In June 2021, G7 finance ministers, agreed in principle, as a part of global tax reforms, to move towards minimum uniform rate of corporate income tax; and make it mandatory for multinational corporations to pay taxes in countries where they operate and not just where they have their headquarters. After G7’s proposal, the G20 has already taken up this issue and the preparations have already started towards the new global tax regime. It’s notable that this proposal was first mooted by the USA. It is expected that if these proposals get through and take form of agreement, it would give a big boost to tax revenue across nations, including India.
Competitive corporate tax rates
A few years ago, the then Finance Minister of India, Arun Jaitley, announced in the Union Budget that the tax rate on companies which do not avail of exemptions will be only 25 per cent instead of prevailing rate of 30 per cent. Significantly, to encourage investment, the governments in the past had made provisions for huge tax rebates. So even though the corporate tax was 30 per cent, the effective rate of corporate tax was not more than 22-23 per cent. In such a situation, even after reducing the tax to 25 per cent, there was no loss to exchequer. This step was considered important because in such a situation, India has come out of the list of high tax countries. This step was considered to be a progressive one, as the same would help attract more corporates into the country and encourage inflow of Foreign Direct Investment (FDI).
The next Finance Minister, Nirmala Sitharaman, announced in her budget speech that old companies, which do not avail tax exemptions, will have to pay corporate tax of only 22 per cent and new companies will have to pay tax at the rate of 15 per cent only. (Note that these tax rates attract 10 per cent surcharge and 4 per cent health and education cess). Looking at the global perspective, there has been a perception about India that corporate tax rate is very high here, which impact investment. This may be true to some extent, because the tax rate was lower in other countries that compete with India in attracting investments.
Its notable that the rate of corporate tax is 17 per cent in Singapore, 25 per cent in South Korea, 20 per cent in Vietnam, 21 per cent in the US and although it is 25 per cent in China, the Communist regime there charges only 15 per cent tax on hi-tech industries. That is, the reduction in the rate of corporate tax in India was justified because the corporate tax in other countries was much lower when compared with India. By reducing this rate, India became one of the lowest corporate tax countries in the world. In fact, the process of reducing corporate tax rates has been going on globally for some time due to the competition to attract foreign investors.
In fact, countries like America did not lag behind in this race and the then US President Donald Trump reduced the rate of corporate tax to 21 per cent. The general feeling is that countries with lower corporate tax will attract more investors. But this step of the countries actually turned out to be counter-productive, because almost all major countries reduced the rate of corporate tax. It is worth noting that corporate tax constitutes a major part of the total revenue of the government. In such a situation, if there is less than expected increase in investment due to lower corporate tax, then naturally the government revenues will get hit. The governments today have to spend a lot on social services and infrastructure.
The effect of this reduction in corporate tax rate is that the corporates’ post-tax profits have increased significantly, albeit at the cost of government’s revenue. It is worth noting that in India, the corporate tax constitutes about 25 per cent of the total tax revenue of the Union government. This means that when instead of 25 per cent, corporate tax in the past, now the rate has been reduced to 22 per cent, it will reduce the potential income from corporate tax by at least 12 per cent.
Governments need money to meet their social obligations
Significantly, as of today, only a small part of government expenditure is available for social services including education, health, drinking water, women development, Scheduled Caste and Scheduled Tribe development. In the previous budgets it was only 9 to 10 per cent of the total government expenditure. Similarly, the country also needs to spend heavily on infrastructure for faster growth and people’s welfare. But in the absence of resources, the government is unable to spend more on infrastructure even if it wants to. If the revenues are impacted, then how can we expect the governments to increase spending on these items?
The most important thing is that neither consumers nor the government benefits from reduction in taxes on corporates; this only increases the post-tax profits of the companies and increases the wealth of the already wealthy company owners. It can be argued that companies will increase investment if they have more money, but the experience of the last 10 years shows that today companies are not ready to increase investment despite having a lot of cash reserves. Not only this, according to a recent report, a large number of rich people are leaving the country and transferring their wealth abroad. This is a matter of major concern.
Further, we know that economies have been hit hard by COVID-19 restrictions. This has caused big holes in governments’ revenues. For instance, India’s fiscal deficit had exceeded 10 per cent of GDP in the last fiscal, USA experienced shortfall of 14.9 per cent, United Kingdom fell short by 16.9 per cent, while it was 7.2 percent for the Eurozone. Compulsion to spend more in the post-COVID era, may make the scenario even more gloomy for countries. If the current proposal of reforming the global tax system gets through, it may boost revenues of governments the world over.
Although the then US President Donald Trump reduced corporate tax, the new President Joe Biden realized his predecessor’s mistake and announced an increase in the corporate tax from 21 per cent to 28 per cent. But in a world where countries compete to reduce corporate tax for getting more investment, the United States is also worried that investors may desert them. Though Biden says that increasing corporate tax will not cause any harm to the economy, his government started international lobbying efforts to halt the trend of competitive reduction in corporate tax rates, that has been going on for the last few years.
US Revenue Secretary Janet Yellen recently said that she is in talks with a group of G-20 countries to reach an agreement on the minimum corporate tax at the international level. This effort of the US government should be supported by all member countries rising above short-term considerations, because competitive reduction in corporate tax has started hitting the expenditure on social services and infrastructure, which only hurts the general public and the country’s economy. Significantly, the US President’s attempt to increase corporate tax is an important part of his $ 2 trillion ambitious infrastructure plan. The need of the hour is to have a stable tax system, so that governments do not lack revenue and there is no obstacle in providing necessary social services and infrastructure. The United States has also made it clear that the government will make arrangements that companies do not send their profits to other countries or ‘tax haven’ countries after tax increases.
There is a need to support this effort by the US government to build a consensus among the G20 countries to increase the corporate tax rate and to end the race to reduce corporate tax in the world, so that the pandemic-ridden world is able to come out of its economic problems and efforts of development can be speeded up in all countries.
In such a situation, if the minimum rate of corporate tax is set as proposed and other pillar of the global tax reform, namely collecting taxes from companies, where they are operating, rather than only in their home country, is adopted worldwide, infrastructure development of all countries will get a boost.
According to UK’s Tax Justice Network, G7 countries would stand to gain $168 billion, while other countries will gain $107 billion annually, with these changes in global tax regime. India also stands to gain significantly from these changes. India is likely to gain from new proposals, as the international tax rules, at present, favour developed countries, from where most of MNCs originate. These rules restrict taxation rights of developing countries and favour developed countries being recipient of incomes from developing countries. This grossly unequal system is also expected to go away with new proposals implemented.
Caveat for India
Several tech and e-commerce companies do not pay any significant tax despite flourishing business, by finding loopholes in international tax laws. It’s increasingly being felt that there should also be a provision for a turnover-based minimum alternative tax (MAT), to discourage the transfer of profits from one place to another, and dodge countries from where they run business. For example, Google social media companies and other tech companies avoid tax in India by not showing profits in India. We need to curb this practice by imposing MAT. If we are trying to make a global consensus on the corporate tax rates, international consensus on MAT is equally important.
(The author is the National Co-Convener of Swadeshi Jagaran Manch and Professor, PGDAV College, University of Delhi)
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