Global Minimum Tax: A new effort to rein in corporates that play games

When Justice Oliver Wendell Homes, in a dissenting 1927 US Supreme Court judgement, stated that taxes are what we pay for a civilised society, he was stating a truism: the money collected from taxes pays for the development of a country, for providing essential services to its citizens. Governments expect citizens and corporates to promptly pay taxes. While governments have a reasonably effective enforcement machinery to ensure that citizens pay their taxes, the challenge has been in ensuring that corporates, particular multinational enterprises, pay what’s due from them.

The G-20 countries, an informal grouping of 19 countries and the European Union, which together account for two-thirds of the global population, and the Organisation for Economic Cooperation and Development (OECD) had in this backdrop suggested an inclusive ‘Framework on Base Erosion and Profit Shifting’ (BEPS) project, which targeted tax-planning strategies that sought to shift profits to low-tax jurisdictions. These tax-planning strategies relied on mismatches and gaps that exist between the tax rules of different jurisdictions to minimise the corporate tax that is payable overall, by either making taxable profits “disappear” or shift profits to low-tax operations where there is little or no genuine activity. The BEPS reports released in 2015 were aimed at improving the “coherence, substance and transparency of the international tax system.”

Base erosion, as has been pointed out, constitutes a serious risk to sovereignty, tax fairness and tax revenues for both developed and developing countries alike. For instance, the Tax Justice Network, a UK-based organization, has estimated that each year, India lost to tax havens a whopping $10 billion.

India ratified the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting – and deposited the Instrument of Ratification with the OECD, Paris, under the Convention. It entered into force for India on October 1, 2019, and its provisions on India’s DTAAs from FY2020-21 onwards.

However, the BEPS project did have very many shortcomings. The OECD released blueprints of proposed solutions to address these challenges – it introduced a two-pillar approach to international tax reform in 2019 to address the digital economy (Pillar One) and unresolved BEPS issues (Pillar Two).

Pillar 1 was meant to “adhere to the concept of net taxation of income, avoid double taxation, and be as simple and administrable as possible.” In simple terms, the OECD did agree to the concerns of governments that companies were not paying enough tax in jurisdictions where they had ‘market-facing’ activities.

Pillar 2 sought to give governments the “right to ‘tax back’ where other jurisdictions had not exercised their primary taxing rights, or the payment was otherwise subject to low levels of effective taxation.” Essentially, Pillar 2 sought to establish a minimum level of taxation on multinational companies doing business around the world; and if companies fell below those thresholds, they would owe additional tax. Pillar 2 required companies to “top up” the tax paid to bring the amount to a minimum effective tax rate.

OECD Pillar 2 was to apply after Pillar 1, rather than concurrently. Companies would first allocate the tax due to jurisdictions where they generate revenue under Pillar 1; then, if they were still below the minimum effective tax rate, Pillar 2 guidelines would be applied.

The OECD proposals got a push when US President Joe Biden came to power, leading to what UK Chancellor Rishi Sunak termed “seismic tax reforms”. The historic G-7 Finance Ministers’ Communique of June 5 committed to the principal design elements of the OECD’s two-pillar approach for international tax reform. This includes a commitment to introduce a global minimum tax of at least 15% on a country-by-country basis. The agreement will now be discussed in further detail at the G-20 meeting this month.

The brilliant French economist Gabriel Zucman, a protégé of Thomas Picketty, known for his research on tax-planning and tax havens and who is at the forefront of the fight to bring multinationals within tax jurisdictions, has estimated that the redistribution of profits from high-tax countries to tax havens or lesser-tax countries has resulted in around 40% of profits having shifted. The resultant loss was said to be in the range of $620 billion. This, he has pointed out, has resulted in headline economic indicators like countries’ GDP, trade balances getting distorted.

Thus, the G-7 decision is a huge step forward and will reduce tax rate arbitrage. Concerns have been raised that the proposal impinges on a nation’s right to decide on tax policy; that taxation is a sovereign policy determined by local factors, and whether it would in any way tackle tax evasion at all. This is a myopic view. No country in this globalised, inter-connected world would like to facilitate corporate tax-planning bordering on the illegal. While the Richter scale of these ‘seismic developments’ -- to stretch the analogy of Chancellor Sunak -- will be known only after the G-20 meeting, suffice it to say that they would shake up the global corporate taxation system.

India in 2019 reduced its corporate tax rate to 22% for domestic companies and 15% for new manufacturing companies. However, its large domestic market size should continue to attract global players. There has been no official government reaction thus far but India, which is a member of G-20, will be watching these developments closely.

The global minimum tax should, in the words of US Treasury Secretary Janet Yellen, “end the race to the bottom in corporate taxation”. Nothing can be better than that result.

(The writer is a former chairman of the Central Board of Indirect Taxes & Customs)