G7 floor tax rate good, but a global tax regime a tough challenge

By: |
June 09, 2021 5:20 AM

Achieving a global consensus on the proposal is a tough challenge as market jurisdictions will have their own sets of reservations

income taxThe Central Board of Direct Taxes (CBDT) issued a circular on Monday on implementation of Sections 206AB and 206CCA with respect to higher tax deduction/collection for certain non-filers.

Tax continues to dominate the headlines as we are witnessing a global convergence in the world of taxes like never before. We are truly living in a connected world where country-specific changes are creating a global impact! There
is an increased expectation by the stakeholders (government, investors, consumers) that businesses must pay their ‘fair’ share of taxes at the right places; and merely a strict compliance with the letter of law is widely seen as inadequate.

Towards this, while the OECD has made remarkable progress to avoid what it calls ‘unfair tax competition’, we are still witnessing several countries ‘race to the bottom’, looking to attract investments by providing a variety of tax concessions. There have been red flags raised against several multinational companies as they are perceived to be not paying their ‘fair’ share of taxes.

The dominance of the digital economy has only accentuated the problem as it is now well known that the current international tax architecture (which gives taxing rights to the market jurisdiction only if there is a Permanent Establishment) is not well equipped to tax modern-day digital businesses which may not require any presence (or merely a skeletal presence at the most) in the market jurisdiction.

The OECD has been a pioneer, spearheading the ambitious project to combat Base Erosion and Profit Shifting (BEPS), wherein it came up with a well-defined roadmap and suggested numerous changes to the archaic tax regime. These changes are largely well accepted by majority of the participating countries, and unilateral as well as multi-lateral amendments are being carried out to ensure its effective implementation.

However, a lot of work still remains to be done, particularly with regard to taxation of the digital economy. In the meanwhile, countries like India have moved ahead with unilateral interim measures such as the equalisation levy to tax the new-age, digital economy.

Against this backdrop, on June 5, 2021, the G7 finance ministers have struck what they have termed as a ‘historic agreement’ to reform the global tax system in order to ensure that the right companies pay the right taxes in the right places. Amongst other things, the communique released by the G7 states that the member-nations are committed to a global minimum tax of 15% on a country-by-country basis. The communique also provides for a profit reallocation mechanism wherein market jurisdictions will be awarded taxing rights for at least 20% of the profits exceeding a 10% margin for the largest and most profitable multinational companies.

The G7 announcement has been hailed as ‘historic’ and, indeed, it is a step in the right direction, more so given it has a US buy-in. It vindicates the stand that developing countries including India have been advocating, regarding the right of the market jurisdictions to tax profits. However, achieving a global consensus on the proposal is a much bigger challenge as market jurisdictions will have their own set of reservations since it is likely they would leave no stone unturned in their attempt to maximise the profit allocation to their nation.

Furthermore, in the absence of specifics, there are several finer aspects which need to be addressed before the proposals can be implemented. To start with, the rate of tax to be applied has to be decided by each country; we then need a framework to reallocate profits which has to be agreed to by 125-plus countries. Also, when one is determining the profits of an enterprise, is it accounting profits or tax profits? If it is tax profits, will the computation of profits as per accounting standards/tax laws of the home country be accepted by everyone or will each country recompute profits?

Will the enterprise-wide profits
be acceptable, or will one have to consider segmental profits basis the operations in the market jurisdiction? What happens to MNCs having margins of less than 10%? Will they remain outside the ambit of the new rules? Given the past track record of ability of companies to reach any manner of consensus on such issues, one does hope that the framework evolved by the G7 does not remain merely a framework and a workable solution is evolved in due course.

While everybody is keen on a global consensus, countries will also want to figure out their economics arising from the new proposals, and one does hope that such an analysis does not defeat the evolving framework. The G7 framework will certainly provide impetus to the ongoing discussions at the G20/OECD-level. However, 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. It will take its time to evolve and will not be an easy exercise.

CEO, Dhruva Advisors. Views are personal

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