This article has been written by Raghav Mittal pursuing the Diploma in Law Firm Practice: Research, Drafting, Briefing and Client Management from LawSikho. This article has been edited by the Priyanka Mangaraj (Associate, Lawsikho) and Dipshi Swara (Senior Associate, Lawsikho).
Every country in the world is now doing everything in its capacity to generate as high revenue as possible which in turn will help in boosting its economy and infrastructure, which is the most important factor for economic development. Every nation wants to improve its GDP or per capita income and ultimately remove the tag of “poor” or “developing country”. A large source of revenue for the countries is from the tax or the fee that is collected from their citizens, corporations, or entities, and among those, the highest collection is from the multinational corporations set up in their countries. The tax collected from these corporations is very high, therefore in order to increase revenue generation, governments prefer multinational corporations to be set up in their countries. And this has led to the introduction of a newly constituted tax structure by the Organization for Economic Cooperation and Development OECD along with the global countries which are seeking to collect tax from the big corporations present in their country on the profits that are generated overseas.
Global minimum corporate tax rate
As it is clear from the word itself that it is a tax that is to be levied globally on the corporations, that is to say, that this is a tax that will be levied on the companies having operations globally. This tax is levied on the corporate entities that are having their operations all around the globe. Since the London Summit in April 2009, the Organization for Economic Cooperation and Development (OECD) has been at the forefront of fighting against tax evasion, ending bank secrecy and tax havens, and addressing tax avoidance by multinational corporations. OECD contributions to the G20 on tax have helped to reform, reshape and modernize the international tax architecture.
The idea behind the application of this tax regime is to curb the practice of large MNCs to shift their headquarters in the jurisdictions of the low or negligible tax regime. Such jurisdictions are – Ireland, Bahamas, Bermuda, Singapore. And there has been a trend especially among the developing nations to lure these large multinational corporations to their territory for tax benefits and the corporations thus tend to shift their headquarters in such countries where they enjoy low tax implications and huge profits.
There is an estimation of loss of around $100-240B to the countries because of such shifting of companies to these tax havens and that is why OECD has been trying and it has succeeded recently to agree the world countries ratify the legislation on global corporate minimum tax so that the practice of large corporations shifting their bases just because the other countries are offering lower tax structure can be curbed, also the corporations should make decisions based on infrastructure that a particular country is providing for the setting up of their business or overall working of the business instead of lower tax.
Around 130+ countries have agreed to impose a global minimum tax rate on the large corporations having transferred their huge profits to the tax havens @15% to be paid to the country from where they have avoided the tax liability.
What was the need?
For development in any field, it requires funds for infrastructure, and labor to work efficiently. In the end, it is all about how capable a country is in respect of allocation of funds, and corporate tax for instance is considered a great source of revenue for any government. If such a source is getting affected because the corporations are shifting their base or transferring their profits, though legally, to some other jurisdictions that are offering lower tax implications, then it is a matter of concern for the countries, especially for the developing countries. If we take the example of India, earlier the corporate tax that was imposed was 30% but recently it got slashed and now it is at 22% of the corporate income. Also, if any new corporation wants to set up its business in India for the first time, the corporate tax that it has to pay is just 15% of its income. The intention behind such benefits can be perceived that the government wants the foreign companies to invest in India and boost the economy.
Also, during the regime of Donald Trump in the USA, he slashed the corporate tax heavily from 35% to 21% so that the companies stop changing their base from the country of their origin to the tax havens and also with the view that other establishments will now enter in the US. Even then, the reduced tax rates did not intimidate the companies to such an extent that they stop transferring their multi-million dollars of profits to the jurisdictions of lower tax as the tax havens are still offering them a much lower tax structure, which ultimately cannot be afforded by the already suffering countries.
How are the profits transferred?
The vital question is how can corporations transfer their profits without paying tax to the government so easily that no one can question it? Big multinational companies are following this practice out in the open and there is nothing that can be done unless and until they want to give a higher tax on purpose and hence avoiding payment of tax in the former country.
It is a simple rule in the world of accountancy that higher the expenses, lower the income. This is the strategy that is being followed by these corporations and the transactions are so legitimate that no one can question such transactions. Though legally, these strategies are considered unethical.
Some of the strategies used by these entities are as follow:
- IP RESTRUCTURE
Let’s suppose that there are 2 companies A & B, A being in the country of higher tax jurisdiction H1 and B being in a lower tax jurisdiction H2. Also, B is a company incorporated in H2 by A only.
Since A is the corporation that is doing all the business operations and therefore has various kinds of copyrights, trademarks, designs registered in its name.
Now what A does is, it sells all the copyrights to B, which is controlled by A, in H2 at huge prices first and then in return B lends all such intellectual property rights to A, again at exorbitant prices and this will reflect in the books of A as an expenditure to A, thus reducing the profit and tax liability. This is where the profits of A get transferred to a lower tax jurisdiction without infringing any laws. Pure legal but unethical.
