Libertarians believe countries should be free to compete for foreign investment using low tax rates. However, the phenomenal expansion of giant companies paying zero or very little tax has raised a public furore that governments can no longer ignore, not even those complicit in tax havens. An IMF research paper estimated that $12 trillion of global corporate investment was “just phantom investment” to avoid tax.
A meeting of 140 countries at the end of June will seek agreement on a new global tax framework, and delegate further work on rules to the G20. The Organisation of Economic Cooperation and Development has long attempted a global framework for a fairer tax regime, noting that in a digital age companies can do business of billions in a country and pay no taxes there. Till now, the US, home of the biggest digital companies, has opposed such reform.
Some countries, including India, have already started taxing digital MNCs on the basis of their revenue, not on profits (which on paper can be zero). The Trump administration threatened India and other such countries with retaliation. But President Biden has now agreed to global tax reforms. These will cover the 100 biggest companies and not be restricted to digital companies, which would disproportionately hit US firms.
Optimists think the era of tax havens is finally ending. I am more cynical. The hurdles for enforcing or even defining a minimum tax are formidable. How exactly will any country be penalised for non-participation, or for creating grey areas and loopholes? Who will enforce such penalties, through what mechanisms, and how will the penalties be shared among other countries?
MNCs and their lawyers will create loopholes, often with the collusion of governments. Britain has long connived in creating tax havens in British territories like Bermuda, British Virgin Islands, Cayman Islands, and the Channel Islands. The US is estimated by some researchers to be the biggest money laundering centre in the world. Former European Commission President Jean Claude Juncker says the light-touch regulations of US states like Delaware are comparable to what Caribbean tax havens do.
Switzerland became rich by attracting global black money, protected by strict bank secrecy. Other countries like Singapore, Ireland, Mauritius, and the Netherlands attracted massive investment though low taxes. Amazon colluded with the Luxembourg government to create financial rules allowing zero tax.
The rise of money laundering by jihadists and mafia has induced the US to force some tax havens like Switzerland and Luxembourg to relax their secrecy rules. Public outrage has created additional pressures for reforms. But enormous counter-pressures will come from MNCs and their parent countries — including members of the G7 — to connive in creating loopholes and grey areas. The supposed reforms may end up benefiting mainly lawyers fighting complex cases forever.
A 15% minimum corporate tax will hit not just tax havens but countries, including India, that offer tax breaks for specific purposes — export industries, investment in backward areas or Special Economic Zones, green investments, R&D, accelerated depreciation, and sundry other legitimate incentives. Besides, trusts, philanthropies, pension funds, government companies for special political purposes, and many other financial entities pay concessional or zero tax. Even if the nominal corporate tax rate is 30%, some companies (including new and small ones, not just giants) pay zero tax because of legitimate tax incentives.
Most countries will insist on continuing tax exemptions and exceptions. This may make the supposed 15% minimum corporate tax a farce in practice. Lawyers will create a thousand ingenious entities and schemes to misuse even the noblest exemptions.
The simplest, most honest solution is to decree an Alternative Minimum Tax of 15% regardless of tax breaks. Any country wishing to attain political or social goals through special incentives will have to do so through budgetary grants, not tax concessions. Politically, this will be hotly opposed. Lobbies will argue for exceptions and exemptions for trusts, pension funds, and a variety of such entities. I predict long delays before concrete implementation, and many loopholes.
However, in the interim, countries like India should be able to continue taxing digital giants on the basis of revenue generated in India, not profits, and not suffer US retaliation. That will be a positive outcome.