On July 1, India, along with 130 other signatory states to the OECD’s BEPS (Base Erosion and Profit Shifting) framework, agreed to make changes to its corporate tax framework. The move was spearheaded by US Treasury Secretary Janet Yellen, who over the past few months has been trying to build consensus between countries on this proposal.
Countries that have come on board include the G7, many emerging economies and even some low-tax countries like Switzerland, Singapore, Bermuda and the Cayman Islands. Some like Barbados, Ireland and Hungary did not sign the proposal.
Much remains to be done before these proposals are implemented in 2023. At first glance, however, the minimum corporate tax proposal seems beneficial for India, while the digital business tax proposal will require some tough negotiations.
Pillar one of the agreement applies to multinational companies (MNEs) with a profitability ratio (PBT / turnover) over 10 percent and a worldwide turnover of 20 billion euros. About 20-30 percent of profit, which exceeds the normal return of 10 percent of sales, is allocated to the countries where the sale takes place. Extractive industries and financial services are worked out from these rules.
As part of the second pillar, the signatories have agreed on an effective minimum tax rate of 15 percent. Companies with a worldwide turnover of more than € 750 million are covered by these rules, while countries can decide to tax smaller domestic MNEs as well. This does not apply to pension funds, holding vehicles and international shipping services.
Benefits from the 2nd pillar
The attached table shows that India is one of the higher effective tax rates at 30 percent. While the corporate tax rate in India was lowered to 22 percent in 2019 for companies that want to forego any tax incentives or deductions, the effective tax rate remains high and not too many companies are opting for this leeway. The levies and surcharges further increase the effective tax rate. The tax rate in India also remains above the global and Asian average. Adopting the proposed 15 percent tax will give the government ample scope to cut tax rates in the future if necessary.
Surprisingly, many of the advanced economies, including the US, France, Germany, and Japan, levy very high corporate tax rates, causing MNEs to relocate their base to low-tax countries. In fact, the corporate tax rate in the US was a whopping 40 percent until Trump lowered it to 27 percent in 2017. The ongoing attempt is due to the Biden government’s desire to raise corporate tax again.
Since the Indian government is also losing revenue due to the innovative tax regimes of the MNEs operating in India, such a minimum tax can also help the Indian tax authorities.
Need tough negotiations
The US was pretty excited about Pillar 2, but it has been lukewarm by Pillar 1, which affects many of the large US-based digital MNEs. In the not too distant past, the US administration has backed its digital companies like Google, Amazon and Facebook against digital taxes levied by countries like India.
The Indian authorities must therefore carefully weigh the consequences of the 2nd pillar. There are three main problems with these proposals. First, it mainly applies to larger companies with a global turnover of over 20 billion euros. The smaller e-commerce operators do not fall under these rules.
Second, the tax is only levied on additional profits greater than 10 percent of the income. With many of the retail and e-commerce businesses operating at razor-thin margins and many of them making losses, it is debatable whether additional profits should be taxed. The US will likely retain the right to tax the greater part of these companies’ profits.
Third, if India abolishes its countervailing levy after these rules are in place, it will not have the tool to tax the medium and small digital MNEs. It needs to be examined whether India can retain the right to withholding tax from other smaller digital MNEs.