The recent decision by European Union (EU) members to implement a Global Minimum Tax (GMT) of 15% on large businesses is a significant move in international tax policy. This agreement aligns with Pillar 2 of the global tax framework proposed by the Organisation for Economic Cooperation and Development (OECD) in 2021, and has generated interest due to its potential implications for multinational corporations and international tax competition.
Understanding the Global Minimum Tax
The GMT imposes a standard minimum tax rate on a predefined corporate income base worldwide. The OECD envisages this new system will generate an additional USD 150 billion in annual tax revenues from the foreign profits of large corporations.
Designed to mitigate the issues of corporate profit shifting and tax base erosion caused by competitive lower tax rates between nations, the GMT is a significant departure from previous tax policies.
Key Features of the Global Minimum Tax Plan
The GMT plan revolves around two main pillars. Pillar 1 focuses on reallocating 25% of the profits that the largest and profitable Multinational Enterprises (MNEs) earn above a certain profit margin to their market jurisdictions – where their users and customers reside. This pillar also simplifies the application of the arm’s length principle to in-country baseline marketing and distribution activities.
In contrast, Pillar 2 sets a minimum tax of 15% on corporate profits, establishing a floor for tax competition. It applies to multinational groups with annual global revenues exceeding 750 million euros. This ensures that if a company’s earnings are untaxed or lightly taxed in a tax haven, the home country can impose a top-up tax to achieve an effective tax rate of 15%.
Objectives and Significance of the Global Minimum Tax
The GMT aims to prevent big businesses with global operations from reducing their tax liabilities by registering themselves in tax havens. By setting a uniform minimum tax level, the policy aims to end decades of tax competition between countries seeking to attract foreign investment.
Additionally, the GMT also seeks to address broader economic and societal issues. Governments worldwide are grappling with budget constraints exacerbated by the Covid-19 pandemic and are keen to prevent MNEs from diverting profits and tax revenues to low-tax countries.
Concerns About the Global Minimum Tax
While the GMT has been hailed as a significant step towards global tax reform, it isn’t without its detractors. Critics argue that it infringes upon national sovereignty by limiting a nation’s ability to set its tax policies. Furthermore, there are concerns that the proposed measures may not effectively eliminate tax havens.
About the OECD
Founded in 1961, the OECD is an international economic organisation committed to stimulating economic progress and world trade. Headquartered in Paris, France, it includes 36 member countries. Although India is not a member, it functions as a key economic partner.
The Way Forward
The implementation of the GMT will likely face several hurdles, particularly the risk of lower tax jurisdictions outside the so-called ‘global tax cartel’, and non-compliance by members within the cartel. Both within and outside the cartel, countries will be incentivised to offer lower tax rates to boost investment and economic growth within their jurisdictions.
