THE CONTEXT: In June 2021, the Group of Seven (G7) major developed economies held their first in-person summit since 2019 in Cornwall, UK. The discussion focused on addressing the Covid-19 crisis, climate change, global taxation, etc. This article analyses the tax-related outcome in detail.
GLOBAL MINIMUM TAX
- The June 4-5 agreement between the G7 Finance Ministers to plug the cross-border tax loopholes used by the giant multinational companies (MNCs) to evade taxes has immense potential to reform and revolutionize the global tax system.
- The reform blueprint is based on two pillars:
- To distribute the profits equitably among countries where these are generated, enabling them to tax such profits
- Adoption of a minimum corporate tax rate of at least 15 percent globally.
The G7 proposal
- Besides proposing a global minimum tax rate of 15 percent, the G7 communique states that multinational companies, which have a 10 percent profit margin, will be taxed on at least 20 percent of the profits which exceed this figure, in countries where they operate.
- It underlines that for the new tax system to take effect, countries like India, which charges a two percent equalization levy on digital companies, will have to abolish their existing taxes on digital services.
WHY THE MOVE
- Using a tax avoidance strategy called Base Erosion and Profit Shifting (BEPS), MNCs have been artificially ‘shifting’ their profits year after year from higher-tax jurisdictions to tax-havens where they pay little or no tax, thus ‘eroding’ the ‘tax bases of the former.
- Countries like Ireland, Luxembourg, Cyprus, Caribbean countries like the British Virgin Islands, Bahamas or Cayman Islands, and Central American countries like Panama have used their tax rate arbitrage to attract the MNCs- About 40 percent of MNCs’ overseas profits are estimated to be shifted to low-tax countries in this way.
LOSS DUE TO PRESENT RULING
- The tax losses are stupendous – estimated to be $50 billion for the USA and over $10 billion for India.
- A global minimum tax rate of 15 percent would preclude countries from undercutting each other, yielding an estimated $50 billion $80 billion in extra tax annually from the MNCs.
RESENT TAX RATES
- The US tax rate was cut down to 21 percent from 35 percent by then President Donald Trump in 2017, which his successor Joe Biden now proposes to increase to 28 percent.
- The average OECD corporate tax rate in 2020 was 21.5 percent, with 18 out of 37 members charging higher rates. Only three countries charge rates lower than 15 percent: Ireland (12.5 percent), Hungary (eight percent), and Switzerland (8.5 percent).
- The average tax rate for Asian countries is around 23 percent; while China and South Korea charge 25 percent, Singapore charges only a 17 percent rate.
- In 2019, India also sharply reduced its corporate tax rates to 22 percent for domestic companies (15 percent for new manufacturing companies) without any deductions, aligning its corporate tax rate to global standards.
WHAT WILL CHANGE AFTER NEW TAX SLABS?
- It can bring to an end the decades-long “race to the bottom” in which some countries compete with each to attract corporate giants with ultra-low tax rates and exemptions, depriving the governments of other countries where the MNCs reap most of their profits of billions of dollars in taxes.
- It will also bring to an end a very lucrative business model of these MNCs that park most of their profits in tax havens, bring to an end the golden era of the heavens themselves.
- The tech giants which operate remotely through digital mediums like Google, Amazon, Facebook, Apple, etc. would start feeling the pinch.
WHAT ARE THE INDIA’S CONCERNS?
SOVEREIGN ISSUE
- The G7 proposal interferes with India’s sovereign right to determine its tax policy. However, in today’s digitally interconnected world, such an approach is anachronistic.
INVESTMENT
- Countries such as Ireland, and Singapore have managed to position themselves as attractive investment destinations by offering low tax rates. This investment, in turn, helps them generate demand by efficiently utilizing resources and creating employment. The Indian government’s decision to slash corporate tax rates in 2019 is a tacit recognition of this larger economic impact of taxation.
TAX COLLECTION REDUCTION
- Since the economic reforms of 1991, the corporate tax rate in India has never come down below 22 percent for domestic companies.
