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Unveiling the Global Minimum Tax: A Game Changer in the Fight Against Corporate Tax Avoidance

The authors are Surjit Raiguru and Rohi Ray, third year students at Symbiosis Law School, Pune.

The global minimum tax, set to take effect in 2025, is a landmark initiative with profound legal and economic ramifications where multinational corporations, with an annual global turnover exceeding €750 million, will be subject to a minimum effective tax rate of 15% in every country they operate.

The primary impetus behind this taxation regime is to confront the pervasive problem of tax avoidance and evasion by such corporations. In recent years, there has been a growing consensus that these companies employ an array of strategies to shift profits to low-tax jurisdictions, thereby diminishing their tax liability. As a result, they pay minimal to no taxes in many countries, despite reaping substantial profits therein. The global minimum tax seeks to establish a minimum tax rate that all multinational companies must adhere to, curbing profit shifting for the purpose of tax avoidance.

Background Study

The origins of the global minimum tax initiative can be traced back to the early 2000s when the Organization for Economic Co-operation and Development (OECD) initiated the examination of multinational corporate tax avoidance. In 2013, the OECD released the influential "Base Erosion and Profit Shifting" report, which identified several tax avoidance strategies employed by multinational companies. In response to the findings of the OECD report, countries worldwide embarked on developing a framework for a global minimum tax. In 2021, the OECD, in conjunction with 136 other countries, reached a consensus on a 15% global minimum tax rate. The agreement was expected to be implemented in 2023.

The establishment of a global minimum tax represents a monumental milestone in international taxation policy, with a significant number of countries united behind a common minimum tax rate. It stands as a major triumph for the OECD and the signatory countries, signifying a major step forward in combating tax avoidance and evasion.

Rationale behind the Global Minimum Tax Regime

A study by the Tax Justice Network found that the global minimum tax could reduce tax avoidance by multinational companies by up to 50%. The global minimum tax is estimated to generate an additional $5 billion in tax revenue for India over the next decade. Further, a study by the Center for Global Development found that the global minimum tax could create 1.2 million jobs in developing countries such as India over the next decade.

Firstly, multinational corporate tax avoidance and evasion present a major financial impediment for the jurisdiction of operation. A study by the Tax Justice Network revealed that multinational companies paid an average effective tax rate of only 9.5% in 2017, significantly lower than the statutory tax rates in the countries where they operate. This stark disparity underscores the pressing need for a standardized minimum tax rate.

Secondly, the global minimum tax aims to restore equity in taxation. Multinational corporations leverage their global presence to exploit variations in tax laws across jurisdictions, enabling them to pay lower taxes compared to smaller businesses that predominantly operate within a single country. By implementing a global minimum tax, policymakers aim to level the playing field for all businesses and reduce the advantage enjoyed by multinational corporations in terms of tax liabilities.

Beyond fairness, the global minimum tax is expected to generate substantial additional tax revenue for governments worldwide which can be harnessed to bolster public services, including education, healthcare, and infrastructure. A study by the International Monetary Fund (IMF) found that the global minimum tax could generate $125 billion in additional tax revenue for developing countries over the next decade. Furthermore, the additional revenue can contribute to reducing government debt and deficits, fostering economic stability and growth.

Challenges to Adaptation of this Taxation Regime

This initiative is not without challenges. One potential hurdle is the prospect of multinational corporations relocating their operations to countries with lower tax rates in response to the new tax framework. This necessitates robust enforcement mechanisms and international cooperation to prevent tax base erosion. Enforcing the global minimum tax may prove challenging, particularly in countries with weak tax administrations. Such nations may lack the necessary resources and capacity to effectively track the profits of multinational corporations and ensure compliance with the minimum tax requirements.

While the global minimum tax initiative offers numerous advantages, there is a risk of a "race to the bottom" scenario, wherein countries may be tempted to lower their tax rates to attract multinational corporations. Such a situation could lead to a detrimental reduction in tax revenue for all countries involved.

