American consultants often quip that we can’t escape two things in life: Death and Taxes. They fail to add that you need not pay tax anywhere if you head a multinational corporation (MNC) with a global network of subsidiaries, branches, licensees, et al. Legal pundits and chartered accountants will advise on how to shuffle costs within the conglomerate and avoid taxes. If you locate your head office in one of those balmy tax-free islands, it is the very heaven. You need no fear of the IRS nor shame as all of them do it.
By any measure, the system is unfair, iniquitous and socially disruptive. The impact on developing countries (DCs) is more harmful than on the advanced countries (ACs), which are home to MNCs. At one level, DCs are advised to offer tax and other incentives to promote foreign investment to accelerate growth, employment, income, etc. At another, MNCs siphon away more revenues than they contribute to the national kitty. OXFAM estimates that MNCs take away around $400–500 billion annually. They argue that if these revenues are retained within those countries, they would not need to beg for foreign aid.
The DCs have been fighting the tax battle to get a better share for decades, but without much success. It has been a battle of wits between MNC experts on the one side against those of the DCs on the other—the latter being invariably weaker. Newer structures for transfer pricing would be evolved to bypass regulation. A major handicap faced by the DCs was that the ACs viewed their defence of the interests of MNCs as tantamount to defending their national interest. There was a change in this mindset with the enormous growth of corporations. They began to threaten state power, and there were massive tax scandals in the first decade of this century, and the need to control the malaise dawned on them.
Another factor was the growing digitisation of the global economy that questioned conventional wisdom and century-old notions of taxation. For instance, a company may operate from anywhere and market everywhere, even without “a place of business” or owning assets or Uberisation. Quarrels also broke out on the newer idea of Google Tax. Attempts to resolve the difference within the EU met with unresolved political challenges when the IF was negotiated. IF is part of an international system named ‘OECD/G20 Inclusive Framework (IF) on BEPS’. BEPS is an acronym for Base Erosion and Profit Shifting. The system came in following a deal between 136 countries and jurisdictions, as OECD announced on July 1, 2021. The deal was touted as “historic” and “groundbreaking”.
IF was based on two pillars. Pillar I will apply to MNCs with greater than $20 billion in revenues globally with pre-tax profitability of at least 10%. The profits of these companies would be allocated to market jurisdictions whether they have any physical presence or not. All the existing digital taxes would be abolished, and no new digital tax would be allowed. Pillar II creates a new category of 15% for large multinational enterprises (MNEs). It seeks to preserve most of the extant privileges/rights.
What is surprising is the speed with which the work was done. On October 8, 2021, OECD was ready with a document for submission to the Finance Ministers of G20. It was done on October 13. By March 14, 2022, OECD had finalised its Commentary to Global Anti-Base Erosion (GloBE) Rules (Income Inclusion Rule (IIR) and the Under Taxed Payments Rule (UTPR), referred to collectively as the GloBE rules). Some members began to implement them.
This speed was possible because the IF was heavily loaded in favour of MNCs. Much of the negotiation was secretive and dominated by the ACs, MNCs and their experts. The minimum (or lowering) tax, or what is called “Formulary Apportionment”, was already in vogue in the West. The IF helped formalise or legitimise that policy at a low level of 15%. By abolishing digital taxes, it cures the festering quarrels with the large MNCs. If and when the IF comes into force, the MNCs will be the happiest. They can buy peace after paying a tax of 15%. There will be no need to worry about later-day Google tax or arbitraging tax jurisdictions.
It is worth emphasising that OECD has no mandate to work out a legally binding code on any issue. OECD codes are morally suasive. OECD is a rich man’s club and not representative of developing countries. As explained earlier, the IF negotiations were secretive and dominated by ACs and MNCs.
The IF was negotiated with a tunnel vision that paid attention only to taxes, overlooking other aspects of MNC operations, such as “transfer pricing”. Under IF, an MNC may be absolved of all unfair practices by paying a tax of 15%. The IF does not recognise the link between tax revenues and growth. A Brookings Paper said, “The new global tax deal is bad for development.” (Julie McCarthy, May 16, 2022). DCs can ill afford to keep taxes at 15% as a formula-based approach to MNE profit reallocation would undermine their revenue base.
The new method, in reality, does not do away with tax havens but could create a new kind of tax haven. Tax Justice Network expressed this view. Though the Global Minimum Tax is ‘historic’, it fails to deliver fair and effective reforms. EURODAD, another Think Tank, also believes that the “OECD tax deal is unfair and fails to solve the problem.” Though the Government of India was involved in the negotiations, it sought changes in the IF. It believes it denies the country its proper share of taxes from MNCs like Google, Facebook, Uber and Netflix. It is opposed to OECD setting tax rates for countries that impinge on its sovereign rights.
Overall, it is unlikely to be accepted or implemented by developing countries, including India. OECD may, however, flaunt it as a moral victory or code.
Kandaswami Subramanian
Served in the Ministry of Finance, GOI, and retired as Joint Secretary