How Base Erosion and Profit Shifting can be avoided

Introduction

The government levies a tax on multinational corporations based on a proportion of their earnings or income. The multinational corporation sends its money or profit to another country, which may be a tax haven, by exploiting loopholes. As a result, the country that assists the multinational firm in generating revenues receives no tax or suffers tax erosion as a result of the corporation's shifting of income or profits.

This becomes headache for tax jurisdictions as MNCs transfer their taxable income to tax heavens which tax minimal or even negligible amounts on profits of companies.?

The issue has been a matter of critical debate in the arena of International Taxation and it gained limelight when Organisation for Economic Cooperation and Development presented a deal for ‘Global Minimum Corporate Tax’. While the proposal has been a subject of intense debate relating to jurisdictional issues, compliance issues etc, this article focuses on BASE EROSION AND PROFIT SHIFITING ( BEPS) and how it can be addressed in contemporary times or particularly with respect to India.?

How BEPS works?

There are ample numbers of ways through which MNCs may transfer huge percentage of their profits to tax heavens (jurisdictions which charge low percentage corporate tax).?

In Thin Capitalisation, MNC incurs a huge amount of loan to finance its operations at a very high loan servicing rate from a foreign company housed in Tax heavens. Incidentally, the loan provider also happens to be the associated company or parent company of the MNC.?

In Patent Box regime, the MNC transfers all its Intellectual Property (IP) rights to another company. As part of royalty cost, MNCs transfer huge amount of Profits to tax heavens.

The transferred funds are supposed Profits for the foreign companies housed in tax heavens. Since, the tax jurisdictions don’t charge much on these profits, Entrepreneurs and owners run free without having their kitty cut by corporate tax.?

These are the most common kind of ways for BEPS, other ways include Double Iron Dutch Sandwich etc.?

Cost of BEPS

As per OECD, BEPS techniques cost nations 100-240 billion dollars in lost revenue each year, which is 4-10 percent of worldwide corporate income tax collection.

According to a research conducted by Tax Justice Network titled "The State of Tax Justice 2020," governments lose billions of dollars each year due to tax avoidance by multinational corporations and wealthy wealth hoarders. According to the survey, India loses about Rs. 70000 crore every year due to tax evasion.

India’s stance

An 'equalisation charge' of 6% on payments above Rs 1 lakh to online ad providers from non-resident businesses was imposed in the Union Budget 2016.?Economy multinationals with Indian branches, such as Facebook and Google, will be particularly affected.

India implemented the key features of the Country-by-Country reporting requirement in the Indian Income Tax Act, 196, which took effect on April 1, 2016. The CbCR must be reported by an Indian affiliate of a foreign-parented group or an Indian parent firm, according to Section 286(2) of the Indian Income Tax Act.

Former Finance Minister Arun Jaitley signed the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (BEPS) in Paris on June 7, 2017. For bilateral tax treaties, the framework's rules will take effect in 2020-21.

BEPS Project

As of November 2021,? 141 countries and jurisdictions are working together in the OECD/G20 Inclusive Framework on BEPS to implement 15 Actions to combat tax evasion, improve the coherence of international tax rules, ensure a more transparent tax environment, and address the tax challenges posed by the digitalisation of the economy.

Global Minimum corporate Tax (GMT)

GMT is designed to address some of the world's largest firms' low effective tax rates, particularly Big Tech giants like as Apple, Alphabet, and Facebook.

These businesses generally use complicated webs of subsidiaries to syphon revenues out of major markets and into low-tax jurisdictions like Ireland, the British Virgin Islands, the Bahamas, or Panama.

GMT aims to limit the chances for Multinational Enterprises (MNEs) to engage in profit shifting by requiring them to pay at least some of their taxes in the countries where they operate.

Intangible revenue from medicine patents, software, and intellectual property royalties is increasingly migrating to Tax Havens, allowing firms to avoid paying higher taxes in their traditional home nations.

With finances squeezed in the aftermath of the Covid-19 crisis, many governments aim to deter corporations from moving earnings – and tax income – to low-tax nations regardless of where their sales are produced.

According to the OECD, the minimum tax will raise an additional $150 billion in worldwide tax collection per year.

The two-pillar package, which has been in the works for much of the last decade and has been coordinated by the OECD, aims to ensure that large multinational enterprises (MNEs) pay tax where they operate and earn profits, while also providing much-needed certainty and stability to the international tax system.

With respect to the largest MNCs, particularly digital enterprises, Pillar One will ensure a fairer division of earnings and taxing rights across nations. It would re-allocate some taxation powers over MNEs from their home nations to markets where they conduct business and make profits, regardless of whether the companies have a physical presence there.

Pillar Two aims to level the playing field in corporate income tax competitiveness by establishing a worldwide minimum corporation tax rate that nations can utilise to safeguard their tax bases.

The two-pillar plan will give much-needed assistance to governments who need to earn money in order to repair their budgets and balance sheets while also investing in critical public services, infrastructure, and measures to improve the strength and quality of the post-COVID recovery.

Challenges for GMT

Getting all of the main countries on the same page, especially because the treaty infringes on the sovereign's prerogative to decide on a country's tax policy. A worldwide minimum rate would effectively eliminate a lever that countries might employ to impose policies that suit their needs.

It would be extremely difficult to persuade smaller, tax-haven countries to relinquish their sovereign right to tax and join a worldwide minimum corporate tax movement.

It would not be very wrong to say that tools available for smaller countries to attract foreign companies to their domestic territories are not numerous but very few. Bringing in Global Minimum Corporate tax would set all countries in globe at same pedestal, i.e., Developed and developing countries to tax at same rate, then Developed Countries would have a clear advantage due to better infrastructural, financial capabilities. On the other hand, smaller countries basically leverage the competition with developed countries only against lower tax slabs.?

Conclusion

The Global minimum tax must be effectively implemented elsely it would be necessarily reduced to a mere paper proposal. OXFAM has called the Global minimum corporate a mockery.

The notion of repairing a GMCTR is a good one, but it must be done in such a way that it is transparent and does not entail individuals hunting for loopholes to exploit.

The application of the new international tax standards, including the Digital Services Taxes, should be coordinated appropriately. Low-tax countries and tax havens must be fairly compensated or else an arrangement needs to be agreed into which confers leveraging rights to attract global enterprises to Smaller countries against Developed Countries.?