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[Burning Issue] Global Minimum Corporate Tax

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Finance Ministers from the Group of Seven (G7) rich nations have reached a landmark accord setting a global minimum corporate tax rate, an agreement that could form the basis of a worldwide deal.

Global Minimum Corporate Tax

  • Major economies are aiming to discourage multinational companies from shifting profits – and tax revenues – to low-tax countries regardless of where their sales are made.
  • Increasingly, income from intangible sources such as drug patents, software, and royalties on intellectual property has migrated to these jurisdictions.
  • This has allowed companies to avoid paying higher taxes in their traditional home countries.
  • With a broadly agreed global minimum tax, the Biden administration hopes to reduce such tax base erosion without putting American firms at a financial disadvantage.

How would such tax work?

  • The global minimum tax rate would apply to companies’ overseas profits.
  • Therefore, if countries agree on a global minimum, governments could still set whatever local corporate tax rate they want.
  • But if companies pay lower rates in a particular country, their home governments could “top-up” their taxes to the agreed minimum rate, eliminating the advantage of shifting profits to a tax haven.
  • The Biden administration has said it wants to deny exemptions for taxes paid to countries that don’t agree to a minimum rate.

Reasons why the USA is proposing it

  • Hike in tax rates: The plan seeks to increase the US corporate tax rate to 28 percent from 21 percent. The ex-US President had reduced the corporate tax rates from 35 percent to 21 percent.
  • Revitalization: It aims to revitalize the transportation infrastructure, water systems with other goals.
  • An increase in the tax rate and other measures to prevent the offshoring of profits will fund it.
  • More cooperation: It will support integration instead of isolationism.
  • Tax evasion: The plan will stop firms from shifting profits to tax haven countries.
  • Stability: The bill aims to stabilize tax systems to raise enough revenue to invest in public welfare.

Significance

  • This measure will help close cross-border tax loopholes used by some of the world’s biggest companies, thus will help limit base erosion and profit sharing (BEPS).
  • Increasingly, income from intangible sources such as drug patents, software and royalties on intellectual property has migrated to the low tax jurisdictions, allowing companies to avoid paying higher taxes in their traditional home countries.
    • 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.
  • This agreement marks a much necessary reform of the global tax system to make it fit for the current global digital age where cross-border digital services are gaining prominence.
  • The introduction of a global minimum corporate tax will contribute to ending the decades-long “race to the bottom on corporate tax rates”, in which countries have resorted to ultra-low tax rates and tax exemptions to lure multinationals companies to invest.
  • Such measures have cost such countries hundreds of billions of dollars whereas the corporate entities have only grown richer.
  • This landmark agreement could form the basis of a worldwide deal.
  • The Organization for Economic Cooperation and Development has been coordinating tax negotiations among 140 countries on rules for taxing cross-border digital services and curbing tax base erosion, including a global corporate minimum tax. The OECD and G20 countries aim to reach consensus on both by mid-year.
  • The agreement has committed to reaching an equitable solution on the allocation of taxing rights. It will focus on protecting the interest of the market countries by awarding such countries certain degree of taxing rights on the profits of the multinational enterprises.
  • This will help ensure that MNCs would pay taxes where they operate and record their profits from based on the concept of ‘Significant Economic Presence’.

International Stand

  • The Organization for Economic Cooperation and Development (OECD) has been coordinating tax negotiations among 140 countries for years on rules for taxing cross-border digital services and curbing tax base erosion, including a global corporate minimum tax.
  • The International Monetary Fund has long favored the adoption of a global minimum tax on corporate profits as it would help in the reduction of current disparities in the national corporate tax rate.
  • It would largely help in reducing tax shifting and tax avoidance.
  • It would reduce the tax base on which governments could collect revenues for funding economic and social spending.

Criticism/ Challenges

  • A global minimum rate would essentially take away a tool that countries use to push policies that suit them.
  • For instance, in the backdrop of the pandemic, IMF and World Bank data suggest that developing countries with less ability to offer mega stimulus packages may experience a longer economic hangover than developed nations. A lower tax rate is a tool they can use to alternatively push economic activity.
  • Also, a global minimum tax rate will do little to tackle tax evasion.
  • The inclusion of investment funds and real estate investment trusts under such a system could also lead to some differences during the negotiations.
  • Lack of consensus: Several countries have taken a different approach to the rate of global minimum tax.

India’s Stand

  • Indian Government has said that it is open to participate and engage in discussions about the Global Minimum corporate tax structure.
  • It said that the government will look into the pros and cons of the new proposal and take a view thereafter.

How Global Minimum Tax would benefit India?

  • The proposal, along with the increased tax bill for U.S. companies, may benefit the Indian revenue department.
  • The State of Tax Justice report of 2020 notes that India loses over $10 billion in tax revenue due to the use of offshore structures, particularly through investments made by Indian residents through Mauritius, Singapore and the Netherlands.
  • This is supported by the overseas direct investment (ODI) data from 2000 to 2021 published by the Reserve Bank of India.
  • Start-ups and large Indian conglomerates commonly use offshore structures for conducting global operations.
  • Revenue from such operations is often retained offshore and not repatriated to India.
  • Tax advantages incentivise such structures, due to which taxes on such income are not paid in India.
  • Once these proposals are implemented, Indian companies would have to pay additional taxes on their offshore structures to the extent that the effective rate of tax is lower than the global minimum tax rate.

Way Forward

  • The agreement will be discussed in detail at a meeting of G20 finance ministers in July in Venice with an expectation to get broader support from countries that may lose investment due to the new policy.
  • There is a need to support this effort by the US government to build a consensus among the G20 countries to increase the corporate tax rate and to end the race to reduce corporate tax in the world so that the pandemic ridden world is able to come out fast of its economic problems and efforts of development can be speeded up in all the countries of the world.
  • Even though a lot more remains to be done to achieve parity in international financial relations and the advancement of the goals of global tax justice, the global corporate minimum tax could go a long way in the accomplishment of these aims.
  • Countries like India should not be recalcitrant about signing on to this proposal, and should approach this idea with cautious optimism.
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