[By Sanskriti Srimali and Dushyant Sharma]
The authors are students at Institute of Law, Nirma University.
“Never let a serious crisis go to waste.”
–Rahm Emanuel
The economic jitters induced by the pandemic are still reeling around the globe. Post pandemic economic recovery has taken the centre stage at a global level. Undoubtedly, governments, around the world, have to be the front-runners to revive the global economy. However, looking at the figures of global debt which now stands at a record $281 trillion, the task of revamping the global economy would not be a cakewalk. The authorities have to search for new avenues to generate revenue or start scrutinizing existing ones to deliver sustainable public finances.
Governments throughout the world generate revenue by collecting taxes via corporations as well as individuals therefore tax rates of each jurisdiction play an important role and can be a game-changer in the coming times. Tax avoidance and evasion have been part and parcel of every country. Multinational firms detest paying their fair share of taxation. They’ll do everything they can to take advantage of loopholes and reduce their tax liability. Since the 1990s, the world has seen an explosion of profit shifting to tax havens. Many companies have established offices in countries with low or no tax rates, such as the Cayman Islands, Bermuda, and Bahamas which are also known as tax havens as they provide a 0% tax rate to increase FDI and employment. Countries compete with each other to get the attention of big well-established companies by lowering the tax rate.
To put an end to this race to the bottom, the US government came up with a bold proposal: a global minimum tax rate of 21% which was revised to 15%, keeping the idea unchanged. Before going into the details concerning its implementation and how it would fill the empty coffers of the government around the world, it is imperative to understand the origin and proposition of the idea of having a global minimum corporate tax.
Each country has the power to decide its tax rate without taking into consideration the interest of others. This notion began to change with the advent of globalization and further through digitization which knows no territorial boundaries. However, the response of the countries was far too slow when compared with the rampant growth of the digital economy. As a result of this, a large chunk of profits earned by MNEs remained untaxed for a good amount of time. The emptied coffers of the governments after the 2008 global financial crisis, forced the G20 and OECD countries to reform the international tax system. In pursuance to it, OECD proposed an action plan to address ‘Base Erosion and Profit Shifting’, containing 15 actions that were approved by G20 nations in Russia in 2013. At the same summit, the OECD recognised that the developing countries have been more hit by the tax abuse of multinationals. However, the plan of actions failed to yield results owing to the lack of coordinated efforts, unilateral actions by the member countries among others.
So the OECD came up with BEPS 2.0 blueprint in November 2020. The blueprint emphasised two pillars to overhaul the international tax system which is as follows :
Pillar 1 – The proposal aims to introduce a formulaic element to apportion some of MNE’s profit to the jurisdiction where the sales occurred. The scheme mandates the filing of self-assessment by the MNEs. After filing, the home country would engage in calculations and allocations. To effectuate such a proposition, several existing tax treaties would have to be amended. This proposal gives the major bargaining power to a bunch of developed nations which are home to most of the MNEs. Also, in lieu of the meagre tax revenue, the proposal wants the recipient countries to roll back their unilateral action like- Equalization Levy (EQL) in the case of India. Given such roadblocks, a global consensus would be hard to achieve let alone the implementation.
Pillar 2– This pillar intends to lay down a certain set of rules to impose a minimum tax rate of 15% on all companies irrespective of where they are headquartered or where they work. So suppose if a company is headquartered in a country that imposes a tax rate of 10% which falls below the proposed rate of 15% then the other country from which the parent company operates would come and take the rest i.e. 5%. This would not only disincentivize the MNE to shift their operations to low tax jurisdictions but will also encourage the low tax jurisdictions to increase their tax rate to the minimum global standard.
But is this as good news as it sounds? Unfortunately not!
This proposal is plagued by two difficulties first lies in implementation and the other, the major concern, is the distribution of the tax collected among the participating countries. Under the OECD proposal, the G7 countries which account for 10% of the world’s population would gain more than 60% of the additional revenues. The imposition of the Income Inclusion Rule (IIR), which allows the ultimate parent country of the MNEs to impose a top-up tax to achieve minimum effective rate would override other provisions in the blueprint, like UTPR and STTR. They have only been included so that the IIR might not sound unfair to the source country. The use of IIR as the main norm, clearly signifies that a major chunk of the pie would go to MNEs ultimate parent country.
