Leaders of G20 nations are set to meet next month in Rome to finalize a landmark deal to overhaul the global corporate tax landscape. Large technology firms could be hurt in particular, having saved tax for long by exploiting loopholes in the existing framework. But so will countries such as India that had already found ways to tax such entities and will now have to forgo that revenue.
If the proposal goes through, multinational enterprises (MNEs) will no longer be able to shift tax liabilities away from their key markets by setting up offices elsewhere. The deal also seeks to put in place a global minimum corporate tax rate of 15% to ensure that MNEs pay at least that minimum, even when they operate in low-tax jurisdictions.
This puts the spotlight on potential gainers and losers from the deal. During negotiations in July, India had backed the plan but wanted the final accord to ensure a fair distribution of MNE profits to emerging market economies. In its present form, the deal only covers MNEs with a global annual turnover of over 20 billion euros. This would yield much greater benefits to developed countries such as the US, Germany and France, where such large MNEs do the most of their business.
At present, all G20 economies—barring some in the European Union—levy an effective corporate tax rate greater than 15% but the MNEs headquartered in these countries have managed to pay much less by booking profits in tax havens. The new regime will leave MNEs less incentive to continue doing so.
Every year, MNEs book $600 billion to $1.1 trillion of their profits in low-tax jurisdictions, resulting in a loss of $90 billion to $280 billion in tax revenue globally, said a November 2020 report by the UK-based Tax Justice Network. However, this tax abuse inflicts a greater toll on low-income countries than high-income ones, even though the latter are far more culpable.
High-income countries are responsible for 98% of the tax revenue loss accrued in other countries due to corporate tax abuse. But they lose just 1.3% of their tax revenue to the same, whereas low-income countries lose 5.5%. The report ranked India as the eighth worst-hit country in terms of revenue lost.
The practice of profit-shifting results in a further indirect loss of $500 billion to $650 billion a year due to tax exemptions that countries allow to attract or retain MNEs and their subsidiaries.
The new framework seeks to implement a taxation regime that better aligns with the growing digital nature of the world economy. This ongoing digitalization and fast-evolving business models have exacerbated the issue of corporate tax avoidance. Technology has made it possible for companies to operate virtually while taxing rights continue to be allocated based on physical location.
This is evident from the massive $96.3-billion gap between the current tax provisions and the cash taxes actually paid by the six major US technology firms—Amazon, Facebook, Google, Apple, Netflix and Microsoft—over the period 2011-2020, as per a May 2021 report by the Fair Tax Foundation. In effect, non-technology companies end up paying far greater tax, US data shows.
Ergo, it is the large technology firms that stand to lose advantage when the new deal accords taxation rights to countries from where they derive their real economic value.
But which companies are large enough for the new deal? The 20-billion-euro sales threshold could exclude thousands of firms already taxed under India’s equalization levy. Despite the broad-based consensus, the new deal could potentially end such levies without enough compensation: India has already promised to withdraw it.
A recent KPMG report counts 26 countries levying such a digital services tax (DST) on tech firms, used as an interim measure to tax cross-border digital transactions. India was one of the first to introduce it in 2016, bringing transactions involving online advertisements by non-resident companies under the tax net. Last year, the scope was expanded to include non-resident e-commerce operators. You should also check how the tax regulations for American citizens living abroad are changed.
DST revenues have been robust and seen significant uptick. Elsewhere too, the DST mop-up exceeds what the new framework would earn. To make the shift to the new regime a net positive, the final taxation deal must provide suitable incentives to countries to do away with existing digital taxes.
Puneet Kumar Arora is an assistant professor of economics at Delhi Technological University.