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Friday, October 22, 2021

Explained: Taxing Big Tech where it earns profits

Amid a consensus that big multinational companies are funnelling their profits through low-tax jurisdictions, 136 countries including India have signed a historic pact to enforce a minimum corporate tax. A look at the deal, why the need was felt, and the challenges for India and other countries in implementing it.

Written by Aanchal Magazine , Anil Sasi | New Delhi |
Updated: October 12, 2021 2:57:29 pm
The move is part of an evolving consensus that big multinationals are funnelling profits through low-tax jurisdictions to avoid paying taxes.

A majority of the world’s nations have signed a historic pact that could force multinational companies to pay their fair share of tax in markets where they operate and earn profits. One hundred and thirty-six countries, including India, agreed Friday to enforce a minimum corporate tax rate of 15%, and an equitable system of taxing profits of big companies in markets where they are earned. Kenya, Nigeria, Pakistan and Sri Lanka have not yet joined the deal.

The move is part of an evolving consensus that big multinationals are funnelling profits through low-tax jurisdictions to avoid paying taxes. The Organisation for Economic Cooperation and Development (OECD), comprising mostly developed economies, has led talks on a minimum corporate tax rate for a decade. A multilateral convention is to be signed next year.

The biggest impact is likely on Big Tech companies that have largely chosen low-tax jurisdictions to headquarter their operations.

What are the decisions taken?

The decisions effectively ratify the OECD’s two-pillar package that aims to ensure that large multinational enterprises (MNEs) “pay tax where they operate and earn profits”.

  • Pillar One aims to ensure a fairer distribution of profits and taxing rights among countries with respect to the largest MNEs, including digital companies. This would entail reallocation of some taxing rights over MNEs from their home countries to markets where they have business and earn profits, regardless of whether firms have a physical presence there.
  • Pillar Two seeks to put a floor on competition over corporate income tax, through a global minimum corporate tax rate that countries can use to protect their tax bases.

The 15% floor under the corporate tax will come in from 2023, provided all countries move such legislation. This will cover firms with global sales above 20 billion Euros ($23 billion) and profit margins above 10%. A quarter of any profits above 10% is proposed to be reallocated to the countries where they were earned, and taxed there.

The move follows an earlier agreement among the G7 economies in London in June. The two-pillar solution will be delivered to the G20 Finance Ministers meeting in Washington DC on October 13, and then to the subsequent G20 Leaders Summit in Rome.

The two-pillar solution, according to Sumit Singhania, Partner, Deloitte India, will result in “a redistribution of $125 billion taxable profits annually”, and ensure MNEs pay minimum 15% tax once this is implemented. A consensus on global minimum tax “will practically make tax competition amongst nations rather unfeasible by narrowing down any such opportunities to rarest circumstances… In the end, two-pillar solutions ought to be reckoned as enduring overhaul of a century old international tax regime, that’s here to change the rule of the global profit allocation amongst taxing jurisdictions completely”.

Why the minimum rate?

The new proposal is aimed at squeezing the opportunities for MNEs to indulge in profit shifting, ensuring they pay at least some of their taxes where they do business. According to Amit Singhania, Partner, Shardul Amarchand Mangaldas & Co., the two-pillar solution will ensure that “once again, the world will be global, at least in following the principles of taxation rather than following territorial laws”.

In April this year, US Treasury Secretary Janet Yellen had urged the world’s 20 advanced nations to move in the direction of adopting a minimum global corporate income tax. A global pact works well for the US government at this time. The same holds true for most other countries in western Europe, even as some low-tax European jurisdictions such as the Netherlands, Ireland and Luxembourg and some in the Caribbean rely largely on tax rate arbitrage to attract MNCs.

The proposal also has some degree of support from the IMF. While China is not likely to have a serious objection with the US call, a concern for Beijing would be the impact on Hong Kong, the seventh largest tax haven in the world, according to a study published earlier this year by the advocacy body Tax Justice Network. Plus, China’s frayed relationship with the US could be a deterrent in negotiations.

Who are the targets?

Apart from low-tax jurisdictions, the proposals are tailored to address the low effective rates of tax shelled out by some of the world’s biggest corporations, including Big Tech majors such as Apple, Alphabet and Facebook, as well as those such as Nike and Starbucks.These companies typically rely on complex webs of subsidiaries to hoover profits out of major markets into low-tax countries such as Ireland, the British Virgin Islands, the Bahamas, or Panama.

The US loses nearly $50 billion a year to tax cheats, according to the Tax Justice Network report, with Germany and France also among the top losers. India’s annual loss due to corporate tax abuse is estimated at over $10 billion.

What are the problems with the plan?

Apart from the challenges of getting all major nations on the same page, since this impinges on the right of the sovereign to decide a nation’s tax policy, the proposal has other pitfalls. A global minimum rate would essentially take away a tool countries use to push policies that suit them. Also, bringing in laws by next year so that it can take effect from 2023 is is a tough task. The deal has also been criticised for lacking teeth: Groups such as Oxfam said the deal would not put an end to tax havens.

Where does India stand?

India, which has had reservations about the deal, ultimately backed it in Paris. Finance Minister Nirmala Sitharaman had last week said India is “close” to deciding the specifics of the two-pillar proposal and is in the final stages of deciding on the details.

India is likely to try and balance its interests, while asserting that taxation is ultimately a “sovereign function”. India may have to withdraw its digital tax or equalisation levy if the global tax deal comes through. OECD said the Multilateral Convention (MLC) will “require all parties to remove all Digital Services Taxes and other relevant similar measures with respect to all companies, and to commit not to introduce such measures in the future.”

To address “the challenges posed by the enterprises who conduct their business through digital means and carry out activities in the country remotely”, the government has the ‘Equalisation Levy’, introduced in 2016. Also, the IT Act has been amended to bring in the concept of “Significant Economic Presence” for establishing “business connection” in the case of non-residents in India.

Also, there are apprehensions on the impact of this deal on investment activity. The New York Times reported on October 7: “India, China, Estonia and Poland have said the minimum tax could harm their ability to attract investment with special lures like research and development credits and special economic zones that offer tax breaks to investors.”

Sitharaman on September 21, 2019 had announced a cut in corporate taxes for domestic companies to 22% and for new domestic manufacturing companies to 15%. The Taxation Laws (Amendment) Act, 2019 amends the Income-Tax Act, 1961 to provide for the concessional tax rate for existing domestic companies subject to certain conditions. Also, existing domestic companies opting for the concessional taxation regime will not be required to pay Minimum Alternate Tax.

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This, along with other measures, was estimated to cost the exchequer Rs 1.45 lakh crore annually. The effective tax rate, inclusive of surcharge and cess, for Indian domestic companies is around 25.17%.

“While taxation is ultimately a sovereign function, and depends upon the needs and circumstances of the nation, the government is open to participate and engage in the emerging discussions globally around the corporate tax structure. The economic division will look into the pros and cons of the new proposal as and when it comes and the government will take a view thereafter,” said a senior government official. The average corporate tax rate stands at around 29% for existing companies that are claiming some benefit or the other.

Another official said New Delhi was “proactively engaging” with foreign governments with a view to facilitating and enhancing exchange of information under Double Taxation Avoidance Agreements, Tax Information Exchange Agreements and Multilateral Conventions to plug loopholes.

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