Rahul Nair

---

Introduction

The hardest thing in the world to understand is the income tax.  

Albert Einstein 

Regarding broader policies of taxation, it still holds true for almost all economies, which are now grappling with the multinational companies that use their worldwide knowledge to exploit the loopholes and mismatches of cross border tax differentials to reduce their tax bills. This has consequently led to a basic public opinion that large public companies pay little tax, resulting in the breakdown of trust that we see throughout the global economy.

The current international tax arrangements largely rest on the companies’ residence and the source of their income, both made meaningless by the phenomenon of globalisation which has accentuated the disconnect between the actual place of value creation and the site where profits are located. This interaction between domestic tax rules, which may not take into account the effect of other countries rules, usually leads to double non-taxation, where income from cross border activities may go untaxed completely or maybe unduly lowly taxed. 

Thus, countries find themselves with little to no tax revenues from these highly profitable, predominantly technology-driven, digital heavy business models. This deprivation is acutely felt and overtly manifested in the various under-funding of public investment that gravely hampers social and economic growth. It is because of these reasons that we needed a fundamental rethink of international taxation. 

The Agreement

The Finance Ministers of the most advanced economies, known as the Group of 7, have backed a U.S. proposal to impose a global minimum corporate tax rate of at least 15 per cent during a meeting held in London on June 5, 2021. This is primarily aimed to tackle a worldwide phenomenon known as Base Erosion and Profit Shifting (BEPS), wherein large multinational corporations register in low tax jurisdictions to circumvent the high taxes payable in the country where they operate. It has also been agreed to allow countries to tax at least 20% of profit exceeding a 10% margin on the largest and most profitable firms that operate in that place. Such a scheme is purported to weaken the joint effects of financial globalisation and tax competition, often mentioned as a force that drives down the corporate income taxes across nations, which the U.S. Treasury Secretary Janet Yellen termed as ‘the race to the bottom’.

Since the 1980s, the flow of inward Foreign Direct Investment(“FDI”) relative to the Gross Domestic Product(“GDP”) has roughly tripled in the developing countries, making its tax treatment and tax competition a very delicate subject for negotiation.  Clearly, garnering worldwide acceptance for a global minimum corporate tax will be a difficult task, due to its complexity and the invariable conflict in the interests of different countries. The success of this scheme would largely rest on convincing as many developing nations about its perceived benefits as possible and providing adequate incentives. What is good for the G7 may not satisfy all. The move is expected to face stiff opposition from countries like Ireland, Netherland and Luxembourg that have long dangled tax incentives to tempt investment, individual wealth and financial activities, as it could disrupt their economic model and diminish its attractiveness amongst business establishments. Because the typical emerging market is smaller, with an elastic supply of international investment and a smaller base of local investors, the pressures are usually high to reduce the tax rates. Thus, it would be interesting to see how the international forums reconcile this conflicting issue between local stress and global necessity. This scheme’s first major litmus test will be to gain acceptance in the G20 finance ministers’ meet, scheduled to take place in Venice on July 9-10, which includes India and China, and thereafter from Organisation for Economic Cooperation and Development (OECD). Evidently, one would hope that a consensus in such a broader global platform is reached only after having a comprehensive deliberation on the complex interaction between financial and trade integration, the global sentiments, diplomatic hurdles, strategic policies and domestic political factors. A positive outcome would consequently enhance the accountability of large multinational companies and lend greater transparency to the system of taxation.

Since both India and China’s existing corporate tax rate is higher than the proposed global minimum tax, accepting this measure should not impede their efforts to increase the inflow of FDI. Moreover, factors such as infrastructure and labour costs often matter more in attracting investment.

Conclusion

A three-decade-long decline in corporate tax rates has undermined faith in the fairness of the global tax system. The role played by the increasing tax competition in the era of increased globalisation and its effect on the whole structure of taxation is unmistakable. This overhaul of international tax law, and the incorporation of an alternate approach to increase global financial integration will ensure that the ‘right companies pay the right tax at the right place’. This would consequently compel the large corporations to pay more into the government coffers, which assumes special importance in the context of the sharp deterioration in the fiscal positions of many countries following the COVID-19 pandemic. 

All in all, this is a welcome development, as it creates and fosters an institutional mechanism to tackle some of the most egregious forms of tax avoidance. This switch from territorial to global taxation would potentially have far-reaching consequences, as it could alter the volume of FDI, its allocation across countries and the distribution of tax revenues. Hence, it is pertinent to have the international forums constantly monitor the macroeconomic consequences of such measures on a universal basis to see where the chip falls, who bears the burden and who emerges as the ultimate beneficiary. 

References

¹ Agence France-Presse, ‘G7 strikes ‘historic’ agreement on global corporate tax to make multinationals liable in country of operants’ (Firstpost, 6 June 2021) https://www.firstpost.com/world/g7-strikes-historic-agreement-on-global-corporate-tax-to-make-multinationals-liable-in-country-of-operants-9688801.html accessed 7 June 2021.

² Radmilla Suleymanova, ‘Race to the bottom: Yellen makes case for global minimum tax rate’ (Aljazeera, 5 April 2021) https://www.aljazeera.com/economy/2021/4/5/race-to-the-bottom-yellen-makes-case-for-global-minimum-tax-rate accessed 7 June 2021.

³ Staff Report, ‘Spillovers in International Corporate Taxation’ (2014) International Monetary Fund https://www.imf.org/en/Publications/Policy-Papers/Issues/2016/12/31/Spillovers-in-International-Corporate-Taxation-PP4873#:~:text=Summary%3A&text=The%20paper%20draws%20on%20the,how%20they%20might%20be%20addressed accessed 7 June 2021.