India shifts international tax deal stand with an eye on revenue

India signing on the proposal, along with 129 countries, to bring only top 100 global companies under the digital tax deal has come as a surprise as New Delhi was so far pitching for a much lower threshold to cover around 5,000 international firms. 

But negotiations at the Organisation for Economic Cooperation and Development (OECD) finally saw India join the global pact for a multilateral solution to tax large digital companies like Google, Facebook and Netflix to ensure that these MNCs pay more taxes in countries where they have customers or users than from where they operate.

The proposed solution consists of two components. The first pillar is about reallocation of additional share of profit to the market jurisdictions. The second pillar relates to  minimum tax and subject to tax rules at 15 per cent. Estimates suggest that $150 billion of additional tax revenues should be mobilized under the second pillar.

India and other developing countries were fighting to include companies with at least Euro 1 billion in revenues as against the final proposal of Euro 20 billion revenues and a profit margin above 10 per cent. India’s proposed threshold would have covered around 5,000 global companies against just 100 companies under the finalised pact. 

However, the government has justified agreeing to a higher threshold to protect its own revenues from large Indian multinationals.

“The greater the threshold, the chances of Indian companies getting in there is that much smaller. Our idea is to see that our revenues are never impacted. We will protect our sovereign rights also and our tax revenues,” said a top CBDT official. The threshold will be reviewed after seven years to cut it to Euro 10 million.

The basic reason for this global digital tax regime is to pick up those companies that are taking opportunities in tax arbitration and the idea is to plug the loopholes, the official pointed out. The deal will come into effect starting 2023.

Most of the sales of Indian multinationals like Tata Consultancy Services (TCS) or Infosys are outside India and if all their profits are allocated outside the country, New Delhi could have lost revenue had the threshold been lower. “It is not the same with the US. Google is parking profits in Ireland, so the US will not lose any revenue from the deal,” said Akhilesh Ranjan, former India chief negotiator at OECD and former member CBDT.  

“The principles underlying the solution vindicates India’s stand for a greater share of profits for the markets, consideration of demand side factors in profit allocation, the need to seriously address the issue of cross border profit shifting and need for subject to tax rule to stop treaty shopping,” the ministry of finance said in a statement on Friday.

Some significant issues including share of profit allocation and scope of subject to tax rules, remain open and need to be addressed. Further, the technical details of the proposal will be worked out in the coming months and a consensus agreement is expected by October.

India has been fighting for taxing rights for source countries where the markets are on the basis of sales in their territories despite no physical presence. However, the outline of the proposal only talks about top 100 companies. For these companies, a portion of their profits would be taxed in jurisdictions where they have sales. Between 20 and 30 per cent of profits above a 10 per cent margin may be taxed. India will seek 30 per cent allocation. 

“It is good that allocation is being done partly on sales in market countries. That’s a positive that markets must also be taken into account. Now, the quantum of profits will depend on quantum of sales. That’s good for us. This is a formulaic reallocation, not transfer pricing arm’s length principle, what India had proposed,” said Ranjan, who is now an adviser at PwC.

India had proposed allocation of profits under fractional apportionment method, wherein the entire profit of the group will be apportioned to different countries in which the group operates through a formula, taking into account factors like employees, assets, sales, and users.

This is part of the proposed OECD Base Erosion and Profit Shifting (BEPS) framework to rework the traditional international tax system to make digital firms pay taxes regardless of their physical presence or measured profits in a country.

Base erosion and profit shifting (BEPS) refers to exploiting gaps and mismatches in tax rules to shift profits by multinational companies to low-tax regimes. Internet companies operate out of low-tax jurisdictions, but do business in several others without having a physical presence and end up avoiding taxes.