The most favourable option that could act as a breakthrough in the current hiatus is the Minimum Effective Tax Rate which is also being endorsed by the World Economic Forum, Tax Justice Network and UN FACTI panel recommendation. This proposal is the modification of GMTR and dispenses with the idea of giving priority to home countries of MNEs over source countries where real activities occur. This proposal works on the following pillars which are described below :
Transparency: Under this, the MNEs have to comply with the requirement of the country by country reporting. This data will reveal the profit shifting into the tax havens and abusive actors like the MNEs and havens could be made accountable for it. It would also help in determining the real activities of the MNEs in each country based on the figures of sales and employment. The EU has already taken some steps on this front, albeit not so significant but can be held as a good precedent to start. The UN FACTI panel on international taxation reforms has also advocated for such kind of action.
Minimum Effective Tax Rate: the minimum tax rate would act as a disincentive for Companies as well as for tax havens. Each country where the MNE has a presence could apply its domestic tax rate which could be below or above the ETR. The said rate of each country would only apply to the share of MNE profits reflecting real activities in the country. Apart from it, it would enable the domestic players to compete with their international peers on an equal footing as the component of harmful tax competition has been eliminated.
Inclusion: The OECD, a club of developed countries, has been engaged in setting up international rules on taxation since the 1960s. The organisation has itself acknowledged that its current framework is not working and failed to deliver the requisite results. Therefore, the responsibility of framing a global taxation framework must now be assigned to United Nations which has already shown its interest to do so in the recent UN FACTI Panel Report. A comprehensive UN tax convention, upon ratification, would legally bind the nations to follow the treaty provisions. The rules so framed would also be far more equitable and inclusive than those framed by the OECD(which always take into consideration their interest first). An intergovernmental body under the said convention to oversee the rules and compliances could also be set up. Such an institution is necessary to resolve the fundamental issues that have flourished under the aegis of OECD.
India was among the first few countries which imposed Digital Services Tax(DST) through The Finance Act, 2016. The committee formed for the imposition of such tax realised, way back in 2016 that a global consensus on uniform international taxation is still a far-reaching dream owing to the different vested interests. The scope of the 2016 levy was limited to digital advertisements but was later expanded substantially and now includes ‘e-commerce operators’ as well through The Finance Act of 2020. The other fundamental difference between the former and the latter lies in discharging tax liability. Under the 2016 act, the obligation of compliance was on the Indian resident service receiver but now it has been amended and the liability of obligation and compliance falls on the Non-Resident Digital Service Provider(NRDSP). These two major changes, brought by EQL, 2020 have led to the scrutinization by USTR which termed this as discriminatory and actionable. The US has refrained from imposing any trade sanction on India, as of now, particularly given the G20 meet which is scheduled this year. The current OECD/G7 proposal would not incentivize the countries, especially the developing ones, to forego their taxing rights and come under a global framework of taxation. Instead, the countries would start taking unilateral actions to grab their share which would eventually lead to sanctions and trade wars among them. The only winner that will emerge out of this arrangement would be MNCs who will continue to shift their profits in low taxing jurisdictions. Therefore, a comprehensive global inclusive framework that takes into consideration the needs of a home, as well as a source country, is the need of the hour.
The difference between the rich and the poor has been widening even before the advent of the pandemic. The Covid-19 has only made it worse. The difference is not only evident intercountry but intra-country as well. As per the estimates of the World Bank, as many as 163 million people are expected to be pushed into extreme poverty due to the pandemic. Reaching an ambitious and comprehensive tax deal like METR under the aegis of United Nations would substantially increase the chunk of developing countries in the amount so collected as shown by estimates of Tax Justice Network which can be accessed here. The need of reaching for an inclusive and fair tax deal is unprecedented otherwise all the gains made by the global community so far on every front, would be wiped out.