A committee set up by the Central Board of Direct Taxes [CBDT] – the policy making body on direct taxes in the revenue department, ministry of finance [MoF] – has come up with a draft report proposing rules for taxing profits attributed to Indian operations of multinational companies [MNCs] carrying offshore operations from India and have permanent establishment [or business connection] in the country.
The permanent establishment [PE] refers to a fixed place of business normally located in the territory of the source country [in this case, India] from where a foreign enterprise conducts transactions – including sales made in India – and is defined in tax treaties. The Income-Tax [I-T] Act provides for levy of tax on the profit attributed to the Indian operations of such an enterprise.
In case however, detailed accounts on the profit that can be attributed to the Indian operations is not available, then rule 10 empowers the I-T officer to determine the profit attribution, by indirect apportionment say, a percentage of the turnover. However, lack of uniformity in this approach results in litigation.
By nature, the operations of MNCs are transnational with entities located in several countries involving a high level of interdependence and cross-border flows of goods, services and technological inputs between them. For instance, inputs/components are made in one country/jurisdiction whereas the final product is manufactured in another. Likewise, research and development [R&D] is done in say country ‘A’ but its output/innovation is used in country ‘B’.
This by itself renders the task of segregation ‘which activity happens where and the value thereof’ complex. Moreover, for such determination the authorities in the source country have to depend largely on the foreign enterprise ‘how the latter presents the accounts, where and how much revenue/expenditure is booked in each jurisdiction’. The exercise is made even more daunting due the MNCs intent to minimize their tax liability [or even reduce it zero] in the source country and resort to manipulation of accounts.
The global corporations are generally prone to showing bulk of their income as being generated from their offshore operations in low/zero tax jurisdictions e.g. Netherlands, Singapore etc. In certain cases, especially global technology companies in the internet space viz. Google, Face book, Twitter, Amazon etc, the enterprise does not even have a PE which is made possible by the very nature of such business being ‘digital’ ; hence need not have physical presence.
The problem has global dimensions afflicting almost all source countries resulting in denial of their legitimate tax dues running in hundreds of billions dollars. It is being addressed under the base erosion profit shifting [BEPS] – a framework agreement developed by the OECD [Organization for Economic Cooperation and Development]/G-20 countries to which India is also a signatory.
So, what is the way forward? How can tax recovery from foreign enterprises be maximized? How can it be done without inviting the charge of tax terrorism?
The government should operate on three major planks.
First, it should convincingly demonstrate that India has jurisdiction to tax income of MNCs. The definition of PE needs to be broad-based say by bringing the concept of ‘significant economic presence’ or ‘digital PE’ [DPE] to cover global technology companies in the internet space which operate remotely through the digital medium. This is in sync with overarching need to the capture the exponential growth in digital transactions and particularly e-commerce.
Second, for determining taxable income, it may avoid going deep in to the balance sheet [except in cases where the MNC has a subsidiary registered in India and statutory filing requirements will automatically throw up the details] which runs the risk of the I-T being labeled as tax aggressor and yet, may not yield significant gain in revenue. Instead, it may focus on broad parameters for arriving at a mutually acceptable basis for the quantum of income to be taxed.
Third, it may opt for a formula-driven approach involving three key factors viz. sales, manpower and assets – as recommended by the CBDT committee. However, instead of equal weight for each factor proposed by the committee, the weightage assigned to each may vary depending on the nature of business activity. For instance, in asset-light sectors such as IT [information technology]/IT-enabled services, manpower and sales should account for an overwhelming weightage.
For global technology companies operating [albeit remotely] through digital mode and generating income/profits from the activities of Indian users of the search engines, social media platforms, e-commerce marketplace etc, relying on the above three factors alone may not help in bringing out the contribution of India operations to their profits. So, the ‘user base’ in addition to sales, manpower and assets may be considered in the formula approach.
The committee has proposed setting a floor rate for profits derived from India ostensibly to protect revenue interests. In certain circumstances, when the foreign enterprise is incurring global losses, it suggests a minimum 2% of the turnover to be treated as deemed ‘profits derived from India’. The proposal is arbitrary and is patently devoid of any logic. How can an entity be taxed in any one country [India] when it is making losses in all jurisdictions?
To conclude, in an increasingly interdependent world wherein global corporations are deriving a good slice of their income from their operations in India – irrespective of whether they have physical presence in its territory or not – the Indian government has every right to tax such income. The tax rate may be in the 30-40% range being the rate applicable to large Indian companies and subsidiaries of foreign enterprises.
For arriving at the quantum of income/profits apportioned to India operations, it should go for a formula-based approach to be decided in consultation with all stakeholders including MNCs in an ‘open’ and ‘transparent’ manner. The rules and the process of determination should be clearly laid down so that the tax liability can be auto-calculated leaving no discretion to the taxman.