The global tax revolution

Synopsis: The OECD agreement on global tax on MNCs, its impact and benefits.

Introduction

International tax jurisprudence received a boost when 130 countries, on the proposal of OECD, agreed to introduce a new global tax regime for taxing multinational corporations (MNC’s) operating globally.

The Global Financial Crisis of 2008 forced all countries to change the international tax rules to prevent base erosion and profit shifting.

India, China, Russia, Germany and other countries have signed the agreement, which has to be implemented from 2023.

How would the new global tax regime work?

A minimum global tax of 15% on profits would be introduced in all countries.

As per the agreement, MNCs would no longer pay taxes in the country where they register their headquarters for tax purposes, but would pay in the country where they generate their sales.

As per the agreement, countries where MNCs operate would get the right to tax at least 20% of the profits exceeding a 10% margin.

How were MNCs taxed till now and the associated issues with it?

For over a century now, the corporate tax system was based on the application of the twin principles of the ‘source rule‘ and the ‘residence rule‘.

All that a MNC had to do to avoid high tax in a country where they did business was to get registered in a tax haven.

Globalisation allowed MNCs to replace fears of double taxation with the joys of double non-taxation by exploiting mismatches between the tax laws of various countries and by cutting taxable profits.

A digitalised world made their task easier, with the rise of intangible assets, which could easily be shifted from one country to another.

What are the resultant impacts seen on countries?

Shifting of profits to low tax havens deprived poor countries of revenue by as much as 5% as compared to an alternative system, where profits are taxed based on the current location of companies, revenues, their employees and their wage codes.

“Race to bottom” for corporate tax would see an end or atleast a decline.

OECD estimates that the proposal would fetch additional $150 billion per year and move taxing rights of over $100 billion in profits to different countries.

What are the challenges for India?

Countries like Belgium, Britain, India and Indonesia brought in ‘Digital Services Taxes’ on the local sales of foreign firms with online platforms. India would have to reconsider the ‘equalisation levy‘ taxed upon digital firms.

The ‘share of profit’ allocation and the scope of ‘subject-to-tax rules’, would have to be addressed.

The draft rules would reset the system for international taxation and subject MNCs to
new nexus and profit allocation rules.

Simultaneous implementation of the law by all the signatories to the agreement would be a great job. If achieved, it may herald the dawn of the ‘Golden Era’ of direct taxes.

Source: This post is based on the article “The global tax revolution” published in “The Hindu” on 21st October 2021.