This article is written by Adhila Muhammed Arif, a student of Government Law College Thiruvananthapuram. This article seeks to explain the agreement on the Global Minimum Tax and what it means for tech giants.
This article was published by Diva Rai.
In the modern age of globalization, multinational conglomerates dominate the global economy, with power comparable to small nation-states. This has necessitated a greater regulation, particularly in the sphere of taxation. At present, multinational companies pay taxes only where they are situated, and not where they perform their operations. As the main motive of these companies is to make a profit, it is only natural that they would avoid high tax rates.
Thus, most of these big companies would establish their headquarters in low-tax jurisdictions, while they sell their products or services and earn profits in other countries. Digital companies like Meta, Google, Apple, etc. can provide services in multiple countries without being physically present, and make huge amounts of profit, and don’t have to pay taxes in those countries. Their profits have increased enormously during the pandemic, and they never had to pay taxes in the jurisdictions they benefit from. This has created a huge concern for governments across the globe, especially due to the strains in the budget caused by the pandemic. According to the State of Tax Justice report, around 427 billion US dollars are lost on a global level every year, due to the tax avoidance practices of MNCs. The same report stated that India loses around 10.3 billion US dollars every year.
The profit-shifting tendency of large companies and the digitalization of businesses have led to the introduction of a new concept called a global minimum tax, where all countries have a uniform rate for corporate tax, preventing companies from shifting their profits to low-tax jurisdictions. It would also ensure that the companies would pay some tax in the countries where they operate.
How BigTech uses tax havens
BigTech or the major American digital giants such as Apple, Netflix, Amazon, Microsoft, Google, and Meta, have a dominating presence in the world of digital commerce. They earn enormous amounts of profits from all around the globe without being physically present, especially from India, due to its massive population. Thus, they can perform their operations in multiple countries without paying taxes, other than the country in which they are headquartered. Moreover, they set up many subsidiaries in low-tax jurisdictions like Ireland, where the current rate of corporate tax is 12.5%, to avoid tax. Only a handful of countries like India, France, Italy, etc. have introduced digital taxes. As many countries have not imposed digital tax, this calls for a globally applicable system of digital taxation. This is where the global minimum corporate tax deal can be of use.
What is the global minimum tax
Global Minimum CorporateTax Rate (GMCTR), sometimes called Global Minimum Tax (GMT) is a tax regime that arises from an international agreement, where the countries which are parties to the agreement would impose a minimum tax rate on the income of big corporations. The proposal was given by the Organization for Economic Cooperation and Development and endorsed by G7 and G20 countries. Its acceptance was announced on the 8th of October, 2021. The OECD has always been committed to its fight against tax avoidance by MNCs, ever since the London Summit in April 2009. This is a major step ever since the Base Erosion and Profit Shifting (BEPS) programme of OECD, which was a multilateral convention that sought to implement measures that decreased the opportunities for MNCs for tax avoidance.
The main aim of the agreement is to implement a 15% minimum tax rate on the overseas profits of multinational companies if they make profits of 868 million dollars or more in their global sales. The proposal was accepted by 136 countries including India, amounting to around 90% of the global economy. The four countries that did not join the agreement are Kenya, Nigeria, Pakistan, and Sri Lanka. It compels the countries to make a law in favour of it by 2022 and to enforce it in 2023.
The agreement comes with a two-pillar solution, which would only affect those multinational companies that make profits of 868 million dollars or more globally. The implementation of the agreement would call for withdrawal of digital taxes or equalization levy imposed in countries like India and France.
The following are the two proposed solutions of the agreement :
Pillar one – fair distribution
Governments have the discretion to decide what their local corporate tax rate should be. But, if their companies are paying lower taxes in other countries, they could set their corporate tax rate at 15%. This would prevent companies from shifting to other countries for profit, and the governments would start receiving taxes from them.
Pillar two – stop competition over minimum tax
The second solution is that even the countries where these companies earn revenue can tax them for 25% of their excess profit. Excess profit of a company is defined as the profit that is in excess of 10% of its revenue. This would target digital giants like Meta, formerly known as Facebook, that offers its services globally, and profits in enormous numbers, without being present physically.
Importance and impact of the agreement
Why do we need a global minimum tax
The following are the reasons why we need a global minimum corporate tax:
- Income from intangible assets like software and intellectual property rarely gets taxed at the home countries of the companies and goes to low-tax jurisdictions where the headquarters are located.
