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Global Minimum Corporate Tax deal by G7 nations

Global Minimum Corporate Tax deal by G7 nations

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  • GS 3 || Economy || External Sector || International Tax Issues

Why in news?

  • The advanced economies of the G7 grouping which includes, the UK, the US, France, Germany, Canada, Japan, and Italy, reached a historic deal on taxing the multinational companies.
  • The finance ministers of the world’s most advanced economies met in London and agreed to counter the tax avoidance through the measures to make firms pay in the nations where they do business.

What were the key decisions taken by G7 nations?

  • The first decision taken by the G7 nations that have been ratified is to force the multinational companies to pay taxes where they operate based on the principle of ‘Significant Economic Presence.
  • In the agreement, the second decision states to a minimum global corporate tax rate of 15% to avoid the countries undercutting each other.

The rationale behind the move

  • A global minimum corporate tax will allow the major economies to discourage multinationals from shifting profits and tax revenues to low-tax countries.
  • The companies involved in tax evasion use the above modus operandi.
    • Opening branches in low tax rate countries
      • With multiple branches spread across various jurisdictions, they transfer the bulk of their profit in accounts set up in countries that offer the lowest tax rate.
      • Often, these tax havens are the Caribbean Islands such as the Bahamas or the British Virgin Islands, or at times.
  • Multinational companies with increasingly intangible assets such as the global tech firms have shifted some actual business and a lot of profits into these tax havens and low-tax jurisdictions, lowering their global tax bills.
    • Countries like Ireland where the corporate tax rate is as low as 12.5% – lower than the proposed minimum rate of 15%.

Significance of the move

  • Reduce tax base erosion
    • This proposal from the major economies aims to reduce tax base erosion without putting their firms at a financial disadvantage, allowing competition on innovation, infrastructure, and other attributes.
    • The average headline corporate tax rate in advanced economies has fallen from 32% in 2000 to just over 23% by 2018.
    • That is largely because smaller countries such as Ireland, the Netherlands, and Singapore have attracted footloose businesses by offering low corporate tax rates.
    • As per some estimates, countries are losing $427 billion every year to tax havens. India suffers an annual loss of $10.3 billion from global tax abuse.
  • Move towards more equitable taxing rights
    • The agreement pledged to find a fair solution for the distribution of taxing rights.
    • It will be focused on safeguarding the interests of market countries by granting them some taxing powers on multinational corporations’ profits.
    • This will ensure that multinational corporations pay taxes in the countries where they operate and report their revenues, based on the concept of “Significant Economic Presence.”
  • In sync with the changing economic pattern
    • This agreement represents a much-needed reform of the worldwide tax system to bring it into line with the contemporary global digital age, in which cross-border digital services are becoming increasingly important.
  • Put an end to the infamous “race to the bottom” and its terrible consequences
    • The establishment of a worldwide minimum corporate tax will help to put an end to the decades-long “race to the bottom” on corporate tax rates, in which nations have used ultra-low tax rates and tax exemptions to entice multinational corporations to invest.
    • These policies have cost these countries hundreds of billions of dollars, while corporate organizations have merely gotten richer.
  • Forms the foundation of a worldwide pact
    • This historic accord could pave the way for a global agreement.
    • The Organization for Economic Cooperation and Development (OECD) has been coordinating tax negotiations among 140 nations on regulations for taxing cross-border digital services and preventing tax base erosion, including the introduction of a global corporate minimum tax.
    • By the middle of the year, the OECD and G20 countries hope to have reached an agreement on both.

Concerns/Challenges

  • Impinges on the right of the sovereign to decide a nation’s tax policy
    • Taxation is ultimately a sovereign role, and the government is willing to participate and engage in the emerging global debate about corporate tax structure, based on the requirements and circumstances of the country.
  • Taking away a tool that countries use to push policies that suit them
    • A worldwide minimum rate would effectively eliminate a lever that countries might employ to impose policies that suit their needs.
    • They can use a reduced tax rate as a lever to push economic activity in a different direction.
    • For example, IMF and World Bank data in the backdrop of pandemics imply that underdeveloped countries with fewer resources to give massive stimulus packages may suffer a long economic slump than developed countries.
  • Little impact on tax evasion
    • Though there seems to be broad agreement on the framework of a global minimum corporate tax, there continue to be differences over the rate of such a tax.
  • Ireland opposing the pact- Ireland with a tax rate of 12.5 percent is opposing the deal arguing that it would be disruptive to its economic model.
  • The inclusion of investment funds and real estate investment trusts under such a system could also lead to some differences during the negotiations.

Global Minimum Corporate Tax: What does it mean for India?

  • Cut in corporate tax
    • In September 2019, the Finance Minister announced a sharp cut in corporation taxes for domestic companies to 22% and new domestic manufacturing enterprises to 15% to boost investment activity.
    • Existing domestic enterprises/companies that choose the concessionary taxation regime will also be exempt from paying the Minimum Alternate Tax.
    • The average corporate tax rate stands at around 29% for existing companies that are claiming some benefit or the other.
      • India’s headline corporation tax rate was effectively brought in line with the average 23 percent rate in Asian countries as a result of the cutbacks.
      • China and South Korea both have a tax rate of 25%, while Malaysia has a rate of 24 percent, Vietnam has a rate of 20%, Thailand has a rate of 20%, and Singapore has a rate of 17%.
  • Equalisation Levy
    • The government has the ‘Equalisation Levy’ to solve the issues faced by businesses that run their company through digital methods and carry out activities in the country remotely.
      • The equalization levy is intended to tax international corporations who have a large local client base in India but charge them through their offshore subsidiaries, effectively avoiding the country’s tax system.
      • In the case of non-residents in India, the Income-tax Act of 1961 has been revised to include the idea of “Significant Economic Presence” for establishing a “business connection .”
    • Exchange of information
      • To close loopholes, India has been proactive in engaging with other governments to facilitate and enhance information exchange under Double Taxation Avoidance Agreements, Tax Information Exchange Agreements, and Multilateral Conventions.
      • These types of agreements encourage tax cooperation.

Mains model question

  • What is Global Minimum Corporate Tax? How it would help in the evolution of the taxation system worldwide and discuss its impact on India.

References