- The tax cuts in 2019 are expected to cost the Indian exchequer Rs 1.45 lakh crore annually. Therefore, the likelihood of the Indian government further reducing the corporate tax rate appears slim as it risks widening the fiscal deficit.
BUT IT CAN BE A GAME-CHANGER FOR INDIA
- The high tax rates in India have meant that corporations devise innovative structures to avoid paying their share. As per the Tax Justice Network, India loses out approximately $10 billion, which is about 0.41 percent of the GDP, on tax revenues annually. As a result, the already-stretched Indian tax administration is engaged in costly litigation with multinationals for decades.
- India is likely to gain in tax revenue on this account, given the size of its market and the growth opportunities it offers. The country has been at the forefront to legislate in her domestic tax laws the concept of ‘significant economic presence (SEP) to create the ability to levy tax on income generated in India (from Indian customers) by foreign digital commerce companies.
- A global minimum corporate tax rate of 15 percent is also expected to be beneficial to India. The Tax Justice Network estimates the country to gain at least $4bn (Rs 300 bn), equivalent to ~6 percent of FY21 corporate tax collections.
- Besides, it would not hurt FDI to India or create any adverse or incremental tax liability in the hands of foreign investors given that the minimum tax rate for new manufacturing business has recently been legislated at 15 percent (plus surcharges).
- At the same time, in respect of outbound investments, it will prevent base erosion of tax in the country as the government will be able to claw back any shortfall in tax paid below 15 percent by an overseas business owned by an Indian resident, once the global threshold rule becomes operational.
ABOUT THE SUMMIT
DATE OF SUMMIT
11-13 June 2021
PARTICIPATION
- Apart from seven G- 7 members (Including UK, USA, Canada, Germany, Japan, Italy, and France), This year the United Kingdom has invited the leaders of four other prominent democracies to the Summit, these are
- Australia
- India
- The Republic of Korea
- South Africa
MAJOR OUTCOMES OF THE SUMMIT
- Climate change: G7 nations are moving closer on their climate strategies, but differences over key details will prevent more concerted action for now.
- Building back better, and greener: G7 countries will channel more international development finance into infrastructure and climate change projects, but they refused to label the initiative as a direct rival to China’s Belt and Road Initiative (BRI).
- Shifting approach towards China: The official communiqué directly mentioned competition with China for the first time—a notable shift from previous summits, although countries differ in their approach.
- Global Covid-19 vaccine rollout: G7 countries are ramping up their vaccine diplomacy efforts. G7 states have lost the public relations battle to China and Russia.
- Global tax agreement remains elusive: Leaders endorsed the 15% global minimum corporate tax plan.
INDIA AT THE SUMMIT
PM took part in two sessions of Summit: ‘Building Back Together—Open Societies and Economies’ and ‘Building Back Greener: Climate and Nature’.
Highlights of PM speech
- India is a natural ally for the G7 countries in defending the shared values from a host of threats stemming from authoritarianism, terrorism and violent extremism, disinformation, and economic coercion.
- Democracy and freedom were a part of India’s civilizations ethos.
- Need to ensure that cyberspace remains an avenue for advancing democratic values and not of subverting them.
- Developing countries need better access to climate finance and emphasized that the planet’s atmosphere, biodiversity, and oceans cannot be protected by countries acting in isolation.
- The planet’s atmosphere, biodiversity, and oceans cannot be protected by countries acting in silos and called for collective action on climate change.
- Indian Railways is committed to achieving Net Zero Emissions by 2030.
- India is the only G-20 country on track to meet its Paris commitments.
- India is increasing the effectiveness of the two major global initiatives nurtured by India i.e. the CDRI and the International Solar Alliance.
- Developing countries need better access to climate finance.
- India’s ‘whole of society’ approach to fighting the pandemic, and also committed support to improve global health governance.
AN ANALYSIS OF THE SUMMIT
ON COVID AND VACCINATION
Positives
- On Covid-19, G7 is right to focus on vaccinating the world. After all, it is now conventional wisdom that no one is safe until everyone is safe.
