It is no news that the current global tax rules have also been struggling with the rise of technology giants that sell services remotely. New digital technologies enable companies to earn revenues even from tax jurisdictions with no physical presence.
As a result, the internationally accepted principles regarding allocating taxing rights and incomes across tax jurisdictions in brick-and-mortar economies (primarily based on companies’ physical presence) have been rendered redundant.
Last fortnight, these challenges drew a sharp response from the leaders of the seven advanced economies at Carbis Bay, Cornwall in the United Kingdom. A watershed joint communiqué was released by them which underscored areas of solidarity among the group members informally called the G7. This included an endorsement to counter tax avoidance and close cross-border (tax) loopholes through a two-part deal to make multinational companies pay more tax in countries where they operate, alongside a minimum global corporate tax rate.
At the outset, it is crucial to understand that the G7 decisions are not legally binding on the seven participants of this exclusive group – Canada, France, Germany, Italy, Japan, the United Kingdom, and the United States – but they carry influence among larger groups such as the G20 and the Organisation for Economic Cooperation and Development (OECD).
Kernel of the new idea
A global minimum corporate tax of 15% (a higher rate may still be contemplated and negotiated on a country-by-country basis) to avoid countries undercutting each other to lure investments; and a way to tax multinational companies in the countries where they do most of their actual business, i.e., pay more tax wherever they sell products or services.
The latter to ensure that large global corporations do not exploit the differential tax rates across the globe to shop for low tax jurisdictions. The fundamental aim is to ensure that global capitalism is compatible with a fairer and more stable tax system that plugs huge tax leakages – such that no income should escape taxation.
Rationale behind the idea
Essentially, the new tax deal enunciates that the same rules should apply to all – what’s sauce for the goose is sauce for the gander. It has been the pet peeve of the G7, G20, and the BEPS project of the OECD to regulate cross-border digital services and curb tax base erosion.
The first measure will apply to overseas profit and stop the competition (read undercutting) between countries to lower corporate tax rates and provide a more level playing field. For instance, low-tax jurisdictions such as the Netherlands, Luxembourg, Caribbean Islands, Ireland, Panama, etc., rely primarily on the tax rate arbitrage to attract MNCs and have attracted billions of dollars in investment from the multinationals over the years.
It has always been a hot topic as to why Google, Facebook, Airbnb, TripAdvisor, etc., have their global HQ in Dublin’s Grand Canal Quay – where the corporation tax rate is as low as 12.5%. Apple, Alphabet, Nike, Starbucks, etc., also operate through a web of holding-subsidiary companies to benefit from low-tax countries as a part of strategic tax planning.
Under the first measure proposed by G7, a government will continue to set the domestic corporate tax rate it wants, but if companies pay lower rates in a particular country, the home government could augment their taxes to the minimum rate, eliminating the advantage of shifting profits. This would enable competition between countries not just on the tax cost but on other factors such as ease of doing business, the rule of law, innovation, infrastructure, quality of the workforce, political environment, etc.
The second measure would mean a reallocation of taxing rights on a portion of the excess or residual profits of the largest multinational companies in proportion to the distribution of their market activity across different tax jurisdictions as also an initial global minimum tax rate of at least 15% on them.
Multinational enterprises happily take advantage of existing tax rules (which can be argued as perfectly legal) to attribute much of their profits to intellectual property (income from intangible sources such as software, drug patents, and royalties) held in low-tax jurisdictions.
Hence, this new agreement is needed to change taxing rights and income allocations across different market jurisdictions. It will bring to fore the claims of countries to tax income from digital commerce and the need for equitable distribution across all tax jurisdictions in which digital firms operate.
A consensus among all major nations on such a contentious proposal will undoubtedly be a tall task. Sovereigns like to paddle their own canoes, especially when it comes to tax policy. Moreover, each government has to secure consensus locally and answer its opposition. I foresee much pushback to keep the minimum global tax rate as close as possible to the existing 12.5 per cent. Or exemptions may become the natural apple of discord.
To a large extent, the result will depend on the finer details – the nuts and bolts. Even if economies sign up to the G7 agreement in the spirit of global cooperation, there will be open questions ad infinitum – how will the minimum tax be enforced? Which accounting policy is to be followed? What will be the definition of profit? How exactly will any country be penalized for non-participation (once agreed or later) or creating loopholes and under-the-counter arrangements – either inadvertently or in collusion with business houses? Who will enforce such penalties, and how? How will the slice of cake be shared among the defaulted countries? Will trusts, pension funds, government companies for particular political purposes, philanthropies, etc., be exempt? Would there be zero tolerance toward strict bank secrecy? How will the pact be enacted and administered in each country?
Those are among some of the questions that are still up in the air. Also, a global minimum tax rate may not be adequate to entirely counter the menace of tax evasion: it is really water off the duck’s back. Much detail is still to be ironed out and possibly watered down, including which companies will be covered and what tax changes countries will see. Till such time, it is sheer crystal ball gazing.
Pankaj Vasani is a seasoned business leader, finance expert, and board member with over two decades of experience in senior executive roles and as a board & audit committee member. Over the years, he has donned various hats – Group CFO, Finance Head, CEO, Tax/Legal/Compliance Head, and Board of Directors. He has held leadership roles with Vodafone, Publicis, Coca-Cola, & Subros. By education, he is a Chartered Accountant (England & Wales), Chartered Accountant (India), Certified Public Accountant (Australia) & Lawyer (Delhi Univ., India).