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In this week's FinMail we take a look on why the world economies came together to implement a minimum corporate tax rate. We also understand why it was necessary - Tax Heavens



The Story:

Last Saturday, Finance Ministers of 20 of the world's largest economies (G20 Nations) agreed to implement a global minimum corporate tax of 15% in countries around the globe to discourage Multi-National Companies from shifting to countries with low corporate taxes.


The idea of a global minimum corporate tax was presented by Treasury Secretary of US (Finance Minister), Janet Yellen during an OECD summit in Paris, April 2021. This comes at a time when almost every country has faced economic pressure due to the pandemic and taxes are a major source of income for the economy. Enabling a global minimum tax would ensure that the tax revenue that is lost every year because of the MNC's shifting their business to low tax countries would not continue further, at least not at the same level. But how is it relevant to us?


Let us tell you India too has backed this agreement after initially having second thoughts about it and China, too, has surprisingly agreed on this as well. You might be thinking if all the world economies are coming together to implement the law and that too which is not related to Climate change, this must be something important. It is! And we are going to discuss just the same. Let's start right away.


What was the need for this agreement?

A government of any economy makes money from the taxes directly or indirectly majorly. Taxes are the biggest source of government revenues and thus governments always look for ways to increase them. This tax revenue is what funds the government's growth projects for the economy. And when these tax revenues start taking hits, it is surely going to keep the government up all night to stop them from decreasing.


Historically, countries have often adopted the practice of slashing the tax rates for the corporates to attract the big corporates in their country. Corporates pay millions and sometimes even billions of dollars in taxes every year to their respective government & countries. If there's a way these corporates can reduce the tax liability and increase the profits as a result, there would always be takers to this opportunity. And so of course, nations often make use of this lucrative offer to invite companies to do business in their own countries and thus increase their nation's revenue as well.


But how is this related to the agreement?


US increased the corporate tax rates and this would mean Corporates there, would not be encouraged to pay more taxes and would look for shifting to countries where there could be fewer taxes? Yes!


How could you stop companies from moving out? Close the other doors. Simple. Let's convince other countries to set the minimum tax limits so that they can't lower the tax rates below a certain limit (15%) and thus there would be no encouragement for companies to shift to low tax countries.


Now we can't open the mind of the US government and search for a reason behind this step but we can see the agendas, right?


Many countries around the globe are facing a problem from a "Global Economic Black Hole" eating out Tax Revenues from economies. And thus a global agreement was signed by countries to implement Global Minimum Tax Rates across economies. But what is this mysterious - Global Black Hole?


Drumrolls please,

Tax Havens.


Why Tax Havens?

If not paying taxes was a crime, then Tax Havens are the Gotham City of it. Corporates hate paying taxes, period. Well, Who doesn't? But not everyone can avoid it. Corporates can.


As per a report, India received ₹4.57 Lakh Crore of taxes from corporates in 2020-21. That's a huge number. Right? But this is the tax that the government earns while Tax Havens co-exist. As per another report, India loses about ₹75,000 Crores worth of taxes due to the global tax abuse by MNCs. And this is the story everywhere in the world. "Taxes are mean to be evaded" is a corporate's own version of "Rules are meant to be broken." And this gave birth to such Tax Havens. The need of the hour was lower corporate taxes and tax havens answered the call. Enough buildup!


What exactly are tax havens?

Tax heavens are also called global economic black holes, designed specifically to avoid taxes. Most of them are tiny island countries and are tiny economies. These tax heavens have become a refuge for the global wealth (black).


The Organisation for Economic Co-operation and Development (OECD) defines a tax haven in a classical sense as "a country which imposes a low or no tax and is used by corporations to avoid tax which otherwise would be payable in a high-tax country". It lists three essential characteristics of a tax haven: (a) no or only nominal taxes (b) lack of effective exchange of information and (c) lack of transparency in their legislative, legal or administrative provisions.


Basically, heaven for those who don't want to pay taxes. Now, you want the names of such countries, don't you?

(Bohot Tez ho rahe ho, hein!)


Experts on the subject prepared a list of countries that allow such hiding of wealth with almost no taxes at all. In 1985, the list consisted of 10-15 such countries. In 2016, the list had names of 91 countries that were categorised as Tax Havens. Some of them were Switzerland, Netherlands, Ireland, Singapore, Hong Kong, Luxembourg, Cayman Islands, British Virgin Islands, Bermuda, Cyprus, Mauritius, Panama, etc.


As you can see most of them are tiny island countries and are tiny economies. These tax heavens have become a refuge for the global black wealth. James Henry's 2010 study, The Price of Offshore Revisited, (written for the TJN), said about $21 to $31 trillion of unreported private financial wealth is located in various tax havens at the end of 2010.


Developed nations are not the only economies that face the problem of Tax Avoidance via Tax Havens. India too is not spared from the same.


Question:- India receives the most FDI/FII inflows from which countries.

US? UK? Japan? China?

Nope!

RBI's FDI Inflow data shows that from the year 2015-2020, India received most of its FDI Inflows from countries like - Singapore, Mauritius, Netherlands, Cayman Islands, etc. In fact, if we had to add up the contributions of Tax Havens in our FDI inflows, 87% of FDI come from the top 10 Tax Havens.


A simple explanation could be summarised as - The money via FDI that India receives is channeled through these Tax Heavens, in order to avoid taxes by the MNCs conducting their business globally.


Billions of tax revenue are lost this way and the countries are concerned about it. The OECD says that corporates have evaded about $240 billion to $400 billion each year from countries that are 4% to 10% of global corporate income taxes by taking advantage of such Tax Havens. So it is quite self-explanatory why countries want to remove the existence of such Tax Heavens.


But you might wonder, how it is relevant to you right?


Let's understand how it is relevant to you.

Collecting taxes is the sovereign right of government, the government needs tax revenues to spend on Infrastructure, Public Health, Public Welfare, Education, and Development. Consider tax as the subscription fees you pay to your government just to live in the country. Whether you like it or not, there ain't no escape. But as we saw, some are trying to create complex loopholes to skip the taxes, so who exactly bears the gap?


You already know the answer, don't you?


The answer is pretty much straightforward, we the goats. (read in Hindi)


Let's understand it with simple math here (simple, I repeat)


For the sake of understanding let's assume a country with a population of just 100 people. Each person is paying a tax of ₹1 (just assume). So govt gets ₹100 as taxes. But one fine year, some found out about the way they can avoid taxes. So now only 90 people pay taxes and 10 are evading it. Govt has estimated that this year too they will get ₹100 as taxes. But they realised, it's not gonna happen. So what they do is, they hiked the tax rates (indirect & direct) so that they can get ₹100. But there are only 90 people to pay it this time. So everybody would be paying more than ₹1 as taxes.


That's basically it. We don't realise it as the number of taxpayers is increasing but directly or indirectly it is marking a dent in our economy. If the government doesn't increase the taxes, the revenue would decrease which would widen the fiscal deficit. In and out, there is damage, no matter what.

The effect might not be visible to us but that doesn't mean it isn't there.


That is it for this week's FinMail. Stay safe & keep learning.

 

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