Several multinational companies usually shift their profits from high tax jurisdiction to tax haven countries such as Mauritius, Singapore, Hongkong, Cayman Islands, Panama, Bermuda etc. through “Base Erosion profit Shifting” (BEPS). Hence, to prevent BEPS, recently, India has joined the OECD Inclusive framework on BEPS. Under the OECD”G20 Inclusive Framework on BEPS, 140 countries (including India) are collaborating to put an end to tax avoidance strategies of the MNCs.
PILLAR 1 OF OECD: ALLOCATION OF PROFITS OF MNCS AMONG THE COUNTRIES
Present Status: Existing tax norms have been framed keeping in mind the brick-and-mortar business models. Hence, these tax norms are not suitable to tax internet-based companies such as Google, Amazon, Microsoft etc. These digital MNCs do not pay tax in the country in which they earn profits. This is because they may operate business without establishing any physical presence.
Implications: This leads to revenue loss of around $ 100 bn on an annual basis for the countries across the world.
Example: While Facebook has users in every country, it doesn’t have physical operations in every country. A country like India might have millions of Facebook users and Facebook is earning huge profits from those users. However, since Facebook has no physical presence in India, the company does not pay tax here.
Proposal: Pillar One addresses nexus rules (or where tax will be paid) and new profit-allocation rules (or what portion of a MNCs profits will be taxable). The idea here is to ensure that the MNCs should pay fair share of tax wherever they operate. It would ensure that the certain profits of the MNCs would be shared between the countries where the MNC has significant economic presence. So, in future, the profits of these companies would be shared among countries in which they operate.
APPLICABILITY
Which MNCs would be covered? MNCs which have global annual revenues of above 20 billion euros and profit margin of more than 10%. MNCs which do not fulfil this criterion will not be required to pay tax.
What will the tax rate? 20-30% of the residual profits earned by the MNCs. The residual profit is computed as profit more than a certain profitability threshold percentage (in this case, it is 10%).
For example, let’s say a particular MNC has global revenues of around $ 100bn and overall profits of $ 15 bn. So, its profit margin is 15%. Its residual profits would be profits more than threshold of 10% i.e., 5% ($ 5 bn). Accordingly, 20-30% of the Residual profits ($ 5 bn) would be imposed as tax on such an MNC.
Which all countries would be allocated tax? A country would get its share of tax if a particular MNC (which fulfils the above criteria) earns at least 1 million euros in revenue in that country.
On what basis will profit be allocated to different countries? Based on the share of revenue earned by MNC in that country. For example, if a MNC earns 10% of its revenue in country “X”, then the country “X” would get 10% of the share of the profits which are allocated between different countries.
Example: For ex., let’s say a particular MNC has residual profit of $ 100bn. 20-30% of the residual profit would be shared among the countries. Let’s consider this as $ 20bn (20% of Residual profit of $ 100bn). So, in this case, the above country “X” would get 10% of the share of $ 20bn i.e., $ 2bn.
PILLAR 2: GLOBAL MINIMUM
CORPORATE TAX
Proposal: All countries across the world need to impose minimum corporate tax of 15%, which is the minimum corporate tax which should be applicable. The countries would have complete flexibility to fix corporate tax rates above 15%. Ideally, no country should have corporate tax rates below 15%.
Working Mechanism: If any country adopts corporate tax below 15%, then in that case, a particular MNC would pay the lower corporate tax to such a country and the remaining tax amount (Minimum Corporate Tax amount of 15% - Prevailing tax rate in a particular country) would be paid to the country to which the company originally belongs.