Negatives
G7 ignores the three immediate actions recommended
- One billion vaccine doses by September 2021 and two billion doses by end of 2022;
- Waiving intellectual property rights (IPR)
- Committing 60% of the $19 billion required for Access to Covid-19 Tools (Act) Accelerator in 2021 for vaccines, therapeutics, diagnostics, and strengthening of health systems.
G7 falls short significantly on all three counts.
- By providing for a paltry one billion vaccine doses over the next year, G7 has effectively indicated that even by the end of 2022, not everyone on this planet will be vaccinated.
ON CLIMATE
- On climate, the question was not whether G7 countries would commit to net zero emissions by 2050. That was the basic minimum that they were expected to do, and which they have done.
- The real question related to climate finance is how will the world’s richest countries meet their Paris Accord commitment of $100 billion every year to finance the energy transition of developing and least developed countries?
- Here again, the communique comes up with the vaguest of language, referring to increasing and improving climate finance to 2025 and reaffirming the developed country’s goal to mobilize $100 billion.
ON CHINA
- While G7 wish to cooperate with China on issues such as climate but called for respect to respect human rights in Xinjiang and autonomy for Hong Kong. Taiwan also gets a mention for the first time.
- G7 has made a valiant attempt to counter the Belt Road Initiative with its Build Back Better for the World (B3W) plan.
- The biggest signal for China is the “Open Societies Statement” signed by G7 and guest countries.
- The statement spells out the unconditional commitment of these countries to human rights for all, democracy, social inclusion, gender equality, freedom of expression, and rule of law.
- This is a welcome move and is perhaps the best sign that democracies can unite based on these universal values.
HOW SHOULD INDIA READ THE G7 SUMMIT?
A TEMPLATE FOR INDIAN ENGAGEMENT WITH THE WEST
- PM Narendra Modi’s statement that India is a natural ally of G7, with an emphasis on its civilizational commitment to democracy, freedom of thought, and liberty, will be welcomed by India’s friends all over the world.
- The PM’s statement should put these doubts about India’s commitment to rest.
ON CLIMATE
- On climate finance, India has a mountain to climb.
- India will come under pressure at the COP 26 meeting in Glasgow to commit to net-zero emissions by 2050.
- Not just this, the communique appears to endorse the idea of “carbon leakage” and hence gives implicit approval to the European Union’s idea of a carbon border tax. This is particularly unwelcome for India.
FAIRTRADE AND FREE TRADE
- The communique harps on “fair trade” much more than it does on “free trade”.
- Fairtrade, by definition, stresses labor and environmental standards and the communique says as much. How these will be implemented without resort to protectionism remains to be seen.
- Similarly, G7 endorses plurilateral initiatives at the World Trade Organization, something India hitherto has studiously avoided. Things will come to a head at the 12th Ministerial Conference of the WTO in December.
WAY FORWARD:
- The Indian government would do well to engage with the multilateral ecosystem to ensure that future multilateral rules do not disadvantage developing economies, instead of outrightly rejecting them.
- India should focus on capacity building and timely resolution of disputes.
- A minimum global tax rate would disincentives corporations to artificially shift their profits to low-tax jurisdictions. It will also reverse the trend of offshore incorporation in Indian entities by eliminating tax arbitrage. The Indian government can consider suggesting carve-outs to the proposal that can mitigate any unintentional adverse impact.
- India’s 2022-23 presidency of the G20 presents an opportunity for the country to articulate a forward-looking vision for fair and comprehensive global tax rules.
CONCLUSION: India’s engagement with the west and the recent tax proposal by G7 is the opportunity for India to overcome the challenge that occurred after Covid-19. Although, India’s concerns are justified, surely, the global minimum tax would be a game-changer for countries like India. The proposal indicates a political momentum and a desire to fast-track structural taxation reforms that could improve India’s economic competitiveness and lower jurisdictional tax arbitrage.
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