14th October 2019- The Hindu Editorials Notes – Mains Sure Shot
Note: There is another article called ‘Chennai Connect’ but that has already been covered in detail in the past two days.
GS-2 & 3 Mains
Question – In the context of the scheduled OECD meet, what is BEPS, why is it important and how should it be dealt with?(250 words)
Context – The scheduled meeting of OECD.
- At present our economy is not at its optimal performance. There are slowdowns and the government is trying to deal with it through different measures.
- For example, various tax reliefs were given to companies to promote investment and hence capital formation.
- But is also the undesired result of this is that in the short run the tax collection of the government will be affected.
- The tax collection was already low and the government had missed the targets massively in the last fiscal year, largely because of poor GST collections.
- So while tax concessions might be good but to deal with the negatives certain measures can be adopted.
- For example, making the existing MNCs actually pay their fair share of taxes.
- But tax collection should not take the form of tax terrorism. Because this could be regressive and counter-productive in the slowdown.
What is a Multinational Company?
- A Multinational Company, as the name suggests, is a company whose business is not limited to any particular country. It operates in many different countries at the same time. It has business operations in multiple countries.
Tax avoidance by Multinational Companies:
- It is difficult to tax the MNCs because the business of a multinational company is not limited to one country.
- Also, the taxation of multinational companies is a challenging and complex issue because – countries want to make sure that corporations bear a fair part of the overall tax burden, but they also want to attract investment and jobs.
- For example, there have been debates about tax avoidance by multinational firms like Amazon or Starbucks.
- It is well-known that MNCs avoid taxation in most countries, by shifting their declared costs and revenues through transfer pricing across subsidiaries, practices described as “base erosion or profit shifting” (BEPS).
So what is BEPS?
- It is a tax avoidance strategy used by Multinational Companies.
- Tax avoidance strategy means making use of legal exemptions in the laws to make or pay less tax.
- In India we have large scale tax avoidance which is legal.
- In BEPS profits are shifted from jurisdictions that have high taxes example usa or western european countries to the jurisdictions that have low taxes (also called tax havens).
- BEPS can be achieved through the use of – transfer mispricing, DTAA (double taxation avoidance agreement), treaty shopping, inflating invoices, benami transactions, round tripping etc.
- According to the International Monetary Fund countries loose almost 500 billion dollars due to BEPS and tax havens.
- It also creates an uneven playing field for domestic companies, since they have to pay taxes that MNCs can avoid.
- OECD had started the BEPS project/initiative in response to the 2008 financial crisis.
- It is a project to devise ways to deal with BEPS.
- It was formally launched in 2012 by G-20 Finance Ministers who called on the OECD to develop an action plan to address the problem of BEPS.
- In 2015, the final report of the OECD’s BEPS project was submitted. It led out 15 action points to curb abusive tax evasion by MNCs.
- India is an active part of the BEPS project.
What can be done?
- As proposed by the Independent Commission for the Reform of International Corporate Taxation (ICRICT), since an MNC actually functions as an entity, it should be treated that way for tax purposes.
- Which means that the total global profits of an MNC 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 already used in the United States where state governments have the power to set direct and indirect tax rates.
- Following this example, 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 MNCs operating in their jurisdictions, in terms of their own shares based on the formula decided.
- What is required for this to work is all the countries coming toghter and agreeing to accept this approach. The Indian government has already proposed in a white paper that it cold take such unilateral initiative for digital companies.
- The OECD BEPS initiative is scheduled to meet on October 19th, to set out its own proposal, and for the first time, it is willing to consider the possibility of unitary taxation.
But there are some concerns:
- OECDs separation of profits of MNCs into “routine” and “residuary” profits, and the proposal that only residual profits would be subject to unitary taxation. This is arbitrary, complicates the process and no system of corporate taxation anywhere in the world makes such distinction.
- Another concern is about the formula to be used to distribute tax profits. The OECD suggests only sales revenue as criterion, but developing countries would lose out from this because they are often producers of commodities that are consumed in advanced economies. The G24 group of countries have proposed that a combination of sales/users and employment should be used, which will make more sense.
The most common practices identified in India from the BEPS perspective are:
- Excessive payment to foreign-affiliated companies.
- Aggressive transfer pricing
- Digital enterprises facing zero or no taxation in view of the principle of residence-based taxation
- Treaty shopping
- Incentives in the tax laws for attracting investment
- Assets situated in India but owned by companies located in low tax jurisdictions with no substance.
So what should India do/ Way forward?
- It should its domestic tax laws as well as tax treaties either through multilateral instruments being developed as part of BEPS project or bilaterally.
- It is also important for the Indian Government to take this issue seriously and take a clear position at OECD meeting because the outcomes of the meeting will be very important for its own ability to raise tax revenues.