The deal aims to end what U.S. Treasury Secretary Janet Yellen has called a “30-year race to the bottom on corporate tax rates” as countries compete to lure multinationals through rock-bottom tax rates and allied exemptions. It is also aimed at bringing worldwide uniformity in corporate taxation.
Corporate tax is a direct tax imposed on the net profits or incomes that enterprises make from their businesses. These tax rates have declined in 88 tax jurisdictions from 2000 to 2020, and are reported to have risen in just 6 countries in the given period. Nations generally compete to lower tax rates in lieu of larger benefits of increased foreign investment, higher capital formation, and hence, more employment that such rates attract. However, in doing so, corporations are not taxed enough, causing governments to lose out on tax revenue. As per Organisation for Economic Cooperation and Development(OECD), $100bn to $240bn worth of tax revenue is being lost annually. For instance, the corporate tax in India was lowered from 30% to 22% in 2019, yet with only 15% being levied on new manufacturing entities. Additionally, India is estimated to lose around $10bn of tax revenue annually due to tax avoidance by multinational corporations(MNCs).
Against this background, in the build-up to the G7 summit in early June 2021, a meeting of the Finance Ministers of the Group of seven advanced economies (G7) endorsed the implementation of a global minimum corporate tax rate in order to tackle the plummeting international tax rates imposed by countries in a bid to outdo each other in enticing foreign investment. The key reason which propelled major economies of the world to contemplate such a measure is the growing tax avoidance by multinationals, who for years now have been taking undue advantage of loopholes in taxation laws in an increasingly globalising world amid the presence of tax havens.
A tax haven refers to a low tax jurisdiction, i.e., an offshore or foreign country where the enterprise would be obliged to pay no or low taxes on the profits they earn. Generally, tax havens are economically not very active and have no transparent flow of information. The famous tax havens include countries like Ireland, Bahamas, Bermuda, and Cayman Islands, with the latter three having a zero percent corporation tax. While the zero corporate taxation regime is in itself non-revenue generating for the countries posing as tax havens, the large amount of Foreign Direct Investment inflows accompanied by revenue from customs, licensing and renewal of licensing, registration, etc. more than offsets the loss of tax revenue.
These regions provide the most ideal and comfortable conditions for large MNCs to set up their subsidiaries or headquarters. By shifting their profits to subsidiaries in tax havens, they avoid paying high taxes in jurisdictions where they actually earn the profit. This leads to what is called the tax base erosion for the high tax territories. Corporations involved in the manufacturing business find it more difficult to manipulate accounts and shift the profits than the IT or Pharmaceutical companies, dealing in intangible assets like Patents, Copyrights, Trademarks, and other such Intellectual Property, who can do the deed much easily. Though not illicit, this foul play has been hurting the finances of developed economies, significantly in the U.S., the home to some of the biggest multinationals such as Google, Facebook, Apple and Amazon. Therefore, not surprisingly, it is the U.S. that has been at the helm of initiating discussions and is expected to play an active role in forging an accord.
The G7 summit proposal contains two pillars. Firstly, the world’s most profitable multinationals would be required to pay tax in all countries where they operate and not just where their headquarters are situated. It would apply to companies with more than $20bn in revenues, and 20-30% of profit above 10% margin may be reallocated and then taxed in each country they operate in. The second pillar involves the imposition of a global minimum corporate tax on overseas profits. Companies would have to pay a minimum of 15% of their profits as taxes, no matter where they operate. Taxation being a sovereign subject, any country shall have full control over its taxation policies and can set corporate taxes at any level even after such a truce comes into effect. However, if a corporation pays less than the minimum agreed percentage in a country, their home countries can ‘top up’ their taxes to the minimum agreed rate. For example, if Ireland continues with its existing 12.5% tax rate, then the home governments of the companies being taxed there will have a right over the remaining 2.5% tax revenue.
This would eliminate the advantage of shifting profits to a tax haven as firms would have to pay the stipulated minimum amount. More importantly, by preventing loss of tax revenue, it will boost government exchequers, especially in times of financial crisis like the coronavirus pandemic. The deal aims to end what U.S. Treasury Secretary Janet Yellen has called a “30-year race to the bottom on corporate tax rates” as countries compete to lure multinationals through rock-bottom tax rates and allied exemptions. It is also aimed at bringing worldwide uniformity in corporate taxation.
However, the issue faces a fair number of reservations as well. Recently, with the growing digitalisation of economies, digital services tax has been introduced in some countries and imposed on firms providing cross-border digital services. This agreement would also see an end to all unilateral digital services taxes imposed, and hence there are fears that poor countries would be at a loss lest this deal becomes successful. Moreover, such a measure only addresses the problem of tax avoidance by multinationals without paying attention to tax evasion or illegal dodging of taxes.
From India’s perspective, an analysis of such a minimum tax’s impact on the Indian economy suggests that it wouldn’t be much of a concern for companies doing business in India since the effective tax rate is above the proposed global minimum of 15%. It is supposed to impact companies using low tax jurisdictions to incur a low global tax liability. Moreover, given India’s large internal market, availability of abundant skilled and unskilled labour at competitive rates, strategic location for exports, and a thriving private sector, it shall continue to draw foreign investments.
Although the effective minimum percentage and other intricacies, like the framework for information and revenue sharing between nations, of any such deal are still to be worked out, a global minimum corporate tax has already won international backing from more than 130 of the 139 member countries of the OECD. Among countries that are not signatories were the low tax European Union (EU) members Ireland, Estonia and Hungary alongside Barbados, Srilanka, Nigeria and Kenya. The proposal will now be deliberated upon in the Group of 20 countries(G20) meeting in October with hopes of ironing out the details and implementing the agreement in 2023.