Why the minimum rate?

The decision to ratify a 15% floor rate follows from a declaration of war on low-tax jurisdictions around the globe announced by US Treasury Secretary Janet Yellen, who had urged the world’s 20 advanced nations to move in the direction of adopting a minimum global corporate income tax in April. She said in a virtual speech to the Chicago Council on Global Affairs that the move to put a minimum rate in place attempted to reverse a “30-year race to the bottom” in which countries have resorted to slashing corporate tax rates to attract multinational corporations.

The US proposal had proposed a higher 21 per cent minimum corporate tax rate, coupled with cancelling exemptions on income from countries that do not legislate a minimum tax to discourage the shifting of multinational operations and profits overseas. One of the reasons the US pushed for this is purely domestic. It aims to somewhat offset any disadvantages that might arise from the Biden administration’s proposed increase in the US corporate tax rate. The proposed increase to 28% from 21% would partially reverse the previous Trump administration’s cut in tax rates on companies from 35% to 21% by way of a 2017 tax legislation. More importantly, the US proposal includes an increase to the minimum tax that was included in the Trump administration’s tax legislation, from 10.5% to 21% — the benchmark minimum corporate tax rate that Yellen has propounded for other G20 countries.

This increase comes at a time when the pandemic is costing governments across the world.

A global pact on this issue, as enunciated by Yellen, works well for the US government at this time. The same holds true for most other countries in western Europe, even as some low-tax European jurisdictions such as the Netherlands, Ireland and Luxembourg and some in the Caribbean rely largely on tax rate arbitrage to attract MNCs.

The proposal also has some degree of support from the IMF. While China is not likely to have a serious objection with the US call, an area of concern for Beijing would be the impact of such a tax stipulation on Hong Kong — the seventh-largest tax haven in the world and the largest in Asia, according to a study published earlier this year by the advocacy body Tax Justice Network. Plus, China’s frayed relationship with the US could be a deterrent in negotiations on a global tax deal.

When this idea of taxing came into existence?

The Paris-based Organization for Economic Cooperation and Development has been coordinating tax negotiations among 140 countries for years on two major efforts: setting rules for taxing cross-border digital services and curbing tax base erosion, with a global corporate minimum tax part of the latter.

The OECD and G20 countries aim to reach consensus on both fronts by mid-year, but the talks on a global corporate minimum are technically simpler and politically less contentious.

Since the talks are consensus based, countries are expected to go along with agreement no matter how unpalatable it may be for some low tax countries.

The minimum tax is expected to make up the bulk of the $50 billion-$80 billion in extra corporate tax that the OECD estimates companies will end up paying globally if deals on both efforts are enacted.

The Organisation of Economic Co-operation and Development (OECD), the global grouping of 36 mostly high-income, free-market economies, has released a consultation paper proposing changes in the rules for taxing Internet giants such as Facebook, Apple, Google, Amazon, and Netflix.

In essence, the proposal, called “Unified Approach”, is to shift the standard of taxation from physical presence to sales in a particular market. That is, the companies will have to pay more taxes in the markets in which they sell more.

The key to the proposal is that the “new nexus” would be based on sales. A “nexus” in international tax refers to the operating presence in a country that makes a company taxable. “The new nexus rule would address this issue by being applicable in all cases where a business has a sustained and significant involvement in the economy of a market jurisdiction, such as through consumer interaction and engagement, irrespective of its level of physical presence in that jurisdiction,” said the OECD report.

Where does India stand?

In a bid to revive investment activity, Finance Minister Nirmala Sitharaman on September 21, 2019 announced a sharp cut in corporate taxes for domestic companies to 22% and for new domestic manufacturing companies to 15%. The Taxation Laws (Amendment) Act, 2019 resulted in the insertion of a section (115BAA) to the Income-Tax Act, 1961 to provide for the concessional tax rate of 22% for existing domestic companies subject to certain conditions including that they do not avail of any specified incentive or deductions. Also, existing domestic companies opting for the concessional taxation regime will not be required to pay any Minimum Alternate Tax.

This, along with other measures, was estimated to cost the exchequer Rs 1.45 lakh crore annually. The cuts effectively brought India’s headline corporate tax rate broadly at par with the average 23% rate in Asian countries. China and South Korea have a tax rate of 25% each, while Malaysia is at 24%, Vietnam at 20%, Thailand at 20% and Singapore at 17%. The effective tax rate, inclusive of surcharge and cess, for Indian domestic companies is around 25.17%.

“While taxation is ultimately a sovereign function, and depends upon the needs and circumstances of the nation, the government is open to participate and engage in the emerging discussions globally around the corporate tax structure. The economic division will look into the pros and cons of the new proposal as and when it comes and the government will take a view thereafter,” said a senior government official. The average corporate tax rate stands at around 29% for existing companies that are claiming some benefit or the other.

Another official said New Delhi was “proactively engaging” with foreign governments with a view to facilitating and enhancing exchange of information under Double Taxation Avoidance Agreements, Tax Information Exchange Agreements and Multilateral Conventions to plug loopholes. Besides, “effective enforcement actions” including expeditious investigation in foreign assets cases have been launched, including searches, enquiries, levy of taxes, penalties, etc and filing of prosecution complaints, wherever applicable.

To address “the challenges posed by the enterprises who conduct their business through digital means and carry out activities in the country remotely”, the government has the ‘Equalisation Levy’, introduced in 2016 following a recommendation by a panel constituted to deliberate on taxation of the digital economy. Also, the IT Act has been amended to bring in the concept of “Significant Economic Presence” for establishing “business connection” in the case of non-residents in India.

Who are the targets?

Apart from low-tax jurisdictions, the proposal for a minimum corporate tax are tailored to address the low effective rates of tax shelled out by some of the world’s biggest corporations, including digital giants such as Apple, Alphabet and Facebook, as well as major corporations such as Nike and Starbucks. These companies typically rely on complex webs of subsidiaries to hoover profits out of major markets into low-tax countries such as Ireland or Caribbean nations such as the British Virgin Islands or the Bahamas, or to central American nations such as Panama.

The US Treasury loses nearly $50 billion a year to tax cheats, according to the Tax Justice Network report, with Germany and France also among the top losers. India’s annual tax loss due to corporate tax abuse is estimated at over $10 billion, according to the report.

How this help nations around the World?

Apart from the challenges of getting all major nations on the same page, especially since this impinges on the right of the sovereign to decide a nation’s tax policy, the proposal has other pitfalls. A global minimum rate would essentially take away a tool that countries use to push policies that suit them. For instance, in the backdrop of the pandemic, IMF and World Bank data suggest that developing countries with less ability to offer mega stimulus packages may experience a longer economic hangover than developed nations. A lower tax rate is a tool they can use to alternatively push economic activity. Also, a global minimum tax rate will do little to tackle tax evasion.

Increasingly, income from intangible sources such as drug patents, software and royalties on intellectual property has migrated to low tax jurisdictions, allowing companies to avoid paying higher taxes in their traditional home countries (tax base erosion of the higher-tax jurisdictions).

These companies typically rely on complex webs of subsidiaries to hoover profits out of major markets into low-tax countries such as Ireland or Caribbean nations such as the British Virgin Islands or the Bahamas, or to central American nations such as Panama. India’s annual tax loss due to corporate tax abuse is estimated at over USD 10 billion.

GMCTR will end a decades-long race to the bottom in which countries have competed to attract corporate giants with ultra-low tax rates and exemptions. And it will bring uniformity in corporate taxation worldwide.