While we have the oft-quoted maxim that death and taxes are certain, how one pays the ‘right taxes at the right place’ has been mired in huge controversy.
The OECD has for quite some time been talking about avoiding what it calls ‘unfair tax competition’, and yet it is a fact that nations have been competing to attract investments by providing tax-shelters. Another challenge is the old school of thought that insists for taxation of companies where their home base is situated, and disregards that other market jurisdiction should also have the right to tax profits.
Therefore, it was only a matter of time that the old tax regime gave way to something new. The first step in that direction was taken by the OECD bloc, when it got significant consensus (apart from the US) on ‘base erosion and profit shifting’ (BEPS). The OECD also evolved the Principal Purpose Test and Multi-Lateral Instrument (MLI), which enable a more transparent global tax regime.
While a lot of work remains to be done - especially about taxation of the digital economy - countries like India have moved unilaterally to impose taxes such as the Equalisation Levy. The proposal by the Biden administration of a global minimum rate of tax of 15 per cent and the ‘historic agreement’ by G7 Finance Ministers to reform the global tax system to ensure that the ‘right companies pay the right tax at the right place’ needs to be viewed in the light of the above developments.
The two key proposals from the G7 finance ministers are a global minimum rate of 15 per cent that companies need to pay on a country-by-country basis. Second, there is a proposal to evolve a profit allocation mechanism where the market jurisdiction will have the right to tax at least 20 per cent of the profits that exceed a 10 per cent margin of multinationals.
These steps have been hailed as ‘historic’ and, indeed, they are steps in the right direction given that there is a US buy-in. They validate the stand that many developing countries have been advocating regarding the right of market jurisdictions to tax profits. A global consensus also ensures that MNCs are not caught between conflicting claims of governments and subjected to double/multiple taxations.
That said, several issues need to be addressed before the proposals can be implemented. As a start, the rate of tax to be applied must be decided by each country, followed by a framework to reallocate profits that must be agreed to by 125 plus countries. While the G7 framework will provide a direction, it will be interesting to watch the country-specific reactions at the discussions scheduled next month.
Fixing the profit to tax
The answers to many questions could be quite vexed. For example, when determining the profits of an enterprise, is it accounting profit or tax profit? Will each country re-compute profits? Will enterprise-wide profits be acceptable, or will one have to consider jurisdictional segment profits? Will MNCs having margins of less than 10 per cent be outside the ambit of new rules?
While everybody is keen on a global consensus, countries will want to figure out their individual economics arising from the new proposals, and one does hope that such an analysis does not defeat the evolving framework.
The journey towards a unified global tax has just begun. A consensus between OECD members and G-20 will likely emerge by end of the year. Evolving a global consensus, particularly on the reallocation of profits, will be the next big step.
It will take its time to evolve and will not be easy. Post that, we will see tax treaties being amended. Thus, while the G7 framework is a giant step, we have a lot of ground to cover before we have a consensus on a minimum rate of tax and a basis for reallocation of profits.