Globalisation Is Taxing

Context: Journey towards a unified global tax framework has just begun, and evolving a global consensus, particularly on reallocation of profits, will be the next big step.

Gaps in the existing global tax regime

• Unfair tax competition: Economies are competing to attract investments by providing tax shelters, tax havens that have no or negligible taxation of income or countries that do not make tax profits from intellectual property (IP).
• Tax jurisdiction mismatch: Continuing old school of thought that provides for taxation of companies where their home base is situated.
  • Disregards that market jurisdiction should also have a right to tax profits irrespective of whether there is a permanent establishment or not.
• Lack of clarity in taxation of the digital economy: India unilaterally imposed taxes like equalisation levy.

Gaining momentum of reforms: Towards a global minimum rate of tax

• OECD’s roadmap for checking base erosion and profit shifting (BEPS): Recognised that tax treaties were instruments for avoiding double taxation and could not be used for double non-taxation. It included -
  • Principal Purpose Test (PPT): Required entities to show that the primary purpose of choosing a tax residence was not tax planning.
  • Multilateral Instrument (MLI): Enabled countries to amend tax treaties without having to go through bilateral negotiations.
• Proposals towards global minimum rate of tax: US’s proposal of global minimum rate of tax of 15% and the recent agreement by G7 finance ministers to reform the global tax system to ensure that ‘right companies pay the right tax at the right place’. Key elements of proposal include:
  • Companies need to pay on a country-by-country basis.
  • Profit allocation mechanism: Where the market jurisdiction (the place where the goods are sold) will have right to tax at least 20% of profits that exceed a 10% margin of MNCs.

Challenges ahead

• In reaching consensus:
  • As the rate of tax to be applied has to be decided by each country, and then, a framework is needed to reallocate profits that have to be agreed to by 125-plus countries.
  • If India was to accept the proposed profit allocation rule, it could be at a considerable loss.
  • E.g. If an MNC was to make a profit of 15%, under the proposed framework, India could tax 20% of 5% of profits. In contrast, the equalisation levy is 2% or 6% of turnover.
• In the calculation of profits: E.g. In determining profits of an enterprise, is it accounting profits or tax profits? Will writing off developmental expenses acceptable?