Stung by the pandemic’s impact on public finances, most major nations want to end tax avoidance. Will it work?
A proposed change in global tax rules, which includes a minimum corporate tax rate of 15% and stricter scrutiny of technology firms, is likely to have a far-reaching impact.
NEW DELHI :
Sundar Pichai, chief executive officer of Alphabet Inc. and Google LLC, told stakeholders in February that 22 years after the company’s birth, Google is still not a conventional company and that it doesn’t intend to become one.
Using the company’s 2020 annual report as a platform, Pichai informed shareholders that the tech major’s products had helped researchers fight the coronavirus pandemic, individuals to build their career and small businesses to serve customers—implicitly pointing to the expanding role of digital technologies and, along with it, the search giant’s near-term business prospects. That is something the tax authorities will not miss.
Alphabet, too, is cognizant of this. It warned its shareholders that the conventional global tax system is changing, with several countries, including India, imposing a digital service taxes and participating in a new global initiative to modernize tax rules. The tech giant foresees one major risk that such a move could trigger: future income could be negatively affected by muted earnings in markets that have lower statutory tax rates and higher than anticipated in others where statutory tax rates are relatively higher.
In other words, the risk that lies ahead for some of the largest global corporations is a possible shift in the way profit and costs are recognized in financial statements across markets. That is something that could also prompt changes to how multinational corporations (MNCs) are structured.
At its heart, the ongoing tax tussle is based on a simple principle—firms must be taxed in jurisdictions where they make their profit. Until now, MNCs could create a litany of registered legal entities in multiple countries and ultimately report a bulk of their revenues in jurisdictions with a very low tax rate. Since there was no global agreement, individual countries had to compete with each other by lowering corporate tax rates, which US treasury secretary Janet Yellen recently described as “a race to the bottom".
Now, stung by the pandemic’s impact on government finances, a vast majority of nations have suddenly found common ground. And a framework proposal, based on which further negotiations will take place, is ready.
India had on 2 July welcomed the broad contours of a tax deal approved a day earlier by a majority of the Organisation for Economic Cooperation and Development (OECD) members and the G20 grouping. New Delhi was in favour of a consensus solution “which is simple to implement and simple to comply". At the same time, the solution should result in the allocation of meaningful and sustainable revenue to market jurisdictions, particularly for developing and emerging economies, the finance ministry said then, while assuring that it would work with other nations for an implementation plan by October.
OECD, which is preparing the blueprint for the global deal, expects the final plan to be ready shortly, with implementation set for 2023. With India’s digital economy expected to grow rapidly over the next few years, the stakes are rather high for the Indian exchequer. The new tax framework seeks to tackle digital economy firms in particular since they do not easily fit into the conventional concept of corporate taxation, which relies on a fixed place of business in a market.
This would be of immense significance to tech giants such as Amazon, Facebook, Google and Netflix, which have a massive customer base in the country. The negotiations would also offer a convenient platform for the Indian government, which pioneered the concept of digital taxation by levying a unilateral digital service tax called equalization levy in 2016 on online advertisements. This has subsequently been expanded to cover the sale of goods and provision of services through e-platforms.
India’s move to impose an equalization levy has since been followed by several other countries—such as France, Austria, Chile and the Czech Republic—given the growth in services delivered remotely by offshore firms to local customers.
“The proposed changes in the global tax rules, including a minimum corporate tax rate of 15% and (the) allocation of taxation rights to countries where global digital firms have consumers such as India, are likely to have a far-reaching impact on the way global companies do business," said Vikas Vasal, national managing partner, tax, Grant Thornton Bharat LLP. Experts are also unanimous about the gains India could have under the new regime.
What’s at stake?
The framework for re-allocation of digital economy taxation rights to consumer countries such as India would cover tech giants with global sales of more than €20 billion and profitability greater than 10% (income before taxes/revenue).
The idea is to allocate 20-30% of the residual profits (above 10%) of these corporations to market jurisdictions. The condition that determines whether a market gets taxation rights is set at €1 million in revenue from that jurisdiction. For smaller markets with a gross domestic product (GDP) lower than €40 billion, OECD has proposed a threshold of €250,000.
Prima facie, India with a large consumer base should have a bigger share of the pie as compared to the other market jurisdictions. However, it is difficult to estimate the quantum of taxes that could flow to India at this juncture, said Grant Thornton’s Vasal. Once the new system comes into play, countries will need to revoke the digital tax provisions in their domestic tax laws—such as the equalization levy in India.
Because of the high turnover threshold, many companies would still not be liable to pay tax in market jurisdictions. “Accordingly, it will have to be seen if India withdraws its digital taxes for such companies as well," Vasal added.
