You are here: Home » Opinion » Columns
Business Standard

Parthasarathi Shome: Are corporations an enigma?

A mix of good and bad behaviour makes MNCs difficult to understand

Parthasarathi Shome 

Corporations, in particular MNCs, are viewed as messengers of deceit by a majority of people worldwide. They are believed to destroy the environment while making sky-high profits for themselves; it is perceived that top corporate managers look out for themselves rather than for shareholders; and it is thought that corporations behaviourally avoid tax by provisioning for losses that they themselves cause — not only for themselves, but for their entire economy, if not the global economy in the case of MNCs. Recently, cases of fraud in various forms – Ponzi loan schemes, insider trading and other forms of information-peddling and illegal interest rate-setting – have rubbed their reputation in the dust. But do all corporations behave in this detrimental manner? It is crucial to divide the corporate world in two — financial and real. The former’s behaviour at the level of international finance has been reprehensible. The latter, by and large, has driven economic growth through innovation and investment, though some have indeed strayed.

In an early study, the Boston Consulting Group demonstrated how corporations expanded through eliminating inefficient competition and gave lower product prices back to consumers that, in turn, reflected reinvested corporate profits in research and technology. The aluminium industry provided a case study. The automobile industry would be another example. The corporate legal form itself emerged as a shelter that protected the corporation from unlimited liability so that production and supply could continue with a reasonable degree of assurance that productive activity would continue without looking over one’s shoulder to cover for unreasonable claims of compensation from aggrieved parties.

With the emergence of large corporations as identifiable entities, it became convenient to tax the incomes of corporations. Often a point is missed out on the philosophical basis of corporate income taxation. Recall that a value-added tax (VAT) is exactly the same in its effects as a retail sales tax. The worldwide popularity of the VAT is because it is a better tax collector. Instead of focusing only on the retail stage and thereby incurring the possibility of not being able to target and collect sales tax from small retailers, the VAT collects the same tax in small amounts as the full retail value builds up in the process of production and distribution. Thus missing out the final retail stage would still ensure revenue from earlier stages. Further, if one stage is missed, it is made up in subsequent stages.

The corporation income tax is to be viewed in a similar light. The corporation is a legal entity that conveniently acts as a conduit for the individual income tax. Ultimately, it is the individual who bears the burden of income taxation since he is the economic agent who earns income – salary, interest, dividends/profits, capital gains – though quite a bit of it is channelled through corporations. There are many more corporations than individuals. Hence it is simply easier to collect tax from the former than from the latter. Otherwise, income tax would be collected entirely from individuals. I will elaborate conceptually below.

Given the reality that the corporation income tax does exist and possesses a significant stature in country tax systems, a big question that has been debated is who really bears the tax. Is it consumers or producers? Many economists believe it is incorrect to view the problem in this manner, since the tax is a tax on capital, which is an input or factor of production. Hence the right question is whether the tax is borne by capital owners or shifted to labour (who are both, in the final analysis, individuals).

Are corporations an enigma?Note further that the corporate income tax is a tax on capital in the corporate sector alone. Thus it is a “partial” tax. As a result of this tax, capital moves out of the corporate sector. It has to be absorbed into the non-corporate sector. But the latter sector is generally more labour-intensive. If it is forced to absorb capital, it will do so only at a price of capital lower than its price when the tax was imposed. Hence the return to capital will have to fall relative to wages. Thus conservative tax economists claimed that the tax is borne entirely by capital.

But, given that the non-corporate sectors – including agriculture and real estate – are the major land-intensive sectors, some economists viewed land as a specific input used mainly in the non-corporate sector. Its use in the corporate sector was small by comparison. For the sake of analysis, then it is not just labour and capital but also land that should be considered as a factor of production. And, because land is fixed and cannot move like labour or capital, it is obliged to absorb some of the burden of the tax, sharing it with capital. Thus both capital and landowners share the burden of the corporation income tax. To the extent that labour cannot flee, labour too might bear some of the burden. The actual division of corporate tax burden depends on whether, post-tax, they are easily absorbed in the non-corporate sector. If they are easily absorbed, they will not bear much of the tax; if they are not easily absorbed, they will bear a high burden.

Thus, corporations tend to bear at least some or most of the tax burden in their role as capital owners. It is not surprising that they go out of their way to devise structures that enable them to minimise tax. They use the term “tax efficiency” which implies that they should not pay more tax than they need to. To counter excessive such behaviour, tax authorities design rules to minimise corporate tax avoidance. Thus, the UK and India are currently consulting on the matter. These rules are important and necessary, and the challenge is to design them in a way that they eliminate abusive taxpayer behaviour while not inadvertently introducing barriers to investment or inducing capital flight.

Again, this type of corporate behaviour must reflect that they at least believe that they have to bear the burden of corporate tax unless they form complex structures to avoid it. Of course they claim that such structures emerge due to market-driven business reasons. Interestingly, the evolution of extremely complex transnational corporate structures is leading corporations themselves to increasingly attempt to control and minimise the spread of their organisational structures. This takes the form of corporate simplification that comprises consolidation, reduction of costs, and enhancement of cash flow. Simply put, it combines the benefits of legal entity reduction and business transformation, and a general preference for converting subsidiaries into branches of a single entity.

Typical corporations work to produce, supply and innovate, with innovation resulting in keeping prices in check, and they do pay tax while, like individuals, they also minimise their taxes. If abusive, institutions should be set up to monitor and counter such behaviour through regulation, imposing appropriate penalties, and taking even stronger action where needed. The mix of good and bad behaviour makes the corporation an enigma — though, as a legal form and function, they should not be automatically considered to be so.

The writer is director and chief executive, Icrier. These opinions are exclusively his own

Dear Reader,

Business Standard has always strived hard to provide up-to-date information and commentary on developments that are of interest to you and have wider political and economic implications for the country and the world. Your encouragement and constant feedback on how to improve our offering have only made our resolve and commitment to these ideals stronger. Even during these difficult times arising out of Covid-19, we continue to remain committed to keeping you informed and updated with credible news, authoritative views and incisive commentary on topical issues of relevance.
We, however, have a request.

As we battle the economic impact of the pandemic, we need your support even more, so that we can continue to offer you more quality content. Our subscription model has seen an encouraging response from many of you, who have subscribed to our online content. More subscription to our online content can only help us achieve the goals of offering you even better and more relevant content. We believe in free, fair and credible journalism. Your support through more subscriptions can help us practise the journalism to which we are committed.

Support quality journalism and subscribe to Business Standard.

Digital Editor

First Published: Mon, July 16 2012. 00:28 IST