As for distribution of profit for the purpose of taxing rights, the agreement allocates to the ‘source’ country the taxing rights only to the extent of 25 per cent of the profit

In July 2021, the G7 meeting of Finance Ministers of advanced economies agreed on a framework to tax multinational companies that stands on two pillars, a global minimum corporate tax 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”.

Meanwhile, 136 countries, including India,were involved in the efforts being made by the Organization for Economic Cooperation and Development (OECD) on arriving at the BEPS (base erosion and profit shifting) framework agreement for taxing profits of the MNCs. On October 8, 2021, these countries signed on the above proposal of G-7 with slight change in the share of profit that source country gets to tax under second pillar.

The OECD action plan requires MNCs to pay taxes at a minimum 15 percent where ever they operate and offers 25 per cent share in profits in excess of 10 percent to be reallocated to market countries. It 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 suffers from certain infirmities. Let us understand with the help of an illustration. Consider an MNC, say Amazon, whose home country is USA; 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. However, it does not follow this route. Instead, it asks its subsidiary in Ireland to raises invoice on Indian customers even as the Indian entity is crafted more like a service company or commission agent to the parent firm. This dubious arrangement ensures that almost all of the income from Indian operations is shown in the books of Irish subsidiary. Amazon’s business being in digital mode — transcending physical boundaries — it is easier for the company to obfuscate the real nature of the transaction.

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 not paying tax anywhere.

No wonder, the source countries are losing billions of dollars in tax revenue; the loss for India is about $10 billion annually.

The logical way to prevent this loss is for the source country, where the profits are earned, to capture and tax them. This was recommended in a draft paper on “Taxing digital companies” released by the OECD on October 9, 2019. It stated: “Profits of MNCs should be available for taxation in the country where their customers are, irrespective of any physical presence in that market.”

The developed countries led by USA have given it a new twist by bringing in the concept of corporate offshore minimum tax. They have picked up things from 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.

In our illustration, being the home country of Amazon, the sole objective of the US is to collect tax on the entire income earned by its Irish subsidiary. The US administration is least bothered that the company is deriving its income mostly from Indian customers and that the GOI has a right to collect tax on it. 

If the administration were to have its way, it would want Amazon to conduct its global business from its base in US so that it gets to tax its income from wherever it earns. Since, in an inter-dependent world, this is not possible, it is looking for options whereby its home-grown MNCs are prevented from setting up subsidiaries outside USA. Hence, it came up with GMCT which President Joe Biden wanted to be set at 21 per cent but was eventually lowered to 15 percent.It is patently unfair.

It will interfere with the sovereign right of a country to determine ‘what should be its tax policy’ and leave no room to adjust tax rate to attract investment. For instance, India will not be able to lower the corporate tax to below 15 per cent currently applicable to new entities in the manufacturing sector. That apart, it does nothing to tackle the core problem of profit shifting.

For instance, the levy of tax at 21 per cent — against the prevailing low of 15 percent (new manufacturing units) — will not result in additional tax collection to fully offset the loss resulting from profit shifting.

As for distribution of profit for the purpose of taxing rights, the agreement allocates to the ‘source’ country taxing rights only to the extent of 25 per cent of the profit. Who gets the right to collect tax on the balance 75 per cent? The US and other developed countries who are home to majority of the MNCs want this right to be with them. 

This is abhorrent.

How can a country (read India) from where the MNC 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 a country (USA) which has no contribution to revenue get away with collecting tax on 75 percent of the profit?

True, from its real intent of pouncing on 100 per cent of the profit recorded in the books of its investment arm or subsidiary in a tax haven for garnering tax, USA has come down to 75 per cent but it continues to deny Indian Government its legitimate share in tax revenue. Earlier, the tax loot (albeit from India) was kept entirely by MNCs; now a big slice of this will go to the US and other developed countries.

To conclude, India should pester OECD to drop the GCMT idea; individual countries should have the freedom to decide the tax rate. As for the second pillar, ideally the source country 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 it on residual basis say 20-25 percent. 

Modi 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 new regime comes into force.

(The writer is a policy analyst. The views expressed are personal.)