The ramifications of the global minimum tax regulations are contingent on their interplay with national tax laws and subsequent adjustments made by other nations to their fiscal systems. Notably, offshore financial hubs, such as the Cayman Islands, Bermuda, and the British Virgin Islands, may lose their incentive to grant income tax breaks or exemptions to multinational corporations (MNCs). As some countries plan to modify their top corporation tax rates, these jurisdictions might become less appealing to MNCs, potentially leading to the relocation of taxable earnings to other nations—a phenomenon known as "reshoring."

Moreover, developing nations may discover that the global minimum tax leads to a loss of tax revenue to other jurisdictions. While these countries may have relatively high headline corporate income tax rates, they are not typically considered tax havens. However, due to years of providing tax exemptions to specific industries, investors, or regions, many major corporations pay an exceptionally low effective tax rate. Thus, a developing country offering tax advantages resulting in an effective tax rate below the global minimum of 15% may inadvertently cede tax revenues to the jurisdiction where the MNC is headquartered. This could occur without the underdeveloped country even being aware, as the jurisdiction hosting the MNC will be the one collecting the minimum tax.

In summary, the global minimum tax regulations may trigger a shift in tax policies across the globe, affecting both offshore financial centers and developing nations. The intricate interactions between these regulations and national tax systems warrant careful consideration, as they hold far-reaching implications for tax revenues and financial dynamics on an international scale.

Way Forward

The impending implementation of a global minimum tax warrants a thoughtful examination of its potential impact on tax incentives and policymaking worldwide. This development carries both opportunities and challenges, as it necessitates striking a delicate balance between a nation's sovereignty and the broader objective of updating global taxation systems. Most jurisdictions are likely to embrace some degree of tax policy restraint, especially when considering the comprehensive package of OECD changes.

The core of the OECD's global minimum tax plan involves a "top-up tax" to be paid at the parent business level if profits earned at lower levels of ownership are subject to a rate below the global minimum. Primarily targeting profit shifting through intangibles rather than tangible incentives, the plan is poised to significantly alter the landscape of tax incentives.

Foremost, the global minimum tax nullifies the advantage of low-tax regimes. Should country X offer an attractive scheme, such as an IP box, leading to substantially lower tax rates, this advantage would lose its appeal if a multinational entity becomes liable for a "top-up tax" in its home jurisdiction. Consequently, the tax incentive that attracted investment to country X loses its efficacy, potentially deterring further investments altogether.

Secondly, the implementation of a global minimum tax might inadvertently lead to a transfer of tax collections to other countries. Let us consider a scenario where a multinational firm invests in country X despite the tax incentive in place. Although the incentive reduces the tax burden in country X, the parent jurisdiction remains responsible for the "top-up tax." In such a case, country X becomes worse off for providing the incentive, as it essentially contributes to the tax income of another nation without gaining the desired benefits of the investment.

These intricate dynamics surrounding tax incentives and their interaction with the global minimum tax underscore the complexities involved in achieving equitable and efficient tax policies at the international level. Policymakers must navigate these challenges carefully to ensure that the implementation of a global minimum tax fosters fairness and supports the greater global goal of advancing tax reforms under the auspices of the OECD.

A global minimum tax will inevitably put pressure on nations with headline rates below the minimum to raise their domestic rates, particularly if doing so would effectively export tax income. In summary, the forthcoming global minimum tax, anticipated to commence in 2025, represents a groundbreaking initiative with significant legal and economic implications. By establishing a standardized minimum tax rate for multinational corporations, governments aim to tackle tax avoidance and evasion practices. While challenges persist, including the potential for corporate relocations and enforcement difficulties, the global minimum tax signifies a substantial stride toward fairer taxation and increased revenue generation, ultimately benefiting governments and levelling the playing field for businesses worldwide. The implementation of this tax holds the potential to curtail the erosion of tax bases, restore equity in tax systems, and contribute to economic stability and growth on a global scale.

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