Should India have top-up taxes?

It could well be possible that Indian constituent entities (CEs) of an in-scope MNE group (mostly foreign-headquartered MNEs, but also domestic-headquartered MNEs) could be exposed to an effective tax rate (ETR) of less than 15%. This could be due to tax incentives or simply since the manner in which the ETRs are calculated are unique and specific to Pillar Two as laid out in the GloBE framework. In these scenarios, a question arises—should India introduce qualified domestic minimum top-up taxes (QDMTTs) irrespective of the fact that India already has a minimum alternative tax (MAT) of 15% on book profits? 

As a start, one should look at how taxes paid pursuant to MAT are treated for GloBE purposes. Consider the case of a foreign parent (company X) of an in-scope MNE group, as defined for the purposes of global minimum taxation under the OECD’s GLoBE framework,  headquartered in Country A, which has ownership in an Indian company (Ind Co). For the sake of simplicity, it is assumed that Ind Co does not pay corporate income tax (CIT) due to a tax incentive. Its book profits, after taking into account adjustments authorised under the Income Tax Act, amount to 100 and the MAT paid is 15. Of course, surcharge and cess need to be added but for the rest of this article we do not take them into account. Assume Country A has introduced an Income Inclusion Rule (IIR) in its domestic law. The formula to determine a jurisdiction’s effective tax rate (ETR) for the purpose of the GloBE rules (IIR or Undertaxed Profit Rule) is the adjusted covered taxes divided by adjusted GloBE income linked to India. The starting point to calculate adjusted GloBE income is the financial statements of Ind Co corrected by adjustments as provided under the GloBE rules. We assume that the adjusted GloBE income is 250. 

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One may ask why the adjusted GloBE income (250) is different from book profits (100) computed under the MAT provisions. This is because there are many differences between the list of adjustments authorised for MAT purposes and those authorised under the GloBE rules. More specifically, the GloBE rules provide for many mandatory adjustments (such as adjustments for transfer pricing outcomes). They also provide for taxpayer election-based adjustments (like the amount of deduction claimed for tax law purposes on employee stock options to the extent there is a difference with the expense reported for financial accounting purposes). Moreover, industry/sector-specific adjustments are also provided (special rules for banks and insurance companies). Thus, when company X makes its ETR calculations for India, any MAT paid in India will be treated as a covered tax for the purpose of the numerator (most likely). Thus, if the MAT is 15 and the adjusted GloBE income is 250, the ETR of Indian operations is 6% for the purpose of the GloBE rules. 

In this scenario, the top-up tax percentage under the GloBE rules will be 9% (15%–6%). The top-up taxes will apply to domestic excess profits. These are calculated by reducing a substance-based carve out from the adjusted GloBE income, which is calculated based on a certain percentage of payroll expenses and the value of tangible assets. If we assume that the carve-out amount is 50, the domestic excess profits amount to 200 (250–50). The top-up tax would then be 18 (9% of 200). If India does not introduce a QDMTT, the top-up tax will be collected by Country A under the IIR. On the other hand, if India enacts a QDMTT, this top-up tax can be collected by India. More specifically, taxes paid under QDMTTs are allowed as a deduction for taxes that are payable under the IIR. Thus, when company X makes its IIR calculation, the amount due under the IIR is zero. Thus, it is recommended that the Indian government introduces a QDMTT and this, hopefully, should form part of the forthcoming budget. In fact, the African Tax Administration Forum (ATAF) has already come out with proposed draft legislation on QDMTTs for many African States.

Maintaining the status quo may not be an appropriate course of action as top-up taxes linked to Indian CEs will then be collected by other countries and India will be deprived of its share. Of course, another alternative is to align the MAT provisions with the GloBE rules. For example, first, policymakers could extend the MAT provisions to all entities which could be considered to be CEs for the purposes of the GloBE Rules (like partnerships, LLPs, or trusts). Second, they could align the list of adjustments to compute book profit for MAT purposes with the GloBE rules so that there is symmetry between both sets of rules. Third, they could repeal the MAT credit carry-forward provisions as these credits would reduce the CIT liabilities of Indian CEs, which could then possibly lead to ETRs lower than 15% in the following years. 

However, one issue with this approach is that the MAT provisions currently also apply to entities of MNE Groups with less than a turnover of $750 million. A second issue is that the MAT rules follow an entity-by-entity approach and not a jurisdictional blending approach, which is provided by the GloBE rules. Another problem is that a sudden change to the MAT provisions could be considered as a “shock” for the broader taxpayer community unless the MAT provisions for the two classes of taxpayers are different. Thus, a complete re-think of the MAT system for all entities will be required and this of course requires detailed analysis. A discussion on rethinking the MAT provisions could be deferred to see how countries will react to QDMTTs. For example, assuming there is global agreement that CFC taxes are pushed down for QDMTT calculation purposes, other developed countries could start enacting broad based CFC rules. If they do so, then tax collections under the Indian QDMTT could be affected. In these circumstances, it is suggested that India responds proactively by revamping its MAT rules. On the other hand, assuming there is global agreement that CFC taxes are not to be pushed down for QDMTT calculation purposes, which should be the stance of a country like India and other developing countries, then enacting QDMTTs should be the way forward for large in-scope MNEs.