India and Global Minimum Corporate Tax

TNI Bureau:  A path-breaking announcement made by the Finance Ministers of the G7 nations last week with support from Biden administration, OECD, G20, and IMF, states 15% global minimum corporate tax rate will help to stem the “race to the bottom” between the countries.

During the pandemic, all the major countries have experienced a fiscal situation where the tax revenues have decreased and the requirement for public expenditure increased resulting in increased public borrowing or printing money which might lead to negative outcomes like inflation pressure building in the near future. This has led governments around the world to go for revenue hunting.

Just to get the idea of the impact of the global minimum corporate tax rate, Action aid international organization has recently published that if even only top 5 silicon valley tech giants paid their taxes fairly, the government can collect up to 32 billion dollars in annual tax revenues and this can actually be enough to vaccinate every single person on this planet. TWICE!

So how do big corporations manage to avoid taxes?
Globalization and rapid technological development are changing the way the world does business. All the big organization have their presence in multiple countries and are taxed by different governments keeping in mind the bilateral treaties and double taxation avoidance agreements (DTAA) signed among the countries.

That means the tax base of these organizations is mobile, so it becomes easy for corporations to shift profits from a high tax regime to a low tax regime by using modus operandi such as paying exaggerated royalties for intellectual property to other subsidiaries in a low-tax regime.

Studies (de Mooij and Ederveen, 2008) suggest that profit shifting is the main reason behind the global trend for lowering corporate taxes instead of the popular belief that it is done for attracting FDI’s.
Individual countries are also faced with (asymmetric) prisoner’s dilemma, where all countries incline towards lowering taxes while in practice higher taxes would benefit all.

Imagine 2 countries like India and Ireland, both start with the same tax rates and as per their changing fiscal policies keeping in mind the macroeconomic factors Ireland decides to reduce its tax rates to attract capital while India decides to increase or keep the rates the same keeping in mind the requirement of revenue.

As a result, some of the capital from India flows to Ireland keeping profitability in mind. Now, Ireland has a much larger capital base and it can afford to further reduce the tax rate and still meet the requirement for public expenditure in its country while India will be forced to either reduce its tax rate or lose even further capital in the hands-off low tax regimes.

There is empirical evidence to prove that this international competition ceases the countries ability to raise sufficient amount of tax revenue from its capital base even when the countries are looking towards pilling debts and increase demand for public expenditure.

For high-income states like the USA, this will mean shifting the tax burden towards less cosmopolitan entities. But for developing countries like India, this will mean shrieking budget substantially and increasing dependence on regressive revenue collection methods like indirect taxes, leading to more inequity in the country.

Now, Tax Havens across the world oppose this policy of introducing a minimum corporate tax on the basis that it will diminish their autonomy to decide the fiscal policy of their own country.

In a recently published paper by Andreas Cassee from the University of Bern, Switzerland, he urges us to imagine a system of “noise control” where everyone will have the right to play music at whatever volume they want and whatever time they wish as long as this reflects their preference. Now, imagine you want to listen to soft music at a low volume one afternoon but you won’t be able to as your neighbour is in the mood to listen to rock at the highest volume possible.

This tells us that preferences for loud music and silence are contradictory and cannot be satisfied at the same time. Note, that rather than creating a fair balance the rule created bias as you not only were not able to listen to your own music at low volume but it also prevented you from listening to the music of your own choice.

So when the question is raised as to why countries should be constrained from enacting their preferred low tax policies, it’s because it negatively affects the countries who prefer high tax regimes keeping strategic reasons in mind. It limits other countries’ ability to collect taxes which can be used for increasing public budgets and expenditure on redistributive policies.

Now, we need to understand that both sides are arguing for their right to self-fiscal determination as negative externalities created by the low tax regimes do not allow other states to effectively practice their preferred tax regime.

Global Minimum corporate tax seems like a moderate solution keeping in mind the interest of both sides. As instead of the tax regime, factors like public infrastructure, skilled workforce, ease of doing business indicators, the market for goods, etc will gain more prominence in deciding capital investment inflow for a country.

It’s a question to ponder, whether the low-income countries with no strategic advantage whatsoever should be exempted from following global minimum tax rates as capital inflows for them can prove to be a channel to get out of this economic trap.

There are 2 pillars for this policy of “Global minimum corporate tax”(GMCT) which are negotiated and are still under discussion:

Pillar 1: This will give the right to countries to tax profits of multinationals that are generated by them in their jurisdiction regardless of the firm’s physical presence. Take the example of ICC headquartered in the British virgin islands(BVI) which earns a major chunk of its revenue from broadcasting rights. In 2019, it earned an income of close to 3000 crores which would be about 650 crore in taxes, but it paid no taxes as such to the countries in which cricket is watched because BVI is a tax haven and other countries still have not right to tax its income. Now, this will change.

Pillar 2: This will give the right to countries to impose minimum corporate tax rate on large multinationals which are headquartered in their jurisdiction but are making profits in other countries and not paying minimum tax rate in their jurisdiction.

This is where the debate is! A large advocacy group “ The tax justice network” has been opposing the headquarter rule. The OECD estimated that a total of $81bn dollars of additional revenue per year can be generated from this reform although the OECD proposal gives an advantage to the headquarters ‘ countries which are the richest countries of the world. They stand to gain more than 60% of the additional revenue expected to be generated.

This reform is being made keeping in mind that it will lead to better redistribution of profits to achieve the end goal of a more equal society but if we look closely lower-income countries like India has always lost a high share of tax revenues by corporate tax abuse but still stand to gain very less after the reform is enacted.

The advocacy firm has given an alternate proposal which is “minimum effective tax rate”(METR) this will give the right of taxing to countries where the real economic activity is taking place instead of to countries where the firm is headquartered. This can result in fair distribution globally.

The difference as anticipated by the firm is quite substantial in both scenarios. In GMCT India could gain $4bn dollars per year of additional revenue as opposed to $13bn dollars per year in METR.

It will take a lot of time for this reform to come to reality as it will require major policy changes across nations and substantial improvements on reporting methods by the industry which means standardization and adoption of new IFRS and GAAP. There are fears that even after the implementation of the new regime, tax evasion will still continue.

The whole world will need to keep its best foot forward in this new direction anticipating fallouts beforehand.

India has suffered an adverse impact for years from a 40% tax rate at the time of liberalization to 15-20% now. Although the ratio of corporate tax collection to GDP initially increased , it has reduced to 2.3% currently, giving some perspective the ratio is approximately 17% in China and 25% in the USA.

India losses over $10bn dollars every year due to corporate tax abuses, GMTR will not solve all of India’s problems as we will still need to work upon building a better investment environment for MNC’s. But now it’s time for India to position itself as a nation that need not resort to lowering tax rates to facilitate economic activity.