India and other developing nations will gain from the OECD Inclusive Framework on BEPS
In a watershed event, 136 countries have signed off on an agreement billed as one of the biggest tax reforms in decades. At the core of this multilateral effort is a minimum 15% tax on multinational corporations; the objective is to ensure they declare profits and pay taxes in jurisdictions where they do business. Increasingly, large corporations—especially technology giants—have been able to get away without paying taxes in their home jurisdictions, or even in markets in which they have large numbers of users. They have used tax havens to avoid paying tax on income from intangible sources such as drug patents, software and royalties on intellectual property.
Once the OECD Inclusive Framework on Base Erosion and Profit Shifting is in place, it is expected to generate over $150 billion in tax revenues, not an insignificant amount. Equally, it should put an end to tensions and minimise litigation arising from differences across nations.
Tax experts believe that if the OECD-BEPS structure works, multilateralism on tax matters could be here to stay. Moreover, they point out established principles may be sacrificed with the role of markets being accorded more importance in the scheme of things. Indeed, the new framework requires MNCs to cough up taxes for profits earned in markets where they may not have a physical presence. Also, the arm’s length principle of transfer pricing, they say, might not be adequate to allocate profits and that a different method may be required.
Until the fine print has been read, it’s hard to say how much countries like India will gain. Nonetheless, the OECD says, developing countries will be bigger beneficiaries from Pillar One than advanced economies, in terms of revenue gains as a proportion of existing revenues. Under this, taxing rights, on an estimated $125 billion of profits, would be reallocated to different market jurisdictions every year.
The government believes India would not be worse off in the inclusive framework. Most companies covered by Pillar One—MNCs that have global sales of over 20 billion euros and profitability over 10%—are doing business in India. New Delhi would like the 20-billion-euro floor to be lowered over time so as to widen the universe to include many more companies. Again, as per the new structure, the profit to be reallocated to markets will be calculated as 25% of the profit before tax in excess of 10% of revenue. India would like to see the residual profit allocation to market jurisdictions at more than 25% when the rules are reviewed.
While it appears India will need to dismantle its equalisation levy of 6%, it is unclear how much the net loss could be if the Google tax goes. The equalisation levy, imposed at 6%, fetched Rs 2,200 crore in FY21 and is expected to bring in Rs 3,000 crore in FY22. That apart, India will need to abolish the special economic presence (SEP) brought in this year to target multinational enterprises (MNEs) with a large consumer base but escaping the tax net. However, experts point out, India can top up the tax rate taxes to the 15% minimum, as stipulated under the rules in Pillar Two, if they are lower.
While India must ensure that joining the multilateral convention will not cost it too much in revenues, there are advantages to being a member of the club. At a broader level, if tax rules are aligned across nations and leave no room for disputes, India could attract foreign investments on a larger scale than hitherto seen.