Relevance: GS-3: Indian Economy and issues relating to planning, mobilization of resources, growth, development and employment.

Key Phrases: Digital Services Tax, United States Trade Representative, International tax system, Organisation for Economic Co-operation and Development (OECD), UN Model Tax Convention.

Context:

• OECD announced that 136 countries had agreed to join an accord to impose a two-pillar global tax reform plan. As per the deal, large multinationals have to pay a minimum tax of 15% on their global incomes from 2023 and those with profits above a threshold will now have to pay taxes in the markets where they conduct business.

What is the Global Minimum Tax?

• The Concept of the “Global Minimum Tax” requires all countries to impose at least a minimum tax of 15 percent on global companies.
• This tax was proposed by the US as a measure to counter efforts by major global multinational firms to escape taxes in their country of operations.
• It aims for developing a taxation structure that is relevant for a digital and globalised world. It is part of the inclusive framework on Base Erosion and Profit Shifting agreed upon by G20 countries and the Organisation for Economic Cooperation and Development.
• It rests on two pillars:
  • Re-allocation of an additional share of profit to the market jurisdictions, and
  • Minimum tax.

Two pillars of the Global Minimum Tax Agreement:

The agreement consists of two pillars to prevent companies from establishing bases in countries with low taxes to maximise profits earned elsewhere.

• Pillar 1:
  • Pillar one would give countries a share of the taxes on profits earned there, though the tax would still be collected where the company has its fiscal base.
  • Multinationals operate in many countries. For example, oil giant BP is present in 85, but usually, pay taxes on profits only in their tax home.
• Pillar 2:
  • Pillar two is a global minimum corporate tax rate to stop competition between countries over who can offer companies the lowest rate in what critics call a “race to the bottom”.

How does the Global Minimum Tax work?

• In terms of its implementation, this tax will be applicable to companies’ overseas profits. This implies that if a global minimum is applied, governments can still set the local corporate tax rate as per their choice
• In case a company pays lower rates in a particular country, their home governments can “top-up” their taxes to the agreed minimum rate, eliminating the advantage of shifting profits to a tax haven

Base Erosion and Profit Shifting (BEPS):

• It refers to the strategies used by Multinational Companies to avoid paying tax, by exploiting the mismatches and gaps in the tax rules.
• Firms make profits in one jurisdiction, and shift them across borders by exploiting gaps and mismatches in tax rules, to take advantage of lower tax rates and, thus, not paying taxes to in the country where the profit is made.

Why a Global Minimum Tax?

• With budgets strained after the COVID-19 crisis, many governments want more than ever to discourage multinationals from shifting profits – and tax revenues – to low-tax countries regardless of where their sales are made.
• Increasingly, income from intangible sources such as drug patents, software and royalties on intellectual property has migrated to these jurisdictions, allowing companies to avoid paying higher taxes in their traditional home countries.
• In the wake of the evolving nature of business, the international tax system has remained outdated.
• Attributed to which the big tech companies, mainly United States (US)-based, have been able to evade taxes.
• This is also called ‘Base Erosion and Profit Shifting’ (BEPS). According to a report by Fair Tax Mark, between 2010 and 2019, multinational companies in the digital space across all offshore setups paid US$155 billion less than what the actual tax would have required them to pay.
• The minimum tax and other provisions aim to put an end to decades of tax competition between governments to attract foreign investment.

Economic Impact on world:

• The OECD, estimates the minimum tax will generate $150 billion in additional global tax revenues annually.
• Taxing rights on more than $125 billion of profit will be additionally shifted to the countries were they are earned from the low tax countries where they are currently booked.
• Economists expect that the deal will encourage multinationals to repatriate capital to their country of headquarters, giving a boost to those economies.
• However, various deductions and exceptions baked into the deal are at the same time designed to limit the impact on low tax countries like Ireland, where many US groups base their European operations.

Way forward for India:

• It is anticipated that the digital tax revenue might decrease as a result of the OECD tax deal.
• Despite this, India ratified the deal as the G20 grouping played a major role in building political consensus on this matter amongst the non-OECD members due to the membership overlap between OECD and G20 countries.
• To circumvent the reduction in tax revenues, India must push for the UN Model Tax Convention.
• Article 12B of the UN Tax Model lays down the principle that the beneficial owner of that income is a resident of the other contracting State, and the amount of tax imposed by the State of source may not exceed a maximum percentage of the gross amount of the payment as may be negotiated between the two parties.
• Whilst the OECD tax deal only taxes those companies that have a minimum of 20 billion euros of global sales, excluding many medium-sized tech companies from taxation.
• Unlike the OECD’s global tax deal, the UN model fares better firstly with respect to flexibility, giving source country a higher stake in deciding the tax rates with the partners, leading to a fair distribution.
• Secondly, the UN model allows taxing of medium-sized firms as well.

Conclusion:

• The UN model tax convention is more developing-countries-centric as it focuses more on taxing rights to the source country than on avoiding double taxation.
• It enables developing countries to accrue a part of the gains that their citizens help the Big Tech companies generate.
• However, a global minimum rate would essentially take away a tool countries use to push policies that suit them.

Source: ORF-Online

Mains Question:

Q. Briefly discuss about OECD’s global tax deal. What is its impact on India? (250 Words).