Global Minimum Tax: Explained
An explainer on the hottest tax update of the century!
India has joined hands with 129 countries, representing 90% of global GDP, to adopt a global minimum tax. This move is being hailed as the most historic moment in international taxation in a century!
So, what’s all the fuss about?
The advent of the digital economy has transformed our world into one small village. A person sitting in Chicago can sell his offerings to a person sitting in Behrampur. As fascinating as it sounds, it has created a whole host of problems for governments across the globe.
How?
Pre-internet Era
Businesses were mostly established to cater to local needs. So, whichever locality was rich in resources (such as labour, raw material, connectivity), and had more customers, was considered the preferred location for operations.
And obviously, if a business was to draw resources from a locality, it would also be required to pay taxes to its government. And these taxes would enable more growth.
Nations were competing in terms of better infrastructure to attract more economic activity.
Life was pretty straightforward.
And then came the internet.
The Internet Era
Companies such as Facebook, Amazon, Netflix, Google earn revenue from across the globe. For all you know, they could be operating from just about anywhere.
Now, as per the tax laws that were conceived in the pre-internet era, these companies will be required to pay taxes where they have significant operations. So what do these companies do?
They establish another company in a country with lower tax rates and transfer their patents and intellectual property rights to these countries (location doesn’t matter, you see). For digital companies, these intangible assets hold a lot of economic value.
Now all the profits are transferred to these countries where tax rates are low. Even after earning billions of dollars, these companies end up paying extremely low taxes. Or in some cases, no tax at all.
You see what happened here?
The country that raised these entrepreneurs, gave them the opportunity and infrastructure to create global behemoths, loses out on tax revenue. To them, this doesn’t seem like a fair deal.
The countries that provide them a big customer base also lose tax revenues. How?
Let’s say Facebook did not exist. So, in its absence the ad revenues would have flowed to the local ad agencies and the local ad agencies would have paid taxes to the government. But now, these countries cannot tax Facebook, as it does not have a presence in their countries. And the local ad agencies don’t earn as much as they used to because of Facebook, so the government can’t tax them either!
On the other hand, some countries, without spending much on creating such citizens, just offer ridiculously low taxes and take undue advantage. But, how do they exactly benefit if they are charging such low taxes?
Let’s take an example. Assume Ireland had a tax rate of 30%, and the companies registered there recorded $30bn worth of profits. Ireland will earn $9bn (30% of $30bn) in such a case.
Now, let’s say it reduced its tax rate to 12.5%. More companies will invest in opening companies in Ireland. And say, the sum total of profits recorded rise to $300bn. Ireland’s revenue will also rise to $37.5bn.
Higher tax revenue collection means more prosperity for Ireland.
It’s practically a volume game.
Tax rates have now become the decisive factor for companies to decide where they ‘show’ their country of operations. Thus, countries have started luring companies by cutting down the tax rates.
Average corporate taxes have decreased by half, from 49% in 1985 to 24% today. OECD estimates that governments lose revenue of between $100bn and $240bn to tax avoidance each year.
Some countries like India(which cannot tax these digital companies) rushed in to charge an equalization levy: the local companies (customers of these foreign companies) were now required to deduct a 2% tax before making payments to the foreign digital service providers.
To deal with the new world issues, countries have been trying to bring some change or the other. But, one country alone cannot do anything about it. So, the US, leader of the democratic world, led this effort to launch a global minimum tax rate of 15%.
Now, most of the global giants are based out of the US. So it is no surprise that the US is pushing for the minimum tax rate to lure the big MNCs back to their home turf. But, why will other countries agree to it?
Because there is another pillar to the solutions that are being worked upon. As per this pillar, jurisdictions such as India, where digital players don’t have a physical presence but provide a large pool of customers, will get to tax them.
Broadly the proposal has been accepted by 130 countries and is expected to be sealed by October 2021.
With the new tax laws, will the corporations finally pay taxes, or will they again find loopholes to evade them? What do you think?
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