Global Minimum Tax Rate Proposed for Corporates: All You Need to Know

The Finance Ministers from the Group of Seven (G7) wealthy nations reached a historic agreement last Saturday (June 5). They have backed a proposal for setting up a global minimum corporate tax. This pact could form the framework of a worldwide deal. It would counter tax evasion and compel large companies to pay certain taxes to those countries where they conduct business. The proposed agreement aims to reform the global tax system and make it relevant to the global digital age.

What led to the need for a global minimum tax rate? How will it affect large corporations? Will this agreement affect India? Let us dive right in.

Reasons for Imposing a Global Minimum Tax Rate

For decades, multinational corporations (MNCs) have been shifting their profits to low-tax offshore havens. These are companies that have numerous branches or subsidiaries spread across the globe. They can easily transfer a significant portion of their profits to accounts set up in countries/regions that offer very low tax rates. This could include the Bahamas, British Virgin Islands, Cayman Islands, etc. Large firms would also transfer their profits to Ireland, where the corporate tax rate is just 12.5%! Authorities have time and again called out Amazon, Alphabet (Google), Facebook, Apple, and several other MNCs for carrying out such accounting practices. Governments around the world are now incurring huge expenses, especially due to the Covid-19 pandemic. However, they lose out on tens of billions of dollars in revenue every year due to corporate tax abuse or evasions.

The G7 nations— consisting of the United States, Japan, Germany, the United Kingdom, France, Italy, and Canada— aim to address this issue through a new pact. They wish to prevent MNCs from evading taxes and also “squeeze” the havens that attract tax evaders.

This deal is based on US Treasury Secretary Janet Yellen’s declaration of war on low-tax jurisdictions. In April 2021, she had urged all advanced nations to adopt a global minimum corporate tax. This would help reverse a “30-year race to the bottom” in which countries have resorted to cutting down tax rates to attract MNCs. 

The Proposal

In the recent meeting held in London, the G7 nations endorsed the proposal to impose a new global tax system. This consists of two parts:

• A global minimum tax rate of at least 15% will be levied on overseas profits generated by multinational corporations. This is irrespective of where the profits are made. For example, US-based Amazon.com, Inc or Google will be levied a tax of at least 15% by US tax authorities on profits they generate from different countries around the globe. This would discourage/prevent large corporations from practicing the scheme of shifting profits to regions where taxes are considerably low.

• The second part of the proposal is to allow countries to tax a share of the profits earned by large corporations. This means that MNCs would be forced to pay certain taxes in those countries where they operate. For example, large firms such as Amazon and Google will be compelled to pay specific taxes to India based on the operating profits or income derived from the country. Countries, where large firms operate, will be given the right to tax at least 20% of profits exceeding a 10% profit margin. This would essentially apply to the largest and most profitable MNCs.

Even if countries agree on a global minimum tax structure, governments can set their own local corporate tax rates. However, if large companies continue to pay lower taxes in a particular country, their home governments could “top-up” or raise their taxes to the agreed-upon minimum rate. This effectively removes all benefits of transferring profits to tax havens. If this deal is implemented, MNCs (especially IT giants) would be forced to pay higher taxes than usual. This could cause a dent in their overall profits.

Will it Affect India?

In 2019, India’s Finance Ministry announced a sharp cut in corporate taxes for domestic companies to 22%. The tax rate for new domestic manufacturing firms was also slashed to 15%. This decision was aimed at increasing foreign investments in our country. The cut in taxes brought India’s headline corporate tax rate broadly on par with the Asian average of 23%. The effective tax rate (inclusive of surcharge and cess) for Indian domestic companies stands at ~25.17%.

As we can see, the corporate tax rate in India is higher than the proposed global minimum rate of 15%. Foreign companies operating in India will not be affected, as these firms are already paying taxes as expected by the G7 countries. They do not experience any sort of benefit by shifting their profits to India. Tax experts believe that India is expected to benefit from the deal, as it is a large market for IT firms. The country would continue to attract significant investments.

The Indian government will take a stand on the new proposal after carefully weighing out its pros and cons. Enforcing such a tax policy in India would be problematic because of the federal structure (ie, governments at various levels). Moreover, India has already entered into agreements with foreign governments to avoid double taxation and enforce measures to plug tax loopholes. Thus, the proposed global tax rate may not provide any additional benefit to the country. The Centre will continue to engage in discussions surrounding the global corporate tax structure with other nations. 

Conclusion

The G7 nations have now formulated the proposal and agreed upon it. They need to further discuss and deliberate on key details, and more nations must agree on the deal. The deal will be tabled before the Group of 20 (G20) nations in July 2021. [A G20 meeting is scheduled for next month in Venice, Italy] The final implementation of this agreement could take years. 

However, there have been strong objections from several countries against the imposition of a global minimum tax rate. Over the years, Ireland and the Caribbean island nations have been prospering from increased investments from MNCs. This is only because they offer very low corporate tax rates. They have argued that the implementation of the proposed deal would be disruptive to their economic model. Several countries such as China have been tracking the G7 proceedings, but are unlikely to support it. However, there will be political pressure on these countries to accept the proposal if more advanced nations agree on it.

Many argue that corporate tax avoidance/abuse will continue to remain a troubling issue for the global economy. We will have to wait patiently and track the discussions surrounding the proposal. What are your views on the global minimum corporate tax? Let us know in the comments section of the marketfeed app.