Some of the biggest multinational companies are known to shift profits to low-tax jurisdictions to avoid paying taxes in the countries where they are based or where they earn the bulk of their revenue. Seen for long as a critical issue, a solution has now been agreed by countries that aims to bring in a “global minimum tax” to nullify the advantages of profit shifting for such companies, although activists have said what it proposes may not be enough to eliminate the problem. Here’s what you need to know.
What’s The Plan To Prevent Tax Avoidance?
According to the Organisation for Economic Cooperation and Development (OECD), the plan agreed by 136 out of the 140 members of the OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting — only Pakistan, Sri Lanka, Kenya and Nigeria have held back for now — marks a “ground-breaking tax deal for the digital age” that will ensure that multinational enterprises (MNEs) “will be subject to a minimum 15 per cent tax rate from 2023”.
The countries that have so far signed on to the arrangement represent more than 90 per cent of the global GDP, OECD said, with a “two-pillar” mechanism having been devised “following years of intensive negotiations to bring the international tax system into the 21st century” and avoid what US Treasury Secretary Janey Yellen had described as a “30 year race to the bottom on corporate tax rates”.
How Does The Plan Work?
The agreement adopts a “two-pillar” approach. “Pillar One”, OECD said, pertains to the MNEs that have a global turnover of more than euros 20 billion (above USD 23 billion) and profitability of above 10 per cent before taxes — which it describes as “the winners of globalisation”. The first pillar is intended to ensure a “fairer distribution of profits and taxing rights among countries” with respect to such companies, ensuring that they pay a fair share of tax wherever they operate and generate profits.
“It will re-allocate some taxing rights over MNEs from their home countries to the markets where they have business activities and earn profits, regardless of whether firms have a physical presence there,” OECD said. The agreement paves the way for reallocation of 25 per cent of the profit of these companies above the 10 per cent threshold to market jurisdictions.
This means that countries where these companies earn revenues can tax 25 per cent of the largest multinationals’ profits in excess of the 10 per cent threshold.
OECD said that Pillar One will lead to reallocation of taxing rights on more than USD 125 billion of profit each year as a result of which, “developing country revenue gains are expected to be greater than those in more advanced economies, as a proportion of existing revenues”.
Pillar Two is the one that espouses the global minimum corporate tax rate, which has been set at 15 per cent. This minimum tax rate will apply to companies with revenue above euros 750 million (above USD 860 million). It is expected to generate around USD 150 billion in additional global tax revenues annually. Reports said that while the agreement allows government to set their own local corporate tax rates, they can now “top up” the taxes to the 15 per cent level if it is found that a company is paying lower rates in a particular country. That is expected to remove the advantage of shifting profits.
So, What Is Profit Shifting?
In recent years and months there have been exposes called the Panama Papers and Pandora Leaks, carried out by the International Consortium of Investigative Journalists (ICIJ), which have showed how corporates habitually open offshore accounts to park profits, thus avoiding higher taxes in the jurisdictions in which they are based or operate.
Advocacy group Tax Justice Network (TJN) says MNEs use profit shifting “to pay less tax than they should”. Explaining how profit shifting works, it says that it “involves a multinational corporation moving the profit it makes in the country where it manufactures products or sells good and services into a tax haven”. How it helps is that it allows the MNE to under-report “the value of its profit in the countries where it produces or sells goods and services”, enabling it to pay “less or no tax in that country” while the profit moved to the tax haven “gets taxed at a very low rate or not at all”.
TJN says that profit shifting is a device through which MNEs “are estimated to shift USD 1.38 trillion worth of profit into tax havens every year, costing countries USD 245 billion in lost corporate tax every year”.
TJN notes that the most common method of profit shifting “is for a multinational corporation to use a subsidiary it has in a tax haven to charge costs to the subsidiaries it has in other countries”.
Giving an example of how it works, TJN refers to the Panama Papers expose. As part of the information surfaced by journalists was the revelation that “Nike was moving vast chunks of its profits to Bermuda — a zero-tax location — by registering their intellectual property (logo, branding, shoe designs) there”. What Nike’s Bermuda subsidiary did was to charge “expensive royalty fees to Nike subsidiaries in the rest of the world for using the intellection property”, allowing Nike to “pay less tax in the countries where it sold shoes and build up billions in untaxed profit offshore”.
Profit shifting is also a strategy resorted to by tech giants. British daily The Guardian cites a report by a tax transparency campaign in 2019 that says the big six US tech firms — Amazon, Facebook, Google, Netflix, Apple and Microsoft — are alleged to have avoided paying USD 100 billion worth of global taxes over the past decade “by shifting revenue and profits through tax havens or low-tax countries”.
When Does The New Agreement Come Into Force?
OECD said that the agreement will now have to be endorsed formally by the G20 countries, which includes India, before its adoption at a summit meeting at the end of October 2021.
OECD is pushing for the signing of the multilateral convention in 2022 so that its effective implementation can begin in 2023.
One of the stipulations of the convention is that all parties have to remove any Digital Services Taxes etc. with respect to all companies. India had imposed a 2 per cent digital service tax on trade and services by non-resident e-commerce operators with a turnover of over Rs 2 crore, which would be payable by the likes of Google and Facebook. Washington earlier this year had slapped, and then withdrawn, retaliatory taxes on India, claiming that the digital services tax targeted tech companies based in the US.
ICIJ said that the tax moratarium was “seen as a win for the US, which is home to some of the largest global tech giants”. It also pointed out that advocacy groups have slammed the agreement, which they claim “unfairly advantages the world’s wealthier countries”. It said that TJN has slammed the agreement “failing to live up to the ‘original ambition’ of the plan, and said that the watered down measures mean that only a ‘sliver of the profits’ of multinationals will become taxable, while incentives to shift profits remain sizable”.
OECD has said that the global minimum tax agreement “does not seek to eliminate tax competition, but puts multilaterally agreed limitations on it”.
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