| All the countries agree to impose minimum corporate tax at 15% Countries to have flexibility to fix corporate tax above 15% If any country fixes the corporate tax below 15%, then the difference tax amount to be paid to be country to which the company originally belongs. | ||||
| Different Scenarios | Tax Rates | Tax Paid | ||
| USA | Country XYZ | USA | Country XYZ | |
| Scenario 1US based Company operating in country XYZ (India)Annual Profits: $100bnMinimum Tax liability: $15 bn | 28% | 15% | 0 | $15bn |
| Scenario 2US based Company operating in country XYZ (Mauritius- Tax Haven)Annual Profits: $100bnMinimum Tax liability: $15bn | 28% | 10% | $5bn | $10bn |
| Scenario 3US based Company operating in country XYZ (China)Annual Profits: $100bnMinimum Tax liability: $15bn | 28% | 25% | 0 | $25bn |
GLOBAL MINIMUM CORPORATE TAX
Rationale
- Proposed Tax hikes in USA: During Trump’s Presidency, corporate tax rates in US were reduced from 35% to 21%. Now, Joe Biden Administration seeks to increase the corporate tax rate from 21% to 35% to raise revenue and provide stimulus measures. However, the proposal to increase the tax rates might prompt the US based companies to shift their bases to other low tax jurisdictions. Hence, the idea is to prevent the US based companies from shifting their bases to low tax authority countries.
- Target Low Tax Jurisdictions: According to research by the Tax Justice Network campaign group, total revenue lost at the global level on an annual basis due to BEPS is as high as $ 427bn. India’s annual tax losses due to corporate tax abuse are estimated at over $10 billion. Almost $8.7 trillion of global wealth is stored in these low-tax jurisdictions.
- Target Technological companies such as GAFAM which end up paying lower taxes due to BEPS.
- Prevent "Race to the Bottom": According to OECD, countries across the world are locked in intense competition to attract foreign investment by reducing the corporate tax rates. The average corporate tax rate has fallen from 32% in 2000 to 23% in 2018.
- Compulsions before US Government to reduce FD, higher Debt levels and finance $ 2 trillion spending program.
Challenges
- Mainly serves Interests of USA: Proposal put forward to finance $2 trillion spending program; 30% of Forbes 2000 MNCs American based and hence US government would be the ultimate beneficiary.
- Against Interests of Poor and developing countries which uses lower tax rates as a tool to attract foreign investment and boost GDP growth.
- Difficult to achieve consensus among multiple countries at international level.
- Goes against Principle of Sovereignty as the country would lose their freedom to fix low tax rates.
IMPLICATION OF PILLAR 1 AND PILLAR 2 ON INDIA
The OECD is set to finalise the proposals on both Pillar 1 and Pillar 2 by the end of October 2021. Let's understand its implications on India and what should be India's stand.
Revenue Implications: Since India has a large consumer base for companies such as Facebook, Google, Amazon etc., India would be able to get a bigger share of their profits as compared to other countries. However, as of now, it is difficult to quantify the amount of taxes which would flow to India.
Doing Away with Equalization levy: India has unilaterally imposed Equalization levy to bring digital companies under the ambit of tax. The finalization of OECD deal would mean that India would have to do away with Equalization levy. India needs to be cautious here. It needs to ensure that the revenue gains from the OECD deal is much higher than the revenue earned through Equalization levy.
Expansion in scope of MNCs covered: Pillar 1 covers only those MNCs which have global annual revenues of above 20 billion euros and profit margin of more than 10%. This criterion would include only the bigger MNCs (such as Google, Apple, Facebook etc) and leaves out smaller MNCs. Hence, India needs to argue for lowering criteria and bring even smaller companies under the tax bracket.
Tax Rates: Pillar 1 proposes tax rate which ranges between 20% to 30% of residual profits above 10% profit margin. The developed economies have argued for a lower tax rate of 20%, while India has demanded for the tax rate to be at higher end of 30%. India needs to ensure its interests and concerns are taken into consideration.
Indian IT Companies: Indian IT companies with a global footprint in business will have to evaluate their current business models and how the OECD proposals would impact them.
Global Minimum Corporate Tax rates: India has brought down the corporate tax rate to 15% for the domestic manufacturing companies, which is on par with the OECD proposal. The adoption of Global minimum corporate tax would put a dent in the appeal of low-tax jurisdiction countries and can help India to attract foreign companies to set up their bases here. Similarly, it would discourage the Indian companies from setting up bases in tax havens solely for the purpose of tax avoidance.