The source country should have the freedom to decide the tax rate it deems fit in sync with its policy imperatives
The agreement reached by the Finance Ministers of advanced economies at the G-7 meeting ontaxing MNCs stands on two main pillars, viz., a global minimum corporate tax (GMCT) rate of 15 per cent and secondly, “reaching an equitable solution on the allocation of taxing rights, with market countries awarded taxing rights on at least 20 per cent of profit exceeding a 10 per cent margin for the largest and most profitable multinational enterprises”.
They also agreed that while coordinating international taxation rules around these two pillars,concurrent efforts will be made for the removal of all Digital Services Taxes, and other relevant similar measures imposed by several countries on these companies. The agreement will be discussed at a meeting of G-20 FMs and central bank governors in July 2021.
The G-7 move is prompted by a tendency among MNCs to register in low-tax European jurisdictions such as The Netherlands, Ireland, and Luxembourg and some Caribbean nations, and show their revenue and profits in those jurisdictions regardless of where their sales are made. This enables them to avoid paying higher taxes in the 'source' country.
According to the Tax Justice Network report, governments in source countries are losing around $100 billion annually in tax revenue with the US alone losing nearly $50 billion a year. India too is losing huge sums estimated to be $10 billion annually. It is affected mostly by digital giants such as Google, Facebook, and Amazon whichreport a bulk of the revenues generated from Indian customers in the books of their investment arms/subsidiaries registered in low-tax jurisdictions such as Singapore, Mauritius, and Ireland.
The problem also referred to as BEPS (base erosion and profit shifting) is also being addressed in a ‘structured’ manner under the aegis of the Organization for Economic Cooperation and Development (OECD) which is coordinating efforts of over 140 countries to arrive at the so-called BEPS framework agreement for taxing profits of these MNCs. In a draft on “taxing digital companies” released on October 9, 2019, the OECD had stated: “Profits of MNCs should be available for taxation in the country where their customers are, irrespective of any physical presence in that market, and that a formula should be evolved for such taxation.” However, progress on this has been stymied by the Coronavirus crisis.
Meanwhile, by-passing the OECD process, the developed countries led by the US have taken the lead. The G-7 agreement seeks to mount a two-pronged attack. First, by requiring every country to set a floor below which it cannot set its corporate tax, it wants to kill the very urge which drives MNCs to register their subsidiaries in low-tax jurisdictions. Second, source countries get to tax a certain portion of the profits generated by most profitable MNCs from the operations in their territories.
Far from addressing the core issue, this prescription will only create more anomalies. Imposing a corporate minimum tax will interfere with the sovereign right of a country to determine ‘what should be its tax policy’ and impair its ability to galvanize the policy to achieve certain objectives. For instance, on September 20, 2019, the Indian Government brought about a steep reduction in the tax rate for new entities in the manufacturing sector (incorporated from October 1, 2019, and commencing production by March 31, 2023) from the existing 25 per cent to 15 per cent. This was done to attract investment (including foreign investment), give a boost to growth, and create jobs. Under the GMCT regime, with the floor set at 15 per cent, India will lose the freedom to lower its corporate tax rate below this level. In fact, under an earlier proposal mooted by the Biden administration to set GMCT at 21 per cent(in 2017, the Trump administration had introduced a corporate offshore minimum tax called "Global Intangible Low-Taxed Income (GILTI) -it is applied on the offshore income of US-based MNCs having subsidiaries in low-tax countries at 10.5 per cent; Biden wanted to double GILTI to 21 per centand in sync GMCT at 21 per cent), India would have been forced to increase its minimum tax from 15 per cent to 21 per cent. India’s ability to attract investment will be further undermined if in addition to GMCT of 15 per cent, the home country of the MNC (read the USA) goes for the ‘top up’ option (under GILTI) i.e., the Indian tax rate remaining at 15 per cent, the former collects six per cent tax on profits earned by the firm in India. The effective incidence of tax - in this scenario - being 21 per cent (15 per cent paid in India plus six per cent levied by US), US companies will be deterred from investing in India. That apart, a global minimum tax rate will do little to tackle tax evasion.
The only logical way forward to do this is for the source country, where the profits are generated, to capture and tax them - as emphasized in the OECD draft. The GCMT cannot be a substitute for this. Taking the Indian example, a levy of tax at 21 per cent- against the prevailing low of 15 per cent (new manufacturing units) - will not result in additional tax collection to fully offset the loss resulting from profit shifting. For instance, if out of Rs 100 only Rs 20 is recorded in India, the extra revenue from the higher rate will be only Rs 1.20 (20x.06) against a loss of Rs 12 due to profit shifting (80x0.15).
This brings us to the second Pillar of the G-7 deal. The proposed formula is seriously flawed. It gives to the source country taxing rights only to the extent of 20 per cent of the profit (exceeding a 10 per cent margin) for the largest and most profitable MNCs. Put simply, if the firm earns Rs 100 from its operation in India then, the latter gets to collect tax only on Rs 20. Who gets the right to the remaining tax on Rs 80? Will the tax haven (read country where the firm is incorporated and where revenue from Indian operations is recorded) get taxation rights on it? Or the home country of the MNC also get a share in the cake?
The formula is erroneous.Neither the country of incorporation nor MNC's home country has any right to collect tax on profits generated from its operations inthe source country. This right should vest entirely with the source country. Further, it should have the right to collect tax from all offshore companies doing business on its territory and notjust from the largest and most profitable MNCs - as proposed by G-7.
To conclude, G-20 should drop the GMCT proposal. It should only focus on Pillar II with a clear stipulation that only the source country from where an offshore firm is deriving its income - irrespective of where it is recorded - has the sole right to collect tax on it. A consensus should be built around a criterionfor arriving at the annual taxable profit. The source countryshould have the freedomto decide the tax rate it deems fit in sync with its policy imperatives. Till this is done, India should retain DST (or 'equalization levy' introduced in 2016/2020 instead of tax on profits) on digital giants.
(The writer is a policy analyst. The views expressed are personal.)
