Global Minimum Corporate Tax and India – Explained, pointwise

Introduction

The recent meeting of G7 countries resulted in the adoption of a 15% Global Minimum Corporate Tax(GMCT). The GMCT would enable the countries to add a top-up tax on companies who try to avoid taxes by showing their incomes in low tax jurisdictions.

A Global Minimum Corporate Tax will also encourage the countries to compete on other factors like the better regulatory regime, ease of doing business, access to global talent etc. rather than merely offering a negligible taxation regime.

The move is a step in the right direction that can further help in building consensus over OECD’s BEPS framework. However, its success or failure would depend upon the number of participants joining the Global Minimum Corporate Tax regime, as countries would not easily give up on their right to taxation and take the risk of reducing future investment towards them.

About Global Minimum Corporate Tax (GMCT)

• Corporation Tax or Corporate Tax is a direct tax levied on the net income or profit of a corporate entity from their business. The rate at which the tax is imposed is known as the Corporate Tax Rate(CTR).
• GMCT is the minimum amount of corporate tax a company must pay on its income, both domestic and foreign.
• It allows home governments to “top-up” their taxes to the agreed minimum rate, eliminating the advantage of shifting profits to a tax haven.
  • A tax haven is generally an offshore country that offers foreign individuals and businesses little or no tax liability in a politically and economically static environment.
• Illustration: Country A has a corporate tax rate (CTR) of 20 percent, Country B has a CTR of 11 percent and GMCT is 15%. There is a Company X that is headquartered in Country A, but reports its income in Country B in order to save tax. Now with GMCT in place, country A can legally impose an additional 4% tax on Company X. 

History of Global Minimum Corporate Tax

• The Organization for Economic Cooperation and Development (OECD) has been coordinating tax negotiations among 140 countries for years. 
• The organisation is determined to create global rules for taxing cross-border digital services and curbing tax base erosion, including a global corporate minimum tax.
  • Based on this, the Base Erosion and Profit Shifting Project program was initiated in 2013. 
  • It is an OECD/G20 project to set up an international framework to combat tax avoidance by multinational enterprises (“MNEs”) using base erosion and profit shifting tools.
• The OECD asked the countries in the BEPS framework to adopt a consensus-based outcome instead of the country’s individual moves in order to tax the companies.
• However, a consensus was not developed as countries were not willing to forgo their taxing powers that acted as a tool for attracting greater investment. 
  • Further, the developing countries were not sure if they would receive the right to tax the mobile incomes of Big tech companies.
• On 12 October 2020, the OECD/G20 Inclusive Framework on base erosion and profit shifting (BEPS) released ‘blueprints’ on Pillar One and Pillar Two. 
  • It aims to reach a multilateral consensus-based solution to the tax challenges due to the digitalization of the world economy.
  • Pillar 1: It addresses the issue of reallocation of taxing rights to all the countries
  • Pillar 2: It aims to address all the remaining issues in the BEPS program.
• The US’s proposal in G7 for imposing a 15% Global Minimum Corporate Tax on companies is in consonance with Pillar two.

Current Scenario of Global Minimum Corporate Tax

• The recent meeting of G7 countries saw a willingness to adopt a Global Minimum Corporate Tax rate.
• The countries agreed to enforce a GMCT of at least 15%. Further, they also agreed to put in place measures to ensure taxes were paid in the countries where businesses operate. The GMCT would be applicable to companies’ overseas profits.
• The agreement could form the basis of a worldwide deal. It would further be discussed in detail at the next meeting of G20 finance ministers and central bank governors in July 2021.

The rationale behind the introduction of Global Minimum Corporate Tax

• First, it would discourage Multinational Companies to shift their operations to offshore units merely for tax benefits.
• Second, it would ensure the imposition of a realistic and uniform corporate tax throughout the world. Over the past decades, many countries have attracted investment merely by lowering corporate tax rates. This, in turn, has pushed other countries to lower their rates as well.
• Third, it will prevent revenue loss to countries that occurred on account of lower tax structure in offshore destinations like Ireland, British Virgin Islands, Bahamas, Panama etc.
  • Countries lose out an estimated $100 billion per year in tax revenue due to the absence of GMCT.
• Fourth, it would induce the countries to compete on other factors like better regulatory regimes, ease of doing business, access to global talent, etc. This healthy competition would create a sustainable business environment in them. 
• Fifth, it will prevent the unilateral imposition of domestic laws by the developed world over the developing countries. For instance, the US is determined to impose its domestic law version of Pillar Two at a rate of 21% if 15% GMCT is not adopted.

Challenges in the adoption of Global Minimum Corporate Tax

• First, it curtails a nation’s sovereignty. Every nation possesses an independent right to formulate its domestic policy based on sovereignty granted under Article 2(1) of the UN charter. Many nations may reject GMCT on the basis of their sovereign rights.
• Second, adoption by a few countries and rejection by others may not yield the intended results. For the effectiveness of GMCT, it should be adopted uniformly by all nations.
• Third, the 15% rate may be more for some countries and less for others. 
  • For instance, experts believe the US Congress may not agree to the 15% proposal, as it was earlier backing a 21% rate. The 15% rate would generate less revenues.
  • Similarly, nations like Ireland where the tax rate is 12.5% may reject the proposal as it would impair fiscal autonomy for smaller jurisdictions to compete with larger economies.
• Fourth, the GMCT would be levied by the country where the ultimate parent entity resides. This may cause a disproportionate tilt in the magnitude of economic power towards the U.S. as around 30 percent of the Forbes 2000 companies are located there. 

India and Global Minimum Corporate Tax Rate

• Indian Government has said that India is open to participate and engage in discussions about the Global Minimum corporate tax structure. It would generate additional revenue for the country.
  • The State of Tax Justice report of 2020 states that India loses over $10 billion in tax revenue due to the use of offshore structures. The popular locations include Mauritius, Singapore, and the Netherlands where there is an almost negligible rate of taxation.
• If passed, the Indian government can impose a tax on offshore subsidiary units of Indian companies. The taxation can be to such a level that it enables the imposition of an effective Global Minimum Corporate Tax on every company.
• Further, the effective tax rate, inclusive of surcharge and cess, for Indian domestic companies is around 25.17%. This is above the 15% GCMT, indicating that the country would continue to attract investment.

Suggestions to improve Global Minimum Corporate Tax Rate

• The Indian government should look into the pros and cons of the new proposal and take a view thereafter. It should continue to impose a 2% digital service tax on foreign companies in order to decrease the magnitude of tax base erosion due to non-taxation.
• The next G20 meeting will see whether the G7 accord gets broad support from the world’s biggest developed and developing countries or not. Here, the countries should develop a consensus over the proposed rate and the categories to which GMCT should be applied. 
  • For instance, in recent times, the companies have increasingly shifted their income from intangible sources such as drug patents, software and royalties on intellectual property to low tax jurisdictions.
• Post its adoption by G 20 countries, prudent steps must be taken for its adoption by all the UN members to inhibit the creation of tax havens across the world. 

Conclusion:

The Global Minimum Corporate Tax is a novel way of bringing parity in the taxation regimes of countries. It should be adopted at a rational rate and with a consensus of both, the developed and developing countries. A prudent rate would effectively prevent tax base erosion of the higher-tax jurisdictions.