Global corporate taxation: The new bare minimum

ON OCTOBER 31, the heads of the world’s major economies — the Group of 20 (G20) nations — approved a new global minimum corporate tax. The deal, announced at the G20 summit in Rome, Italy, is “historic” since this is the first time nearly all nations have agreed to such a system. Earlier, on October 8, some 136 countries had endorsed the new regime.

The deal has two aims: First, to prevent multinationals from paying low taxes (or no tax) by booking their profits in tax havens; and second, to make them pay taxes wherever they operate or conduct business in, even if they do not have physical presence in the country.

Under this deal, there are two “pillars” of taxation on corporations. Under Pillar 1, which is estimated to affect the world’s top 100 companies, governments would levy tax on profit margins of above 10 per cent, while under Pillar 2, there would be a global minimum tax rate of 15 per cent [see the box Global tax regime at the bottom).

Pillar-1 provisions empower countries to tax companies where they earn their revenue. Under this, companies’ excess profit — defined as in excess of 10 per cent of total revenue — will be taxed at 25 per cent.

Pillar-2 will be applicable to overseas profits of multinational firms with €750 million ($866 million, nearly Rs 6,400 crore) in sales globally.

Governments have the power to impose any local corporate tax, and if a company pays less than 15 per cent tax, its home country can levy a tax to bring it to the minimum rate.

The Organisation for Economic Co-operation and Development (OECD), an international organisation with 38 member countries, which steered the deal, says the new regime covers 90 per cent of the global economy.

“This is a massive and historically significant reform which will make our international tax arrangements fairer and work better in a digitalised and globalised world economy,” said Mathias Cormann, secretary general, OECD.

Tax avoidance

The new deal was a bitterly fought battle over rampant tax evasion by multinational firms. Nations have been competitively adopting low tax regimes to attract investments. This gave rise to what we know as “tax havens”. These are the countries/territories where corporate houses are registered in or operate from.

In fact, 90 per cent of the world’s top 200 companies have a presence in tax havens. According to current tax laws, companies pay taxes not at the place of economic activities, but at the tax havens where they are registered. For example, a company might do business in India but it would not pay tax on profits made here since it is registered elsewhere.

Also, corporate houses pay tax based on the overall performance of the group, not on individual entities under the group to avoid higher tax rates.

The International Monetary Fund estimates that the global revenue loss to governments due to this tax avoidance was between $200 billion and $600 billion in 2019.

The State of Tax Justice 2020, published by the Tax Justice Network, a UK-based advocacy group, found that “of the $427 billion in tax lost each year globally to tax havens, $245 billion is directly lost to corporate tax abuse by multinational corporations and $182 billion to private tax evasion”.

Corporations avoided tax massively by shifting $1.38 trillion worth of profit from the countries where they were generated to tax havens.

“Private tax evaders paid less tax than they should have by storing a total of over $10 trillion in financial assets offshore,” said the report.

This is a loss to both developed and developing countries. According to Tax Justice Network, this revenue loss would be around $500 billion, with lower-income countries losing around $200 billion — money they could have used to fund critical development requirements.

The tax losses of these countries are equivalent to 52 per cent of their combined public health budgets, the report added.

In 2019, there were 650 million poor people in the world living under the international poverty line of $1.9 per day.

If $2 is provided to each of them, one can argue the avoided tax of $500 billion would have eradicated global poverty, even if for a few days or weeks.

Long negotiations

Countries had been negotiating the new tax deal for the past five years. The points discussed or proposed by OECD included “apportionment approaches that assess profits at the level of the multinational group, rather than individual entities, and then apportion it as tax base between countries of operation in proportion to the share of real economic activity in each”.

In fact, OECD already has a ‘Base Erosion and Profit Shifting Action Plan’. In 2013-15, under this plan, OECD aimed at reducing profit sharing between places of registration and the real economic activity.

Currently, many companies do report country-wise business activities and profits. This helps track disproportionate tax sharing. India and other countries in G24 (a sub-group of G77, which is a coalition of 134 developing countries), pushed for a nation's right to tax based on location of a company’s employment and sales.

The COVID-19 pandemic added urgency to the negotiations. Countries, rich and poor, needed more resources to fight the pandemic and the consequent economic fallouts. Many countries, including the rich ones that host the maximum profit-making multinational corporations, noticed the shifting of profits to tax havens.

US President Joe Biden, too, supported the deal, giving it that much needed fillip for closure.

