The Biden administration is giving a big push for a global corporate minimum tax (GCMT) rate under the new international tax rules being coordinated by it with G20 countries. In 2017, the erstwhile Trump administration had introduced the U.S. corporate offshore minimum tax called “Global Intangible Low-Taxed Income (GILTI)”. It is applied on the offshore income of US multinationals (MNCs) having subsidiaries in low-tax countries @ 10.5% which is half the domestic corporate tax rate (DCTR) of 21%. Biden wants to double GILTI to 21% and correspondingly increase the DCTR to 28%.
The US move is prompted by a tendency among MNCs (US companies included) to register in low-tax countries such as Singapore, Mauritius, Ireland etc and show their revenue and profits in those jurisdictions regardless of where their sales are made. This enables them to avoid paying higher taxes in the source country. The GCMT is intended to prevent this ‘tax base erosion’.
The US would want other countries to agree to a certain minimum tax say 21% so that American companies have no incentive to register their subsidiaries in low tax countries or so called tax havens; ensure that they stay back and tax revenue accrues to USA. Alternatively, if, a firm pays lower tax than this in a particular country, then its home government (read: USA) could levy tax equal to the differential (call it a ‘top up’) thereby eliminating the former’s advantage of shifting revenue and profits to a low tax jurisdiction. The administration will deny exemptions in respect of taxes paid, to countries that don’t agree to a minimum rate.
The problem arising from MNCs shifting revenue and profits to low tax jurisdictions also referred to as BEPS (base erosion and profit shifting) is afflicting most countries including India. India is affected in particular, by the actions of digital giants such as Google, Facebook and Amazon (all US based MNCs) who have investment arms in low-tax countries such as Singapore, Mauritius, Ireland etc. They invoice Indian customers via these offshore entities despite having significant revenue, users or paying customers in India even as their Indian entity is crafted more like a service company to the parent located abroad. This way, they book bulk of their revenues in the parent firm while a very small portion of service revenue is reported in Indian entity.
It results in a situation whereby these firms generate most of their profits from users located in India and yet don’t pay taxes to the Government of India (GOI). This anomaly can be corrected by taxing profits of MNCs in the country where their customers are. This position is endorsed by the Organization for Economic Cooperation and Development (OECD) which is coordinating with over 140 countries to arrive at the BEPS framework agreement for taxation of their profits.
In a draft on “taxing digital companies” released on October 9, 2019, the OECD had stated: “Profits of MNCs should be available for taxation in the country where their customers are, irrespective of any physical presence in that market, and that a formula should be evolved for such taxation.” Instead of taking it forward, the US is trying to foist on other countries the idea of a GCMT which it asserts will solve all problems related to erosion of tax base arguing that addressing it is technically simpler and politically less contentious. Its approach is flawed.
First, imposing a corporate minimum tax will interfere with the sovereign right of a country to determine ‘what should be its tax policy’ and impair its ability to galvanize the policy to achieve certain objectives. For instance, on September 20, 2019, the GOI brought about out steep reduction in the tax rate for new entities in the manufacturing sector (incorporated from October 1, 2019, and commencing production by March 31, 2023) from 25% to 15%. This was done with a view to attract investment (including foreign investment), give a boost to growth and create jobs. This objective will be defeated if under the GCMT regime proposed by the USA, India can’t lower its corporate tax to below a certain threshold say 21%.
The purpose would be defeated even when the home country of the MNC (read: USA) goes for the ‘top up’ option i.e. the Indian tax rate remaining at 15%, the former collects 6% tax on profits earned by the firm in India. The effective incidence of tax – in this scenario – being 21% (15% paid in India plus 6% levied by US), US companies will be deterred from investing in India.
Second, for preventing ‘erosion in tax base’, the only logical way forward for the Government in the source country where the profits are generated is to capture and tax them – as emphasized in the OECD draft. The GCMT can’t be a substitute for this. Taking the Indian example, levy of tax @ 21% – against the prevailing low of 15% (new manufacturing units) – won’t result in additional tax collection to fully offset the loss resulting from profit shifting. For instance, if out of Rs 100/- only Rs 20/- is recorded in India, the extra revenue from higher rate will be only Rs 1.2/- (20x.06) against a loss of Rs 12/- due to profit shifting (80×0.15).
Third, the US move is an attempt to garner more revenue without at the same time, undermining its own tax competitiveness globally. In other words, the Biden administration wants American companies to stay back even while taxing them at high rates. This is like the proverbial ‘have your cake and eat it too’.
Despite the inherent flaws, the US is overwhelming focused on steering a case for GCMT @21% – double the extant 10.5% GILTI under its 2017 law while at the same time, maintaining stony silence on the more important issue of ‘taxing digital companies’ that concerns a vast majority of developing countries including India and a consensus already reached among the 140 countries involved in the negotiations on the BEPS framework agreement of the OECD.
The US should refrain from pursuing something that is neither desirable nor workable. Telling sovereign governments to go for a uniform tax at the lower end is a flawed idea. Instead, the focus should be on adopting a uniform policy for combating the unhealthy practice of shifting profits and evading tax payment in a jurisdiction (read: source country) where it is due. The OECD draft (2019) suggests the way forward.
In the context of taxing digital companies, a committee set up by the Central Board of Direct Taxes (CBDT) had mooted the concept of digital permanent establishment (DPE). As a follow up, in the Finance Act 2018, the GOI proposed that “such offshore firms should be taxed in India if they have a market presence above a threshold to be defined in terms of their customer base and revenue.”
A consensus should be built around a criteria for arriving at the annual revenue/profit from all such transactions (not just digital) of an offshore firm taking place in the source country but recorded in an offshore (albeit low) tax jurisdiction and letting the former collect tax on it. The source country should have the freedom to decide the tax rate on those profits in sync with its policy imperatives.