On 5 June 2021, finance ministers and central bank governors of the Group of Seven or G7 nations reached a breakthrough in their efforts to update century-old international tax laws. The G7 communique unveiled an agreement that aims to deter large multinational companies from artificially shifting their profits to tax havens. It calls for a new global minimum tax rate of at least 15 per cent. The Indian government, however, seems to be of the view that the proposed arrangement could take away its sovereign right to determine tax policy.
The attitude of multinational corporations to taxation is the product of international tax rules rooted in the 20th century. These assume that businesses will be physically present in countries where they have to operate. As a consequence, only a smaller share of profits is attributed to countries like India, whose large consumer base helps generate significant revenues for big corporations without the need for a physical presence. Therefore, much angst stems not only from how much taxes large corporations pay but where they pay it. However, the G7 proposal is worth India’s consideration, as explained below.
The G7 proposal
Besides proposing a global minimum tax rate of 15 per cent, the G7 communique states that multinational companies, which have a 10 per cent profit margin, will be taxed on at least 20 per cent of the profits which exceed this figure, in countries where they operate. It underlines that for the new tax system to take effect, countries like India, which charges a two per cent equalisation levy on digital companies, will have to abolish their existing taxes on digital services.
For several years now, countries have been meeting at the Organisation for Economic Cooperation and Development (OECD) to design and update the tax system that can tackle the challenges posed by digital businesses. To the frustration of lawmakers, a solution has remained elusive. As a result, several countries, including the UK, France, and India have introduced taxes on digital services.
The US thinks that these taxes – including India’s equalisation levy – are discriminatory and unfairly target American companies. The US Trade Representative has confirmed this view following an investigation, and retaliatory tariffs have been introduced, but their application is currently suspended until the end of the year.
The initial unofficial reaction of the Indian government indicates that the country may lock horns with the rich economies on the G7 proposal. There is a view that the G7 proposal interferes with India’s sovereign right to determine its tax policy. However, in today’s digitally interconnected world, such an approach is anachronistic.
India’s taxation policy not only impacts the sovereign purses but also has a larger effect on the investment environment. Countries such as Ireland, and Singapore have managed to position themselves as attractive investment destinations by offering low tax rates. This investment, in turn, helps them generate demand by efficiently utilising resources and creating employment. The Indian government’s decision to slash corporate tax rates in 2019 is a tacit recognition of this larger economic impact of taxation.
It is worth pointing out here that, historically, India has been a high-tax jurisdiction. Since the economic reforms of 1991, the corporate tax rate in India has never come down below 22 per cent for domestic companies. Out of the 94 jurisdictions studied by the OECD, India had the highest statutory corporate income tax rate at 48.3 per cent in 2017. The tax cuts in 2019 are expected to cost the Indian exchequer Rs 1.45 lakh crore annually. Therefore, the likelihood of the Indian government further reducing the corporate tax rate appears slim as it risks widening the fiscal deficit.
The high tax rates in India have meant that corporations devise innovative structures to avoid paying their share. As per the Tax Justice Network, a UK-based advocacy group, India loses out approximately $10 billion, which is about 0.41 per cent of the GDP, on tax revenues annually. As a result, the already-stretched Indian tax administration is engaged in costly litigation with multinationals for decades. Take, for instance, the Vodafone case which dates back to 2007. In the past 14 years, the case has been heard by the Bombay High Court, the Supreme Court, an international tribunal, and a final decision is still awaited.
Since 2015, India has also increased taxes on the growing digital economy. In 2016, it introduced an equalisation levy of six per cent on revenue generated from online advertisements. Its scope was further expanded to other digital services like platform and cloud services in 2020. However, the levy imposed on transacted, taxable value can be passed on to the consumers easily – just like customs duty or sales tax. Illustratively, last year, Apple decided to pass on the burden of the levy to the consumers, which made services available on iTunes and AppStore costlier.
The G7 proposal indicates a political momentum and a desire to fast-track structural taxation reforms that could improve India’s economic competitiveness and lower jurisdictional tax arbitrage.
The Indian government would do well to engage with the multilateral ecosystem to ensure that future multilateral rules do not disadvantage developing economies, instead of outrightly rejecting them. For instance, India has also introduced the concept of “significant economic presence” to create the ability to levy tax on income generated locally and from Indian users by foreign digital companies. However, to fully operationalise the concept of the “significant economic presence”, the country will have to renegotiate its tax treaties to allow it to tax corporations even if they do not have a physical presence here.
It is worth emphasising that despite the attention on digital players, the G7 proposal will equally affect traditional and non-digital businesses. For starters, a minimum global tax rate would disincentivise corporations to artificially shift their profits to low-tax jurisdictions. It will also reverse the trend of offshore incorporation in Indian entities by eliminating tax arbitrage. The Indian government can consider suggesting carve-outs to the proposal that can mitigate any unintentional adverse impact. For instance, the UK is pushing for exempting financial services, as it fears that the tax may disrupt its position as a global center for financial services.
The next few months will test commitments countries have made to reinvigorate international cooperation. The G7 proposal is expected to be tabled before the G20 meeting, which is scheduled for July in Italy. If endorsed by the G20, the forum will have its task cut out for the next two to three years, i.e., translating the vision into easily implementable rules. Here, India’s 2022-23 presidency of the G20 presents an opportunity for the country to articulate a forward-looking vision for fair and comprehensive global tax rules.
Mohit Kalawatia works at Koan Advisory Group, a technology policy consulting firm. Views are personal.
This article is part of ThePrint-Koan Advisory series that analyses emerging policies, laws and regulations in India’s technology sector. Read all the articles here.
(Edited by Anurag Chaubey)