Ideally, the source country from where an offshore firm is deriving its income should have sole right to collect tax
Over the years, an increasing share of the income generated globally has gone towards boosting the profits. The proportion of corporate profit in global GDP (gross domestic product) went up from 14.5 per cent during 1975 to 16.2 per cent in 2000 and further to 20 per cent during 2019. The growth in profit, in turn, was driven largely by multinational companies (MNCs) – companies which operate in several jurisdictions. Their share in corporate profit increased from four per cent during 1975 to 18 per cent during 2019.
Even more disconcerting is the fact that such companies didn’t pay taxes in countries from where they earned profits (call them ‘source countries’). According to the Organization for Economic Co-operation and Development or OECD, corporate tax avoidance costs countries anywhere from $100 billion to $240 billion annually, equivalent to 4-10 per cent of global corporate income tax revenues.
Developing countries are disproportionately affected because they tend to rely more heavily on corporate income taxes than advanced economies. India is losing about $10 billion annually.
MNCs don’t pay tax in source countries by taking recourse to a disingenuous practice of registering their subsidiaries in low-tax countries such as Singapore, Mauritius, and Ireland, and showing their revenue and profits there regardless of where their sales are made. Over time, this practice has proliferated as is evident from the fact that the share of multinational profits booked in tax havens increased from less than two per cent in the 70s to over 37 per cent in 2019.
To better understand the dynamics, consider an MNC, say Amazon, whose home country is the US; it has all its customers located in India who buy goods and services on former’s on-line platform and it has a 100 per cent investment arm/subsidiary registered in a low-tax jurisdiction, say, Ireland.
If Amazon were to have a subsidiary registered in India and record the revenue from sales to Indian customers in this very subsidiary (this indeed is the right way to go), it would have paid tax on such income to the Government of India. But it does not follow this route. Instead, it asks its subsidiary in Ireland to raise invoices on Indian customers even as the Indian
entity is crafted more like a service
company or commission agent to the
parent firm.
Since the revenue is recorded in the books of the Irish subsidiary, the right to collect tax is vested with the Government of Ireland. Being a tax haven, Amazon either pays very little or no tax in that jurisdiction. Not having to pay any tax in India either (as no income is shown here), it gets away with not paying tax anywhere.
To address the problem, October 8, 2021, 136 countries and jurisdictions representing more than 90 per cent of global GDP, including India, agreed to a deal called the OECD action plan. It requires: (i) 25 per cent share in profits in excess of 10 per cent to be reallocated to market jurisdictions where the companies’ users are located; this applies to firms with an annual global turnover exceeding 20 billion euros, which can be potentially reduced to 10 billion euros, and profit before tax greater than 10 per cent of the revenue and is expected to cover about 100 of the most profitable MNCs and (ii) MNCs to pay taxes at a minimum 15 per cent (referred to as global minimum corporate tax or GMCT) where ever they operate; this applies to companies with annual global revenues of over 750 million euros.
The plan also says “no newly enacted digital services taxes (DSTs) or other relevant similar measures will be imposed on any company from October 8, 2021, and until the earlier of December 31, 2023, or the coming into
force of the MLC (multilateral
convention).”
The deal is heavily tilted in favour of the developed countries and brings little gain for India. Picking up from the above example, the plan requires Ireland to impose a minimum tax of 15 per cent in which case Amazon will have no incentive to continue with its subsidiary in that country. In case, Ireland keeps the tax rate at a lower level say 10 per cent or even ‘nil’ then the US would impose a top-up tax of 5/15 per cent that would bring the effective rate to 15 per cent.
This is in sync with a law enacted by the Trump administration (2017) to impose” Global Intangible Low-Taxed Income (GILTI). GILTI is applied on the offshore income of US-based MNCs having subsidiaries in
low-tax countries at 10.5 per cent. The incumbent President Joe Biden wanted GMCT - the new face of GILTI - to be set at 21 per cent but was eventually lowered to 15 per cent.
The big question is: Can the US – the home country of Amazon – collect tax on the profits of its subsidiary in Ireland despite the fact that the latter's income is derived mostly from Indian customers and that the GOI has a right to collect tax on it? This brings us to the second pillar.
The plan allocates to the ‘source’ country (read: India) taxing rights only to the extent of 25 per cent of the profit. How does India from where the MNC/Amazon gets all its revenue and profit be treated as residual, getting the right to tax only 25 per cent? On the other hand, how can the US, which has no contribution to revenue, get away with
collecting tax on 75 per cent of the profit?
The initial game plan of the US and other developed countries which are home to MNCs operating from tax havens was to garner all of the tax on profits booked in those jurisdictions. Now, they have made developing countries sign on a deal which enables them to collect tax on 75 per cent of these profits. This is patently unfair and violates the spirit of the OECD as reflected in its draft paper on “Taxing digital companies” released on October 9, 2019 stating: “Profits of MNCs should be available for taxation in the country where their customers are, irrespective of any physical presence in that market.”
As for GMCT, far from any help in addressing the problem of profit shifting and resultant loss of tax revenue, the requirement to impose a minimum tax will take away from India the policy space to lower the tax and attract foreign investment.
To conclude, ideally the source country (read: India) from where an offshore firm is deriving its income, should have the sole right to collect tax on it. Yet, if at all ‘non-source’ countries are to be given something, they should get to tax on residual basis say 20-25 per cent. India should also pester OECD to drop the GMCT idea; countries should have the freedom to decide the tax rate.
India should also not agree to withdraw the ‘equalization levy’ (a DST introduced in 2016/2020 in lieu of tax on profits) which under the OECD action plan is required to be done before the new tax rules take effect. The levy should be withdrawn on the date the new regime comes into force.
(The author is a policy analyst)