- With the financial crisis brought by the pandemic, governments are seeking to prevent companies from profit-shifting and providing revenue to other countries.
What is the positive impact of the agreement
The following are the merits posed by the agreement:
- This agreement would provide governments with more financial resources, especially to reverse the financial losses caused by the pandemic.
- It mainly serves the purpose of stopping the financial diversion to low-tax jurisdictions, avoiding tax competitions among governments to attract foreign investment.
- According to OECD, an estimated 150 billion dollars could be generated by the global minimum tax.
- It would encourage companies to provide capital to their home countries.
- It takes digital commerce into consideration.
What are the challenges posed by the agreement
The following are the disadvantages of the global minimum corporate tax agreement:
- The first disadvantage posed by the agreement is that it causes a loss of sovereignty for countries in deciding their national tax policy. The uniform model for tax rates does not take the unique needs of every country into consideration.
- It also received criticism for being beneficial only for the major developed economies, as it was first endorsed by the G7 countries, pressurising other economies into accepting the reforms.
- For many countries, the rate of 15% is too low compared to their statutory rates of corporate tax.
- Less developed economies heavily depend on corporate revenue. Once the corporate tax is lower, the tax imposed on individuals will increase, burdening their incomes. This would also decrease public expenditure in such countries, negatively impacting the accessibility of social services to vulnerable groups. As per Article 2(1) of the International Covenant on Economic, Social and Cultural Rights, governments have a duty to gather resources for fulfilling the human rights of their citizens.
- Since all countries have not accepted the agreement, there will be a new form of competition, giving opportunities for MNCs to shift to those countries.
Implications for digital commerce in India
India’s assent to the agreement would impact digital taxes imposed by the government recently. In 2016, the Parliament of India enacted the Finance Act, 2016, which introduced the concept of equalisation levy that taxed the income by non-resident service providers through online advertisements, at the rate of 6%. It was introduced to give effect to the BEPS (Base Erosion and Profit Shifting) Action Plan. It would tax the income of foreign e-commerce platforms that profit from Indian customers. In 2020, the Finance Act, 2020 was passed which widened the scope of the imposition of equalisation levy on non-resident e-commerce platforms for providing online sales or services to Indian customers at the rate of 2%.
The terms have been widened in the 2020 Act in such a way that even foreign companies that do not fall under e-commerce could still fall under the purview of this Act, as customers usually make online payments to avail of the services of foreign companies. With the equalization levy, India collected Rs 1600 Crore in 2021, which was two times more than the previous year. The provision of equalization levy serves the purpose of providing a level playing field for local e-commerce platforms, to compete with foreign e-commerce giants.
Once the agreement comes into force, the digital tax provisions will be withdrawn, to bring the taxation system in line with the agreement. It is difficult to estimate how much revenue India would earn on the implementation of the agreement. The agreement is only applicable for countries that earn at least 868 million dollars in their global sales, and it is hard for many companies to cross that threshold. The agreement will not apply to those companies that earn revenue below the fixed limit. The agreement does not seriously threaten the sovereignty of our state in the matter of taxation, as it does not impact the local corporate tax rates. However, it is hard to predict if India will benefit more from the global minimum tax deal than under the present taxation system.
It is quite clear that the agreement mainly targets digital giants or BigTech, which earn enormous profits from countries all around the globe. It is important to note that this agreement does not impact the local corporate tax. This is only applicable against multinational companies that earn profits above the threshold set by the agreement. Once the agreement is enforced, the digital taxes imposed in countries like France and India will be withdrawn, bringing more uniformity and certainty in digital taxation. Thus, the digital giants have responded positively to the news of the deal. It is not fair to blame digital giants for “avoiding tax” when the taxation system in itself is flawed in most parts of the world.
Most countries are still stuck in the times when digital commerce was not born. It is only natural that companies would try to get the maximum profits and minimize the costs, which would involve shifting to low-tax jurisdictions. It is safe to say that the global minimum tax agreement has addressed this problem. The announcement of the global minimum corporate tax agreement and India’s acceptance of the deal, is a major step towards in our fight against tax avoidance due to the profit shifting of big multinational companies, particularly digital giants.
The agreement gains its relevance due to the recognition it gives to digital commerce. It does not restrict itself in its application to traditional brick and mortar industries. Though it pervades and violates the sovereignty of nation-states, it has no effect on local corporate taxation. However, it is too early to say if India will have significant benefits from the agreement, or if it is just a tactic to serve the major economies of the first world.
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