While tax tinkering will continue to dominate the discourse at least till the Budget, one question hangs in the air: has ‘tax terrorism’ abated at all? As we survey the global economy, the two things that stand out is the evolution of digital economy, and the consistent tug-of-war between multinational corporations (MNCs) and tax authorities on the adequacy of taxes paid in each country they operate.
Enhanced digital economies across the world have virtually created a borderless world where the physical presence of companies has lost relevant.
The role of tax havens where servers can be located makes the task of a tax authority even more difficult. The debate on where MNCs should be taxed has grown interesting. The largest economies have been reducing their tax rates so as to be competitive. The expectation is that low tax rates will ensure compliance and encourage MNCs to repatriate profits to the country of residence.
A December 2019 study (bit.do/fnLTv) by the US-based Institute on Taxation and Economic Policy (ITEP) shows that 91 of the Fortune 500 US companies paid zero tax, and managed to get around the 21% tax rate in the US successfully.
Nowhere is the tussle to get their tax equivalent ‘pound of flesh’ between countries more evident than in the taxation of the digital economy. The traditional concept has been that a foreign corporation can be taxed only in the country of residence, unless it has a permanent establishment (PE) in another country. India has advocated that the traditional concept of PE has no relevance in the context of digital economy.
When the late finance minister Arun Jaitley proposed the charge of an equalisation levy (EL) on digital advertising transactions irrespective of a PE in the Union Budget on February 29, 2016, India faced flak from the global corporate community. As time passed, more and more countries adopted the EL concept, although at arate of tax lower than that of India.
Cyber Biz, Digital Tax
When France announced a similar levy, US President Donald Trump called it a measure that US MNCs could be taxed only in the US. Also, India has advocated that it offers a huge market to MNCs and the profits they make cannot be delinked from the fact that without the market, the profits may not be made, and that the existence of a PE is irrelevant.
Subsequently, OECD member States set up a committee to review the existing tax architecture, and recently came up with recommendations, accepting India’s point of view that physical nexus was not relevant for taxation. While the overall frame of taxation of digital transactions is still being worked out, the acceptance of the proposition that taxability can be linked to markets is a big step in a new direction.
Responding to the use by MNCs of structures across jurisdictions to help them reduce their overall tax rate, the OECD has come out with an even more radical set of recommendations.
Every company has to pay tax at a minimum (yet to be prescribed) threshold rate. If it escapes tax, or pays tax below the threshold, four alternatives have been prescribed on how tax at the threshold rate can be charged.
These include denying tax treaty benefits that are otherwise available. These quite radical proposals are, at this stage, merely recommendations, and need to find acceptance by member countries. But when accepted, they may provide a common tax platform that will be acceptable globally.
Structuring transactions with a view to mitigating taxes in one country may not find favour if, ultimately, tax has to be paid in the country of residence at a threshold rate. The proposals will not be easy to implement, given that they envisage a level of transparency and cooperation between governments and a uniform appreciation of facts. However, when the dust settles, this could truly be the end of the perennial ‘cat and mouse’ game played between taxpayers and revenue collectors.
While all these developments are taking place, India has implemented its own tax changes — reducing the effective rate of corporate tax from 35% to 25.17%, without benefit of deductions and exemptions. For new manufacturing companies, there has been a further effective tax rate of 17% in a bid to make it more attractive for US MNCs to move their manufacturing base from China to India.
App-Happy to Tax-Happy
As it happens, we mistake tax rate rationalisation as being tax reforms.
True tax reforms come in only when the tax administration is perceived to be judicious, consistent and even handed. As of now, we continue to see revenue officers chase targets, additions being made to collect revenues and a long litigation route. The proposed e-assessments will see an era of faceless interface between the taxpayer and revenue collection.
The doing away of the dividend distribution tax (DDT) and rationalisation of capital gains tax should usher in welcome changes in the ensuing Budget.
The writer is CEO, Dhruva Advisors