15th October – A tax policy that could work

The Indian government should now be desperate to raise more tax revenues. It missed its tax targets massively in the last fiscal year, largely because of poor goods and services tax (GST) collections.


  • Government’s declared budgetary target for the current year requires tax receipts to increase by around 25%, when the first quarter increase was only 6% over the previous year.
  • To address the current slowdown is more tax relief to corporates, it has offered tax rate reductions to 25% of profits to companies that do not avail of other concessions, and further rebates to new companies.

Looking at MNCs –

  • Fortunately, there are measures that could provide significantly more tax revenues to the government. One obvious lowhanging fruit is a strategy to ensure that multinational companies (MNCs) actually pay their fair share of taxes.
  • It is well known that MNCs manage to avoid taxation in most countries, by shifting their declared costs and revenues through transfer pricing across subsidiaries, practices described as “base erosion and profit shifting” (BEPS).
  • Matters have got even worse with digital companies, some of the largest of which make billions of dollars in profits across the globe, but pay barely any taxes anywhere. The International Monetary Fund has estimated that countries lose $500 billion a year because of this. Also, it creates an uneven playing field, since domestic companies have to pay taxes that MNCs can avoid.

How the idea works –

  • The Organisation for Economic Co-operation and Development (OECD) has now recognised this through its BEPS Initiative. The basic idea is breathtakingly simple, and has been proposed by the Independent Commission for the Reform of International Corporate Taxation, or ICRICT.
  • The idea is this: since an MNC actually functions as one entity, it should be treated that way for tax purposes. So the total global profits of a multinational should be calculated, and then apportioned across countries according to some formula based on sales, employment and users (for digital companies). This is something that is actually already used in the United States where state governments have the power to set direct and indirect tax rates.
  • Obviously, a minimum corporate tax should be internationally agreed upon for this to prevent companies shifting to low tax jurisdictions (ICRICT has suggested 25%). Then, each country can simply impose taxes on the MNCs operating in their jurisdictions, in terms of their own shares based on the formula.

Key concerns –

  • The biggest problem is the arbitrary separation between what OECD calls “routine” and “residual” profits, and the proposal that only residual profits will be subject to unitary taxation. This has no economic justification, since profits are anyway net of various costs and interest.
  • Another concern is about the formula to be used to distribute taxable profits. The OECD suggests only sales revenues as the criterion, but developing countries would lose out from this because they are often the producers of commodities that are consumed in the advanced economies.
  • Instead, the G24 group of (some of the most influential) developing countries has proposed that a combination of sales/users and employment should be used, which makes much more sense.

Conclusion –

It is important for the Indian government to look at this issue seriously and take a clear position at the OECD meeting, because the outcome will be very important for its own ability to raise tax revenues.

SourceThe Hindu

QUESTIONGlobalisation has paved the way for Multinational Corporations to take undue benefits of tax provisions in several jurisdictions against the interests of domestic companies. Discuss.

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