G7 pact on corporate tax reforms a major step in march ahead

Allowing countries to tax companies that generate value in their jurisdictions without paying tax is Pillar 1 of the proposed tax reform. A minimum tax in every country is Pillar 2 of tax reform

The G7 agreement might not immediately lift countries such as India on fairy wings towards a land of bounteous tax revenue. But it is an important step forward in the march of globalisation (PTI)

The G7 grouping of rich countries — the US, Japan, Germany, Britain, France, Italy and Canada — have arrived at some important decisions at their meeting of finance ministers in London on June 4-5. The three most consequential ones are taxation of companies, standards for green financial reporting and a prohibition on issuance of stablecoins until norms and standards have been finalised. The last-mentioned delays Facebook’s proposed digital coin further.

The G7 comprises the seven richest nations that are happy to live under Pax Americana — without that qualification, the seven richest would include China and India, and exclude Italy and Canada. It is also possible to see the grouping as of countries with the most evolved institutions of capitalism. That definition would also keep China and India out.

However, the G7 began as a geopolitical grouping, with a focus on economic matters, initially of just four nations, when the finance ministers of the US, Britain, France and Germany met in 1973 in Washington DC. Months later, Japan was added to the list, to extend the group to five. Then, in 1975, the G5 met at the level of the heads of government/state. In 1976, Italy was added to the group, making it the G6. The following year, Canada too joined in, to make it the G7.

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After the collapse of the Soviet Union, its successor state Russia was invited to attend as a guest, to make the grouping the G7+1. Russia was not the eighth richest country, and its inclusion underlined the geopolitical nature of the grouping.

The G7 has arrived at a consensus on reforming how countries tax corporate income: “We strongly support the efforts underway through the G20/OECD Inclusive Framework to address the tax challenges arising from globalisation and the digitalisation of the economy and to adopt a global minimum tax. We commit to reaching an equitable solution on the allocation of taxing rights, with market countries awarded taxing rights on at least 20 per cent of profit exceeding a 10 per cent margin for the largest and most profitable multinational enterprises. We will provide for appropriate coordination between the application of the new international tax rules and the removal of all Digital Services Taxes, and other relevant similar measures, on all companies. We also commit to a global minimum tax of at least 15 per cent on a country by country basis. We agree on the importance of progressing agreement in parallel on both Pillars and look forward to reaching an agreement at the July meeting of G20 Finance Ministers and Central Bank Governors”.

Every sentence of this portion of the statement is worth parsing. The first sentence makes it clear that this is the continuation of an ongoing attempt to coordinate tax policy among nations. Two sets of problems are sought to be addressed. One is what the rich country club OECD calls Base Erosion and Profit Shifting (BEPS). Through elaborate tax planning, countries are able to shift their profits across the globe to finally assign it to a subsidiary at a low- or zero-tax jurisdiction.

If intellectual property developed in San Francisco is transferred to an entity in the Bahamas, so that royalties, which account for a huge part of the final price that consumers pay, end up in a country with zero tax. Transfer pricing is another method of shifting profits around. Instead of selling a part from a unit in Country A to unit in Country C, you first sell it to a unit in Country B at a low price and then sell it on to the unit in Country C at an inflated price, so that the bulk of the value accrues to the unit in Country B. Country B’s attraction, you guessed it, is that its tax rate is extremely low.

Business today is done on a global basis. Taxation is done at the country level. Lots of corporate income escape taxation in the process. Sure, there are valiant attempts to block transfer pricing, with pricing norms, Advance Pricing Agreements, bilateral tax treaties, and so on. But ultimately, companies manage to get away paying very little tax. That is the relevance of OECD’s efforts to end BEPS. The solution is to recognise that each jurisdiction where taxable income is generated is entitled to tax on the profit element of that income.

Another kind of value escaping tax is from digital business. Facebook, Google and Amazon can generate revenue from countries without having a physical presence there, all the income they earn being generated through digital transactions that do not require a physical presence in the country where that income is generated.

