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On July 1, India, along with 130 other countries which are signatories to the OECD’s BEPS (Base Erosion and Profit Shifting) framework, agreed to bring about changes in their corporate tax framework. The move has been spearheaded by US Treasury Secretary, Janet Yellen, who has spent the last few months trying to bring about a consensus among the countries on this proposal.
The list of countries who have come on board include the G7 countries, many emerging economies and even some low-tax jurisdictions such as Switzerland, Singapore, Bermuda, and the Cayman Islands. Some such as Barbados, Ireland and Hungary have not signed the proposal.
A lot of work is yet to be done before these proposals are implemented in 2023. But prima facie, the minimum corporate tax proposal appears conducive for India while the proposal on taxing digital companies will need some tough negotiations.
The proposals
Pillar one of the agreement is applicable on multi-national enterprises (MNEs) with profitability ratio (PBT/revenue) above 10 per cent and global turnover of €20 billion. Around 20-30 per cent of the profit, exceeding normal return of 10 per cent of revenue, will be allocated to countries where the sales take place. Extractive industries and financial services are carved out of these rules.
Under the second pillar, the signatories have agreed to a minimum effective tax rate of 15 per cent. Companies with global turnover above € 750 million will be covered by these rules, while the countries can decide to tax smaller domestic MNEs too. Pension funds, holding vehicles and international shipping services are excluded.
Benefits from pillar 2
It can be seen from the accompanying table that India has among the higher effective tax rates, at 30 per cent. While the corporate tax rate in India was slashed to 22 per cent in 2019 for companies willing to forego all tax incentives or deductions, the effective rate continues to be high, with not too many companies opting for this leeway. The cess and surcharges further increase the effective tax rate. The tax rate in India also continues to be higher than global and Asian average. Adopting the 15 per cent tax proposed will leave the government with sufficient room to move rates lower in the future, if necessary.
Surprisingly, many of the advanced economies including the US, France, Germany and Japan levy very high tax rate on corporates, which is leading to the MNEs shifting their base to low-tax jurisdictions. Corporate tax rate in the US was, in fact, at a steep 40 per cent until Trump slashed it to 27 per cent in 2017. The ongoing attempt is a result of the Biden administration wanting to raise corporate tax again.
With Indian government also losing revenue due to the innovative tax arrangements of MNEs operating in India, such minimum tax can help the Indian revenue authorities too.
Need tough negotiations
The US has been quite enthusiastic about pillar 2 but it has been more tepid about pillar 1, which affects many of the large digital MNEs based in the US. The US administration has, in the not-so-distant past, supported its digital companies such as Google, Amazon and Facebook against digital taxes imposed by countries including India.
Indian authorities therefore need to weigh the consequence of pillar 2 carefully. There are three main issues with these proposals. One, it applies to mainly larger companies, with global turnover above €20 billion. The smaller e-commerce operators will not be covered by these rules.
Two, the tax is only on extra profits above 10 per cent of revenue. With many of the retail and e-commerce companies operating with razor thin margins, and with many of them being loss-making, it is moot whether there will be extra profits to tax. US is likely to retain the right to tax the larger chunk of the profits of these companies.
Three, if India scraps its equalisation levy after adoption of these rules, it will not have the tool to tax the medium and small-sized digital MNEs. It needs to be seen if India can retain the right to levy witholding tax on other smaller digital MNEs.
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