The recognition of profits and costs across markets has been something that has witnessed a cat-and-mouse game between businesses and tax authorities under existing tax laws. One common practice among many businesses is to keep ownership of intellectual property rights (IPR) with subsidiaries set up in countries with a low tax rate, say Ireland.
The right to use these intangible assets in markets where revenue is earned (but tax rate is higher) involves a cost to that local subsidiary (paid, in turn, to the entity based in Ireland) which helps to keep profits lower there. With national budgets under strain from economic stimulus measures, governments around the world want a new playbook on taxation.
“The underlying principle is that the current system of attribution of a major portion of profits based on the legal ownership of IPR, regardless of where the data (content) is actually consumed, needs to be modified to ensure that countries where customers are located get their fair share of taxes," explained Sudhir Kapadia, partner and national tax leader at EY India.
“While this change will be beneficial for India due to its large consumer base, much will depend on its actual implementation," said Kapadia, referring to the need for global acceptance of accounting principles and audited accounts based on which the profit thresholds are derived.
Experts say that the new taxation framework may have a big impact on digital economy firms. Since these companies would in any case be paying taxes in the markets where the consumers are located, it may encourage them to have physical proximity to their markets by way of having offices to cater to the unique preferences of each geography, said Neeru Ahuja, partner, Deloitte India.
Indian IT companies with a global footprint in business will also need to evaluate their current business models and the global allocation of their profits as the proposed revision in the profit allocation methodology will equally apply to them, said Kapadia of EY India.
In fact, Indian IT and information technology enabled services (ITeS ) firms may be a key point of leverage for the US in the ongoing negotiations. Efforts would inevitably be made to make things harder for Indian IT firms in order to secure better terms for the US-headquartered tech giants. A related aspect relevant for Indian IT firms is the proposed ‘offshoring’ tax of 10% on the base tax payable in the US, which is a part of the Biden administration’s tax proposals. Along with the proposed increase in the US corporate tax rate from 21% to possibly 28%, this new provision would mean a tax outlay of as much as 30.8% for US firms that offshore services to countries such as India, Kapadia said.
The other element of the proposed new tax framework endorsed by most countries is a global minimum corporate tax rate, which is likely to be 15%. A dent in the appeal of certain low-tax countries could in turn boost India’s attractiveness at a time when New Delhi is offering tax incentives for setting up factories locally. The lowest corporate tax rate that India charges is 15%, which new manufacturing companies are eligible to claim. Since this is on par with the proposed global minimum tax rate, it is not likely to impact new investments into India. On the other hand, Indian companies will be unwilling to set up intermediary firms in jurisdictions such as the United Arab Emirates (UAE) as India will get the right to tax profits in such ‘low-tax’ jurisdictions under the proposed regime.
A spokesperson for the Central Board of Direct Taxes (CBDT) said that India’s position on the OECD proposal is clearly articulated in the 2 July statement.
The way ahead
It is not just tax rules, however, that are likely to reshape the tech industry. Anti-trust laws, data privacy laws and data localization rules are also evolving.
Emails sent to Facebook and Google seeking details about the extent of revenue recognized via their Indian arms and the profits and tax contribution in India remained unanswered at the time of publishing. But the trend seems to be of growing physical presence in India.
Data available from the Registrar of Companies (RoC) showed that Facebook India Online Services Private Ltd, a subsidiary of Facebook Singapore Pte. Ltd, reported ₹892 crore gross receipts in FY19, paid ₹49.7 crore in taxes and made a net profit of ₹105.8 crores—a near 86% jump from the profits reported in the year before.
A spokesperson for Amazon welcomed the OECD tax initiative and explained how the e-commerce group was investing in India and contributing to empower small businesses, artisans, women entrepreneurs and startups, besides enabling the access of local products to global customers.
“Amazon is committed to digitizing 10 million small and medium businesses, facilitate exports worth $10 billion by 2025 and create 2 million direct and indirect jobs in the country by 2025," the spokesperson said in a statement.
“The ongoing pandemic has forced MNCs to re-evaluate their business models and supply chains across the globe," said Grant Thornton’s Vasal. “This, coupled with the major changes in the international tax regimes, offers a unique opportunity for India to attract foreign investment." With continued policy rationalization, increased focus on ease of doing business and more business-friendly policies, India should regain its status as one of the fastest-growing large economies in the near future, Vasal said. While the OECD plan gives the broad contours of the new tax regime, a lot of finer details are yet to be negotiated. New Delhi’s ask is clear: a sustainable plan that is simple to implement.
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