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Spotify and Netflix can sell streaming subscriptions in Bangladesh without having an office in Bangladesh, for example. How would Bangladesh exercise its sovereign right to be reimbursed, via tax, for the service of arranging the affairs of the nation in such a fashion that the activity that generates revenue can be carried out?

Countries like France and India have levied a tax, informally called the Google Tax, to tackle delivery of digital services, whose revenues and profits escape taxation. In India, it is called the equalisation levy, 6 per cent of the revenue. If you advertise on Facebook for ₹10,000, Facebook will charge you ₹10,000 plus ₹600, that is ₹10,600, so that you can deduct ₹600, while paying Facebook the remaining ₹10,000, and remit the deducted tax to the government.

The unstated assumption is that if the company has 18 per cent of its India-specific revenue as profit that should bear tax in India, collecting 6 per cent would mean a tax of 33.33 per cent, much the same as on other businesses. Such presumptive taxes are a sore point with digital businesses and their home government, that of the US of A. The US has imposed penal duties on imports from India, in retaliation, but kept them suspended for the time being. Allowing countries to tax companies that generate value in their jurisdictions without paying tax is Pillar 1 of the proposed tax reform.

Then, there is the reference to a minimum rate of tax. Many countries keep their rates at zero, so as to serve as a location through intellectual property trade and investments are routed, the accounting and legal paperwork involved earning these countries a major income, even when the corporate tax rate is zero. Then, there are countries like the Netherlands and Ireland, with tax rates of 5 per cent and 12.5 per cent, to attract foreign direct investment and host subsidiaries of multinationals.

Take a company like Accenture. It was formed out of the consulting arm of Arthur Andersen, the accounting firm that had to be wound up after one of its major clients, Enron, turned out to have been a powerhouse more of accounting creativity than of actual business. This typically American company is headquartered in Ireland.

Since the Biden administration wants to spend big to revive the American economy and entrench American leadership, under challenge from China, and does not want to rely entirely on borrowings to finance that spending, it has decided to increase its taxation of companies.

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Companies are less than eager to pay tax. The Biden administration discovered that 90 of America’s Fortune 500 companies pay zero tax. The average tax paid out is 7 percent of taxable earnings. Hence, his government’s enthusiasm for instituting a minimum tax of15 per cent in every country.

If the Bahamas and Ireland had at least 15 per cent tax, why would anyone set up companies there, except to service these small national markets? Having a minimum rate of tax is needed to address a vital criticism of increases in corporate tax. The criticism is that taxing companies harms workers, and erodes wages.

Since capital is mobile across countries and businesses, a higher rate of tax on profits, it is argued, would shift businesses to lower-tax countries, lowering job opportunities and pushing wages down. If countries end a race to the bottom on corporate tax rates, with a minimum rate of tax, that would dilute the incentive to move capital out. A minimum tax in every country is Pillar 2 of tax reform.

Market countries are to be accorded the right to tax at least 20 per cent of profits after a 10 per cent margin. A market country is not a market economy (China is yet to be recognised as a market economy). It is the country that serves as the market for the digital service in question.

Naturally, the statement expects Google Tax and its look-alikes to be removed once Pillar 1 tax reform is rolled out. After all, if Google pays tax on the profit it generates in India under the general corporate tax, there is no need for the equalisation levy.

Agreements have to be hammered out at the G20 and later shaped into multilateral pacts that every country honours. How to apportion the value that is liable to tax in each jurisdiction where a company operates is another tough call. Once agreement is reached on all such matters, companies will pay more tax than they do at present. And all national governments would benefit, as would their citizens, on whom they spend their additional tax revenues.

The G7 agreement might not immediately lift countries such as India on fairy wings towards a land of bounteous tax revenue. But it is an important step forward in the march of globalisation and a noticeable acceleration in the pace of metronome regulating that march.

(The Federal seeks to present views and opinions from all sides of the spectrum. The information, ideas or opinions in the articles are of the author and do not necessarily reflect the views of The Federal)

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