Since India does not offer tax arbitrage opportunities to foreign companies, which, instead, are attracted to its large domestic market, its large pool of trained and relatively cheap manpower, its technical prowess and its strategic location, the new G-7 pact on corporate taxes is likely to help India in the long run.
Here’s another reason why multinational corporations and other foreign investors will continue to pour money into India. The recent agreement among G7 countries on a 15 per cent minimum corporate tax rate will have no impact on foreign companies operating in India and could, in fact, help attract firms operating in low tax jurisdictions only for the tax arbitrage opportunity.
Several rich countries, including the US and the UK have reached this landmark pact to force companies such as Apple, Google, Amazon and others that route their profits through tax free or low tax jurisdictions with which their home countries have double taxation avoidance treaties to lower their tax burden and increase their pool of profits.
Result: This will lead to the accretion of several hundred billion dollars a year to the tax revenue streams of countries such as India, the US, the UK and others and rob many tax havens of their attractiveness as investment destinations.
This is how it works currently: Company A, which owns valuable intellectual property such as drug patents, software or other such intangible assets register them in countries such as Luxembourg, Dubai, Liechtenstein, The Netherlands and similar low or zero tax countries and then sell the underlying products or services around the world. The profits, thus, accrue not to the parent company in the US or UK or India but to the company registered in the offshore jurisdiction. Thus, the companies avoid paying higher taxes in their home countries, which are deprived of the tax revenues that should have accrued to it.
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For example, if Company A above pays, say 5 per cent tax in the country in which its IPR is registered, it will now have to pay the difference between the tax paid and the minimum tax rate, or 10 per cent, in its home country. This will disincentivise it from setting up subsidiaries in low tax countries solely to gain from the resulting tax arbitrage.
In May, the Organisation for Economic Cooperation and Development (OECD), a club of rich countries, said most governments agree on the need for and design of such a minimum corporate tax but there is still a divergence of opinions over the exact rate. However, the G7 consensus over the 15 per cent rate is expected to create a strong global momentum in its favour – even though many low tax countries are expected to oppose it.
The question of whether this minimum tax rate will apply only to manufacturing and services companies or if it will also be imposed on investment firms and real estate investment trusts has been left open ended and will be the subject matter of future negotiations.
In September 2019, Indian Finance Minister Nirmala Sitharaman cut the country’s corporate tax rates to 22 per cent for existing companies and 15 per cent for companies that set up new manufacturing facilities subject to certain conditions. In the light of this, many leading tax experts are of the view that India will continue to attract investments, especially as it is a massive market for many of the world’s leading technology and manufacturing companies – unlike many Caribbean countries or nations like Ireland and the Netherlands that depend on lower taxes to attract investments.
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Other factors contributing to India’s attractiveness include the availability of skilled labour at relatively cheap rates, the country’s strategic location bang in the middle of the sea routes between the Middle East and Southeast Asia and the Far East and the existence of a thriving private sector.
The Indian exchequer is also likely to receive more taxes as many of these companies route their investments through various low tax countries. India will, thus, have the right to mop up the differential between the tax paid and the minimum global rate, subject to there being a digital imprint.
The case for a more universal agreement on a minimum global tax rate for the corporate sector will come up at the upcoming meeting of the G20 in Venice. The group will deliberate on the matter and also on the precise architecture to decide how this tax can be implemented and to which companies it will apply.
For now, the new global minimum tax will be another positive for India.