Introduction
The taxation of the digital economy was first on the Organization for Economic Co-operation and Development (OECD) list of 15 Base Erosion and Profit Shifting (BEPS) Action items. BEPS Action Plan 1 was announced in 2013 in which it had partially addressed the challenges that would be faced by the digital economy. However, due to its complications, it was put aside and was discussed later. Finally, in January 2019 it was moved to the forefront with a policy note by Inclusive Framework that triggered a flood of tax and transfer pricing policy ideas.
Regarding the tax challenges of digitalization of the economy, the OECD in its January 2019 Public Consultation Document outlined various propositions. A two-pillar approach was set out. The first pillar focused on the reallocation of taxing rights. On the other hand, the second pillar dealt with what has been labeled as “unresolved BEPS issues”. The latter pillar involves a plan for an effective minimum tax on international corporations’ profits, also known as the “global anti-base erosion proposal” (GloBE).
The plan was divided into two parts. Firstly, if a country’s effective tax burden abroad falls below a certain level, the “income inclusion rule” requires it to tax its own firms’ foreign income. This system prohibits taxes from being deliberately distributed to companies that reside in low-tax jurisdictions. Secondly, the “undertaxed payments rule” which allows a country to tax outgoing payments from international companies’ domestic subsidiaries to their related entities in other countries till when the related profit is taxed below a particular limit.
In this post, the author will discuss GloBE which is the second pillar of the OECD two-pillar approach, its implementation possibility and what should be done for it to succeed.
Policy analysis
The 139 members of the Inclusive Framework are expected to agree to a solution and if they are unable to present an exhaustive consensus-based solution, there is a possibility that various nations will start adopting unsystematic tax measures. From a global economic perspective, the Inclusive Framework is conscious that stability and predictability are the elementary units of international economic growth and rapid increase in unsystematic tax measures will not only undermine the applicability of the international tax framework on worldwide international business activities but will also negatively impact global investments and growth.
Multinational corporations are known to use practices such as transfer pricing, funding strategies, etc. to low-tax jurisdictions and tax havens to move their profits. The minimum tax seeks to curb multinational companies’ ability to take advantage of the low tax rates of such foreign countries.
The minimum effective tax will have several advantages as elucidated below-
1. To begin with, a minimum tax rate enhances the international distribution of money, i.e., it increases the efficiency of investment. From a global productivity perspective, businesses should spend where they can get the best before-tax return. However, businesses seek to optimize after-tax returns rather than before-tax returns. If source-based taxes vary, they will be much more likely to invest in places where the gross return is lower but the net return is higher due to lower taxes. A minimum tax reduces these tax disparities and thus lowers the efficiency loss caused by distortion.
2. There might be certain irregularities in some countries’ tax competition and GloBE can be used as a medium to balance out those irregularities. Domestic firms are subject to regular domestic taxation and international firms have an access to tax havens and advantageous tax regimes. If there would be a minimum tax rate domestic firms will not be at a disadvantaged position to the international firms.
3. A minimum tax rate will allow certain countries to compete for foreign investments by lowering effective tax rates. It will set an equal ground for competition thus preventing high-tax countries from having to fully abandon their own divergent tax policies. It may also, be crucial that some stipulations need to be made in minimum tax rules regarding the special reliance of least developed countries (LDCs) for foreign direct investments in them.
To summarize, a minimum tax boosts productivity by improving the international distribution of capital, saves money by making unnecessary evasion practices less appealing, and reduces tax rivalry, allowing for more effective public goods provisions.
While with its key advantages, it also has some disadvantages. The following are mentioned below:
1. Even when a minimum tax reduces inefficient profit shifting, it stifles other practices as well. Tax competition, according to one view, boosts welfare by decreasing excessive state consumption and providing smaller countries with the means to attract foreign direct investment to account for positive spillover effects, especially in the case of underdeveloped economies on the perimeter that they miss other locational advantages.
2. If a significant number of countries start imposing the minimum tax, low-tax jurisdictions’ ability to set an effective tax rate below the minimum level will be effectively taken away. This will cause distress between the stakeholders and will put restrictions on the sovereignty of a nation. The national tax system of the country can be put under strain and hence can cause a greater harm to the national economy.
3. It is very early to introduce an international minimum tax rate as a supplement to anti-BEPS measures. Moreover, the OECD BEPS guidelines are still being implemented and it is unknown what issues can occur in profit shifting or how effectively they are being treated. Only after the successful evaluation of the BEPS project, as forecasted in the final report on Action 11 these steps should be taken.
After looking at both advantages and disadvantages of the minimum tax, it can be said that if it is not properly planned and systemized then it might lead to international double taxation.
Implementation
The implementation and collection of the GloBE minimum tax would necessitate changes to be made in the national legislation of each country that attempts to put it into practice. The technical layout of the respective instruments may be left to every state, as far as the expected top-up tax is imposed in the end. For example, by limiting the tax deductibility payments. Nonetheless, the inclusive framework should create model legislation to aid this mechanism. In comparison, there is unlikely to be an added benefit in rendering the state’s political promises legally binding through a multilateral agreement that can be broken by the states unilaterally anytime in the future. Besides that, a globally integrated implementation will necessarily require a higher degree of international administrative support, which the existing instruments lack.
Conclusion
Even though the drafters of the GloBE blueprint went to considerable lengths to make this new regime administratively viable, multinational corporations and national tax authorities would still be facing major challenges. Regardless, it would add a significant amount of challenges to the existing international tax law system to make it adequately functional, globally well organized, and structurally sustainable. Furthermore, the minimum tax rate’s layout will be a critical feature of the GloBE minimum tax and how it will unfold in the future. Therefore, striking a balance between minimum tax efficiency and administrative viability is particularly critical.
To achieve a consensus-based solution on GloBE, each country needs to carry out political engagements and endorsements. These would be required in addition to the technical work that has to be accomplished by the Inclusive Framework. This is due to the fact, that interest of nations will go over and above the technical issues. It will impact revenues and the balance of taxation rights. The outcome they are able to reach should mirror a balance between precision and administrability for all countries at the diverse stage of development. The end-result should be founded on strong and stable economic principles for its success.
(Author Anuj Kumar is a 3rd year law student from Vivekananda Institute of Professional Studies, New Delhi.)
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