- THIN CAPITALISATION
Every company in order to start its business activities or to further expand its market area requires funds and there are numerous options available in the market to raise funds i.e loans, issue of shares, debentures, securities, etc. but there is no better option than self-financing. That is to say, using your funds is always a better option than taking from outside sources with an additional expense of interest.
Companies in a higher tax jurisdiction set up another company in a lower tax jurisdiction and raise a massive amount of loans from the latter and that too at a huge rate of interest and as a result the revenue generated by the former company comes down drastically, resulting in low tax liability and this is where the profits get shifted to the lower tax jurisdiction from higher tax jurisdiction but the profits are enjoyed fully by them.
Some other practices are also prevailing in the industry such as “green jersey”, “single malt” but as the name itself gets complex the working also gets a bit complicated.
How does this global corporate tax structure work?
Both G7 and G20 countries that represent the world’s largest economies have agreed on the tax reform plan of OECD that includes the global corporate minimum tax design, which brings in the overseas income of the multinational corporations in the purview of the domestic tax structure. Around 130 countries have agreed to the action plan of OECD for global taxation but it still needs the mechanism to make it applicable over the globe. Currently, it suggests implementing a top-up method that will be applied by and paid in the country from where the funds are being transferred. The top-up will be the difference between the tax structure where Global Minimum Corporate Tax (GMCT)is adopted and lower tax jurisdiction. As this is the difference which these multinationals were trying to avoid payment of and so the loss/deficit which the government was facing will now be back in the hands of the government.
EXAMPLE- suppose if a corporation has transferred its profits from country A to country B. corporate tax at A is 21% and that at B be 5%. As a result of the transfer of profits the tax on such profit paid to B is 5%. Now, with the implication of GCMT if the rate of taxation fixed is 21% then the difference between the tax structures i.e 21% – 5% = 16% will be taken, which means that a corporation has to pay 16% tax in the country A on the profits transferred from A to B.
The countries will now be bound to sync their corporate tax structure with the rules and regulations of the GMCT i.e if GMCT is made applicable in India then the corporate tax will have to be reduced to 15% from the current 22% and so will the other countries.
If we analyze the trend of the countries from 2000-2020 almost 88 countries have reduced their corporate tax and just 8 countries have increased the corporate tax in their country. It seems like a race among the nations to reduce the tax rate in their jurisdictions to attract the multinational companies in their territory to improve their infrastructure, reduce unemployment, and improve the standard of living of their citizens.
There is nothing wrong with a reduction in the tax rate in their territory if it results in the improvement of a particular nation. As in today’s world, a nation has to become self-reliant and technologically advanced so that it does not depend on any other nation for essentials. This strategy of luring big companies to their soil by slashing the tax rate or providing subsidies is one of the most ordinary means especially for the poor countries and the developing countries, who are still lacking technology resources available with them, hence they need big corporations to set up businesses in their region even if they have to do away with the high revenue generation.
This concept of global taxation which proposes to tax the corporations at the same rate all over the world also takes away the power of a sovereign nation to tax their corporations at their own will. This can be a serious issue as this affects the sovereignty of the nations as they will now have no control over the taxation on the corporations. Even if they want to change the tax rate they first have to agree with all the signatories of the international agreement as it would now have international implications on any derogation of the agreement.
Each country has its own needs and a common tax regime cannot benefit every state. It may be beneficial among the developed countries as they have various other factors that are contributing to their GDP but developing or poor countries who majorly depend on the revenue generated from the corporate tax, will be at a loss as they will be left with nothing to offer to these companies and the companies in such places may shift their businesses back to their home country as they ultimately had to pay tax to the government, as a result, the tax havens jurisdictions will not be able to survive in the long run and will remain underdeveloped and that is why Ireland is against GMCT and its implication.
There is no doubt that the profit shifting or base erosion or tax avoidance is now a big hurdle in front of the countries but it is also true that some of the countries are generating their revenue by residing such companies in their homeland and providing the ideal infrastructure and ease of doing and managing their business. Also, it is not sensible for the developed or nearly developed countries to be unable to control their corporations from moving out so they come together and put restrictions of such a nature that will impact the developing or poor countries. There is a reason why the big MNCs are shifting their base to some other countries and therefore the countries to boost up their revenue should try to provide the corporations in their territory such similar conditions instead of cutting out the benefit that the corporations are enjoying elsewhere.
The idea behind the implication of GMCT is not all bad because as per the current scenario, almost 130 countries are ready to implement the all-new tax regime even when the sovereignty of the nations will be affected. It is also to be noted that the power to amend such laws in the future will be in the hands of influential countries like the US, China, or Russia as the concept of GMCT has got in the news only when the US shows its interest in the same. Instead of deciding on such sensitive issues, the countries must provide their individuals with the working atmosphere that they are getting in another country. The government should work on providing the business entities with offers that they cannot refuse or the perks or incentives that can force them to think beyond the higher tax. The government should provide incentives to hold them from shifting their base to another jurisdiction, as tax has become such a major issue for entrepreneurs’ economic growth.
- International taxation – Organisation for Economic Co-operation and Development (oecd.org)
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