Gaps in tax reform

Details of new global agreement will need to be scrutinised

A long process of negotiations, initiated by the Organization for Economic Cooperation and Development (OECD) and the G-20 grouping of large economies, has come to an end with agreement on the taxation of multinationals. The impetus for this agreement is, in particular, the digitisation of the global economy, which makes it harder to pin down a tax base; the long process to end base erosion and profit shifting (BEPS) has come to this conclusion. About 130 countries, including India, have agreed in principle. This global tax agreement has two pillars. The first is that a proportion of the “supernormal” profits — where normal profits are defined as 10 per cent over revenue — of the multinational groups with a turnover over 20 billion euros will be distributed among those countries that provide their markets, and not just be taxable in whichever jurisdiction that they are technically based. The second pillar is on a global minimum tax, which in essence will be a 15 per cent minimum corporate tax in order to disincentivise companies from shopping around for “home” jurisdictions that provide them with low tax benefits — basically, an anti-tax haven device.

It is easy to see why this is an attractive solution for some. The Democratic administration in the United States, for example, has said this will end a “30-year race to the bottom” in terms of corporate income tax, which it has said has been deleterious for its tax base. Agreement might have been harder to find earlier if not for the fact that many countries that serve as markets for large digital multinationals in particular feel that they are unable to tax them effectively because they are domiciled elsewhere. This was the impetus behind the “equalisation levy” that India had developed — basically to target American multinationals like Google’s parent company, Alphabet. The equalisation levy has been among the greatest sources of friction with the US over trade in recent years, leading to investigations and threatened tariffs from the US trade representative under both Republican and Democratic administrations. The revenue it has brought in has also been remarkably little: Just Rs 4,000 crore in its first four years of operation from 2016-17. It is hardly surprising that the government is happy to find other ways to tax digital companies. Even so, many tax experts have questioned whether Pillar One of the agreement, which distributes supernormal profits, is sufficient. Some estimates suggest that under 1 per cent of Alphabet’s profits, for example, will be distributed to all countries in the Asia Pacific region. Meanwhile, Amazon — which does not make supernormal profits — may not even qualify under this agreement.

In order to gain this access to a tiny fraction of digital profits, what have countries like India given up? It is all very well for countries like the US to talk about a “race to the bottom”. But tax competition is crucial arsenal for developing economies that are chasing investment. The minimum rate of 15 per cent may need to be re-examined in the future. India’s current corporate tax rate may not fall afoul of Pillar Two, but questions remain about whether incentive mechanisms and alternative tax rates might be ruled out by the eventual implementation of the scheme. India must be careful when negotiating the details.