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The tax matter India must not cede ground on
October, 21st 2019

This should have been basic logic: MNCs must pay their share of tax in every market where they make a profit.

In an interview with Nobel laureates Abhijit Banerjee and Esther Duflo in ToI last Saturday, Banerjee stated, “You can’t have all the production of India being attributed to the Maldives. You have to somehow think of ways to declare income where it is produced, some value added share or something. But you can’t just say that we will assign it anywhere.” He was responding to a query on how high tax rates drive people (and businesses) to move to countries that attract lower tax rates.

This is broadly in sync with the principle underscored by the OECD, and fully supported by India, that governments have the right to collect tax due on value created in the economy and that MNCs must pay their share of tax in every market where they make a profit.

Countries across the world worry when MNCs shift profits to tax havens to avoid payment of their due share of taxes in markets where they operate, depriving governments of their fair share of revenues. All the more so in a digital economy, where these companies often do not have a physical presence in the country.

Finance ministers and central bank governors of the G20 who met in Washington last week, deliberated on the revamp of global tax rules, drafted by the OECD, to stop this practice. India’s keenness to gain taxing rights over foreign digital giants found reflection in finance minister Nirmala Sitharaman’s intervention at the closed-door meet. She endorsed OECD’s new ‘nexus rule’ — the connection between the jurisdiction that charges the tax and the business entity that must pay the tax.

What countries will now haggle over is how much profit should be attributed to each jurisdiction. Take the film, Star Wars: The Force Awakens, an example Kyle Pomerleau, chief economist and vice-president, economic analysis, of the US-based Tax Foundation provides in his 2017 paper, How a Destination-Based Tax System Reduces Tax Avoidance

The movie used intellectual property (IP) located in the US; actors from Britain and the US; special effects developed in San Francisco, Singapore, London and Vancouver; shot in the United Arab Emirates (UAE), Britain, Iceland and Ireland; and tickets sold throughout the world. This makes it tough to figure out exactly how much of profits must be attributed to each country.

OECD has sought to provide an answer, proposing new profit allocation rules. Take an MNC with global profits of $10 billion. It sells in 70 countries, of which it has subsidiaries in 50 countries (physical presence) and sells remotely in the other 20 countries (no physical presence). Routine profit will be allocated to the 50 countries having physical presence.

This may consume $8 billion of the profits. From the balance non-routine or residual profits, 80%, or $1.6 billion, may be allocated to the parent companies holding the IPRs, technology and capital. And the remaining residual profits of $0.4 billion would be allocated to the 20 countries having no physical presence, in proportion to their sales.

India is happy with the proposal to define an alternate nexus. But the proposed profit-allocation framework needs further work, says Akhilesh Ranjan, member, Central Board of Direct Taxes (CBDT), who featured among the top 20 people in the world who has had a major influence on international tax policy on a global level in the annual listing of the “Global Tax 20’ published by the International Tax Review for 2018.

The basic premise is that MNCs are able to sell in a country without physical presence. Then why should the ‘routine profits’ also not be allocated to countries where there is no physical presence? Once we have a tax nexus, profits must be allocated to that nexus, regardless of whether they are ‘routine’ or ‘residual’. The OECD approach is a strange mixture of ‘moving beyond’ the arm’s-length principle, and yet treating the principle as inviolable, says Ranjan.

So, India’s fears that it may end up getting only a tiny slice of the tax pie, even as the bulk goes to developed countries such as the US, can’t be brushed aside. Negotiations involve give and take, and GoI should push for a robust impact analysis on what each market jurisdiction would expect to get in a year.

India already charges a 6% equalisation levy — the ‘Google tax’ — on online advertising payments to foreign entities without a permanent establishment here. Why not charge for Netflix subscriptions in India, or Google or Amazon web services’ cloud storage? After all, GoI’s right to tax any entity derives from its efforts of having created the conditions in which the entity in question is able to generate profits in India.

Countries such as France and Britain charge domestic digital sales taxes. These unilateral measures can go once a consensus is reached on global tax rules, bringing certainty for digital companies. It will obviate the need for countries to keep cutting corporate tax rates to attract businesses, and end practices collectively called base erosion and profit-shifting.

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