The Group of Seven (G7) countries issued a joint communiqué after their meeting in the first week of June supporting the Global Minimum Corporate Tax (“GMCT”). This comes as a support to the Group of Twenty (G20) and Organisation of Economic Cooperation and Development (OECD) countries on their Base Erosion and Profit Sharing (BEPS) Framework. The GMCT seeks to impose a minimum corporate tax on companies globally to curb the shifting of profits to low tax jurisdictions and prevent evasion of tax. In a time when the countries are still healing from the COVID-19 pandemic and developing countries have to rely on foreign investment for growth and employment, this article seeks to question whether the GMCT is the need of the hour, and how promising would it be for a developing country like India?
The context behind GMCT?
Countries have been competing against each other to provide lower corporate taxes to corporations in order to attract them to their countries, which will further attract foreign investment and growth. When one country lowers its corporate tax, other countries follow the lead in retaliation. Owing to what we call the “race to the bottom”, the global average corporate tax rate has fallen from 49 percent to 24 percent. For the past decades, Corporates have been targeting the low tax-jurisdictions of Bermuda, the Cayman Islands, Ireland, Luxembourg, Netherlands, Singapore and Switzerland to channel their profits through these countries through complex tax avoidance schemes. Even if they don’t carry out their day-to-day business operations in the country they are in, they just move their company headquarters to the low tax jurisdictions to evade tax. Consequently, the global annual tax loss is estimated to be $245 billion annually to tax havens.
The advancement of globalisation and digitalisation of the economies have been complicating and imposing a challenge on tackling taxes. The G20–OECD’s Framework, BEPS, adopts a twin objective of fixing a global minimum rate in order to tackle the current tax challenges. In lieu of this and President Biden’s personal interest to increase the corporate tax in the U.S, has given a pathway to the adoption of GMCT. GMCT is seen as a feasible way to end the 30 years of destructive “race to the bottom” in international taxation.
What is GMCT?
The G7 summit has proposed a 15% global minimum corporate tax rate on large corporations. Under this proposal, the companies will have to pay taxes where they operate and not where they are headquartered and subsequently companies will then have to not only pay to their source countries but also their home countries. This proposal is seen as a stepping stone that will prevent countries from undercutting one another.
The Global minimum tax rate would not imply that the countries with tax rates above 15% would have to lower it, but it will majorly apply to countries with tax rates lower than the threshold to increase their rates through domestic legislation. GMCT is to majorly prevent the corporations from escaping to these tax haven countries. Under this deal, the subsidiaries of the companies that go untaxed, the global 15% tax would ensure that companies in countries with below the 15% tax rate would have to pay the additional tax in order to bring it to the threshold. This would reduce the profit shifting by the companies as they would be taxed at home anyway.
With the advancement of technology and science, there has been low ‘physical presence’ in countries, making it difficult to impose tax on such companies since taxation is generally conditioned on the physical presence before being imposed. The current value of international trade in services is almost $6 trillion. The lack of physical presence due to the majority of trade being done through intangible assets makes it difficult for the government to monitor or ascertain the real value of the businesses because they do not have benchmarks that can assess the real value of the digital products. This thereby results in tax leakages. A global minimum tax is required to prevent huge tax leakages and to move towards a more equitable tax regime which can also help to reverse direct tax cuts in India. GMCT’s primary agenda shall be to target corporations like Facebook and Alphabet which have been earning huge profits through their online business without paying much in taxes to the countries where they are generating profits.
How does GMCT benefit India?
India, in order to compete with other nations, has been cutting its corporate tax rates over the years. The corporate tax rates have fallen from 40% in 1993–94 to 22% and 15% for domestic companies which do not avail of tax concessions and new manufacturing companies respectively. These continuous tax rates have not been proved to be favorable in the long run. Though in the short run, the GDP did see a boost from less than 1% to 3.9% from the early 1990’s to 2007-08, it has eventually seen a fall to 2.3% now. The primary reason for corporate tax rate cuts is to increase the private sector investments; even that has seen a steady fall from 28.1% to just 23.4% between 2007 and until now. Clearly, the substantial corporate tax rate cuts are not working for India. What is more alarming to note is the collection of indirect tax superseding the direct tax collection which showcases a disproportionate shift of the tax burden. The cut in the corporate tax is compensated by shifting the tax burden in the form of direct and indirect taxes. While direct tax is borne by the higher income groups; lower income groups face the brunt of indirect taxes. Data shows that the reduction in corporate tax has an effect on the tax-GDP ratio which has further declined from 10.2% in 2011–12 to 9.8% now.
India currently stands at an advantageous position as far as this policy lies. First, the domestic corporate tax rate in India is above the global minimum 15% threshold; second, owing to its tax rates, India is also in a fair position to provide concessions to big companies while still conforming to the international tax rates. Though the 15% tax regime doesn’t affect the current investments, what remains a challenge is to set up more Special Economic Zones (SEZ) or giving additional incentives to the company to bring them to India since they cannot go lower than the 15% rate. On a positive side, owing to India’s large internal market, quality labour at competitive rates, strategic location for exports, and a thriving private sector, the minimum threshold should not possess a great difficulty.
Notwithstanding the broader and positive aspect, India’s fiscal deficit for 2021-2021 stands at 9.3% of the GDP. In situations of high fiscal deficit, the government generally lowers that tax rate to invite companies to set up their business activities and get the economy going. We are yet to see what India will agree to. India on July 1, 2021 has accepted the broad proposal, however there still lies reservation on the amount of profit sharing and meaningful and sustainable revenue to market jurisdictions.
The proposal framework is yet to be finalised and is aimed to reach a consensus by October 2023. While one may argue that India should adopt a fair and flexible tax system in order to cater to the long term needs of its countrymen and preserving the interests of the exchequer, we cannot overlook the amount of tax loss that India has to bear annually by way of transfer-pricing, debt-financing and restructuring of intellectual property rights. A global minimum tax will prevent the creative and complex tax-avoidance schemes by the corporations and can bring positive changes to India in terms of bringing equality, attracting investments and making a more equitable tax regime without the fear of competing with tax havens.
This article was written by Garima Agarwal. She is a 4th-year undergraduate student pursuing BBA.LLB(Hons.) from O.P Jindal Global University.