease going forward. The world has reached a comprehensive agreement on digital taxation after six years. From 2026 to 2027, the way taxes are collected from multinational corporations will change. How has the world devised a plan to cut off tax avoidance?

In the past, the method of taxing companies was simple. If a factory or headquarters was located in a country and generated profits, taxes were paid according to that country’s laws. If goods were exported to another country, customs duties were paid, and if a business was established locally, corporate taxes were paid. However, with the advancement of digital technology, the situation changed. It became possible to provide services and generate profits online without necessarily having a local business presence or passing through customs.

Some companies exploited this. Multinational corporations emerged that located their headquarters in countries with very low corporate tax rates. These countries acted as tax havens. Although these companies earned money worldwide, taxes were levied based on the location of their business establishments, resulting in taxes flowing into unexpected countries. Because of the low tax rates, companies could significantly reduce their burdens. According to the Organisation for Economic Co-operation and Development (OECD), the estimated annual amount of corporate tax avoidance reaches up to $240 billion.

As the problem surfaced, the world responded collectively. In 2012, the Group of Twenty (G20) created its own project at the summit and began cooperating to combat multinational corporate tax avoidance. In 2015, the OECD established 15 action plans, submitted them to the G20 Finance Ministers’ meeting, and released its own report. After the outbreak of COVID-19, discussions accelerated as digital companies amassed enormous wealth. Finally, in 2020, a plan to reach a country-by-country agreement was introduced.

Tax where revenue is generated, additional collection if taxed at low rates

Digital taxation is broadly divided into Pillar 1 and Pillar 2. The term ‘Pillar’ means a supporting column, so you can think of digital taxation as being supported by two main pillars.

Pillar 1 is a system that requires global companies to pay taxes not only in their home country but also in other countries where they actually generate revenue. It applies to multinational corporations with consolidated revenues of 20 billion euros (approximately 28 trillion won) or more and an operating profit margin of 10% or higher. In Korea, Samsung Electronics and SK Hynix are expected to fall under this category.

Pillar 1 is further divided into two parts: ‘Amount A’ and ‘Amount B’. Amount A is the principle that allows taxation of multinational companies’ income in the countries where revenue is generated. Taxes can be collected even if there is no physical business presence, unlike in the past. It will come into effect if at least 30 countries agree by the end of this year and more than 60% of the countries where Pillar 1 companies are located sign on.

Amount B concerns the method of pricing. To collect taxes, it is necessary to know how much these companies spent and at what price they set their costs. Therefore, Amount B contains guidelines on how to calculate the prices of international transactions of multinational companies. It is expected to reduce frequent disputes between companies and countries.

Pillar 2 plays a role in adjusting different tax rates among countries. If payments such as interest or royalties are taxed at less than 9% in the recipient country, the country where the income originates (source country) gains the right to collect additional tax. Pillar 2 does not apply to all countries but is available only to developing countries that meet certain criteria.

There is still debate about whether digital taxation will be advantageous or disadvantageous for Korea. The government has projected a slight increase in tax revenue. In 2021, Hong Nam-ki, former Deputy Prime Minister and Minister of Economy and Finance, stated, “In the case of Pillar 1, a tax revenue decrease of several hundred billion won is inevitable, but Pillar 2 is expected to increase tax revenue by several hundred billion won,” adding, “The government believes that combining these will have a slight positive effect on tax revenue.”