In a globalised and digitalised world, companies earn much more from non-traditional sources — patents, software and royalties on intellectual property. The US Treasury Secretary Janet Yellen celebrated the tax deal as a “victory for American families as well as international business”.

“We've turned tireless negotiations into decades of increased prosperity — for both America and the world. Today's agreement represents a once-in-a-generation accomplishment for economic diplomacy,” she said after the deal.

The new deal will significantly raise the taxable revenue and thus the tax.

OECD estimates that with the new minimum rate, countries will have $150 billion annually in additional revenues.

Countries will get to tax $125 billion of profit due to the provision of taxing where ever companies earn the profits.

On the face of it, the reshuffling of tax revenue will level the playing field for developed and developing countries.

According to The State of Tax Justice 2020, developed countries (represented in OECD) and the G20 are responsible for 98 per cent of the total tax losses. Developing and poor countries just cause 2 per cent of such losses.

The G20 that approved the new deal was actually accountable for 26.7 per cent ($114 billion) of global tax losses in 2020. Due to tax avoidance, G20 countries lost over $290 billion in 2020. The Corporate Tax Haven Index 2021, prepared by the Tax Justice Network, said the OECD countries that set the global tax rules were responsible for over two-thirds of global corporate abuse.

Status quo

As details come out, it becomes clear that the deal will barely benefit developing countries and the profits will continue to go to the rich nations.

Companies might not even have to take the route of tax havens and still continue to evade or avoid tax.

Moreover, the deal applies to a very small part of the corporate profits and is also limited to a few companies. Effectively, the deal targets 100 top companies in the world. The countries would now have 10 years to roll out the tax, starting 2023, instead of the original five years proposed.

Experts say the 15 per cent tax rate is not ambitious enough. Before the deal was signed, the proposed draft had “at least 15 per cent” rate.

The “at least” offered scope for a higher tax rate. Earlier this year, UN Financial Accountability, Transparency and Integrity (FACTI) recommended 20-30 per cent global corporate tax.

The Independent Commission for the Reform of International Corporate Taxation, an international coalition of intergovernmental, civil society and labour organisations, had called for a 25 per cent global minimum tax to be applied. Estimates show that the 25 per cent tax rate will result in $17 billion more annually for the 38 poorest countries than the 15 per cent rate.

Many developing countries, though signatory to the deal, have expressed concerns about the implementation of these new taxing rules being conditioned upon them removing all unilateral taxes on technology companies. Many countries earn a significant revenue by levying tax on digital services. Besides, this tax covers a larger number of companies for tax revenue and in many cases they earn more than the expected tax under the new regime.

As per international non-profit Oxfam, the new tax regime will affect only 69 multinationals and would only apply on “super profits” above 10 per cent. Oxfam estimates that 52 developing countries would receive 0.025 per cent of their collective GDP in additional annual tax revenue from the Pillar-1 proposal.

Oxfam’s tax policy lead Susana Ruiz said: 

What could have been a historic agreement to end the era of tax havens is rapidly becoming a rich country stitch-up instead.

According to her, “the proposal for a fixed global rate of 15 per cent will overwhelmingly benefit rich countries and increase inequality. The G7 and EU will take home two-thirds of new cash that it will bring in, while the world’s poorest countries will recover less than 3 per cent, despite being home to more than a third of the world’s population.”

For Alex Cobham, chief executive at the Tax Justice Network, the rate will hardly help meet the main objective of stopping profit-shifting and evasion. “Pillar 2 does set a global minimum rate, but so low at 15 per cent that the incentives to shift profit will remain substantial; and with the great majo rity of revenues captured by the US and just a few others,” he said.

Many say the OECD-brokered deal has not been inclusive of developing countries’ concerns and the redistribution of tax has not been fair. There is also a growing call for making the tax regime inclusive.

Dereje Alemayehu, executive director of the Global Alliance for Tax Justice, says, “The OECD’s repeated failure to deliver on its promises — above all, the promise to be ‘Inclusive’ — makes it imperative to bring the negotiations to the legitimate alternative: The United Nations.”

Coinciding with this call is a recent initiative by heads of states to agree on a UN-led tax global convention based on the tax reform blueprint prepared by FACTI. Moran Harari, lead researcher on indices at the Tax Justice Network, said: “To get approval from its most powerful member countries, the OECD had to water-down its global tax rules to the point of obsolescence. Rather than eliminating tax havens, the OECD’s global rules normalised them. Only a UN tax convention, where global rules are determined by democracy not plutocracy, can make tax havens a thing of the past.”

This was first published in Down To Earth’s print edition (dated 16-30 November, 2021).

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