Drawing a fair share of tax from multinational firms

While delivering the landmark Vodafone judgment, the Supreme Court reiterated that the Westminster principle is the cornerstone of law, and every taxpayer is entitled to arrange his affairs to reduce tax liability. The fact that the motive for a transaction is to avoid taxes does not invalidate it unless a particular enactment so provides. The Vodafone case related to taxation of offshore indirect transfer of shares with underlying Indian assets.

The current global tax climate has, however, blurred the lines between legal tax mitigation/ avoidance and illegal tax evasion. Tax ‘avoidance’ by corporate entities include using tax laws in complex structures and ensuring that profits move offshore to tax havens. This has come under greater scrutiny, with governments scrambling to plug loopholes in their tax codes and bringing new laws to obtain their fair share of tax. While amendments to existing laws and introduction of new taxes to increase revenues in difficult economic times is acceptable, what is surprising is the attitude of various governments to tax mitigation or planning carried out within the legal framework.

Recently, the UK Public Accounts Committee stated that the taxman should get tough with large multinational companies to ensure they pay their ‘fair share of tax’ in the UK, where they undertake significant business operations. Payment of low taxes in the UK, albeit through complex but legal structures such as payment of royalties to group companies in tax havens or giving inter-company loans or making arm’s length payments to group companies in low-tax jurisdictions even when the UK operations were making loss, have been deemed as ‘outrageous and immoral’. The public ‘naming and shaming’ has resulted in companies reviewing their accounting practices to reduce taxable profits on ‘moralistic grounds’.

The argument is that tax structuring by multinational corporations reduces equity in tax laws, as local businesses and individuals without access to complex international tax structures continue to struggle and pay their ‘fair share of tax’. There needs to be a better way of ensuring this ‘tax equity’ without maligning large companies as tax avoiders and undermining the law by invoking principles of morality and ethics.

One way in which governments around the world are ensuring that individuals and corporations pay their ‘fair share of taxes’ is by introducing new taxes. India already has specific anti-avoidance laws and is on the threshold of implementing the General Anti-Avoidance Rules (GAAR). However, judicious use of GAAR must be ensured.

To promote equity in tax law, various countries have introduced an inheritance tax on the rich, based on the primary argument that ‘highest taxes should be levied on those with the highest ability to pay’. The French government’s proposed introduction of a super tax for millionaires recently caused an uproar among the wealthy, with some high-profile citizens choosing to change domicile.

India, too, has been toying with the idea of re-introducing inheritance tax (estate duty was abolished in 1985). While this is supposedly meant to address the growing social inequity, there is also an argument that such a tax regime is not really equitable as it penalises the economically successful taxpayer. The attempt to increase tax revenues should not end up causing an exodus of wealthy entrepreneurs, who would otherwise have contributed to the economy by creating jobs, consuming products and generating wealth. Given India’s current growth story, which is vastly different from the socialist economy of the 1950s to 1980s (where the estate duty operated), there is need for a thorough cost-benefit analysis ahead of any move to reintroduce inheritance tax.

The need of the hour is greater tax compliance and administration; to facilitate voluntary payment of taxes by creating a fair and equitable system. As an example, to strengthen tax compliance and increase transparency, the Foreign Account Tax Compliance Act was recently introduced in the US to cover anyone investing and earning income through non-US institutions. Foreign financial institutions should report specified foreign financial assets of US taxpayers that exceed certain thresholds. It also imposes a withholding tax obligation on payments for which the documentation and reporting requirements are not met.

There are no easy answers to the question of how governments can increase revenues while maintaining equity. While we continue to debate on base erosion and profit shifting theories, what is required is a proper understanding of the nature and purpose of tax payments, clear laws specifying the taxes to be paid, increased compliance and administration, as well as increased tax cooperation to enable all countries to obtain their fair share of tax.

Indraneel R. Chaudhury is Executive Director and head of PwC’s South India tax practice

Vinisha Lulla, Manager, contributed to the article.

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