End of tax dodging

Largely unnoticed, India has come out strongly supporting an international initiative for plugging tax avoidance by multinational corporations (MNCs). The initiative has been endorsed at the last meeting of G20 finance ministers at Cairns in Australia. 

Known as the Base Erosion and Profit Shifting Project (BEPS), this initiative tries to capture the moves of MNCs to shift their corporate bases to avoid paying tax in one country and move their corporate tax headquarters to other jurisdictions. A closer look at the various elements of the BEPS indicates that other forms of tax shopping by MNCs would also be captured under the proposed new tax regime, including treaty shopping. This new regime would thus make it easy to deal with issues which India had been grappling with of late – like taxing overseas sale of assets located in India, belonging to two overseas companies.

The BEPS has four major elements: 
First, the agreement proposes to reduce discrepancy between where a firm does most of its business and where it pays most of its taxes.

Secondly, the agreement looks at “transfer pricing” which is one of the main instruments for shifting profits from one jurisdiction to another in the form of arbitrary pricing of inter-firm sales of goods and services.

Thirdly, it is aimed to stop what is known as “treaty shopping”. That is, taking advantage of treaties although a firm is not a resident of either of the countries party to a treaty.

Fourthly, it will make it illegal to practise “hybrid mismatches”, that is, classifying financial instruments as debt or equity in different countries for getting advantages in tax treatment. 

But finally, the BEPS Project seeks to establish an information network among countries to share information on the operations of multinational enterprises (MNEs) to find out tax dodging. 

However, nothing happens unless some US interests are hurt. So, for the present, stopping shift of corporate headquarters for tax advantages is the main focus. This was tried by Pfizer, America-based world’s largest drug company, while it proposed merger with Astra Zeneca of the UK. 

Following merger, Pfizer’s tax base would have shifted to the United Kingdom while its corporate headquarters effectively remained in USA. A host of other companies are also proposing to shift their tax headquarters across the world to avoid high rates in one country and take advantage of  tax havens or certain concessions elsewhere. 

The US tax authorities have already moved against such practices of large multinational corporations on the ground that this leads to erosion of tax base of a country. President Barack Obama is reported to have observed on this phenomenon: “I don’t care if it is legal. It is wrong.” The companies involved also dodge paying taxes while at the same time taking advantage of various other concessions given to them in the form of tax breaks for research and development work, use of R & D products from its society (like from universities) and other social advantages.

MNEs spend huge sums for getting legal advice on tax avoidance. The process has been aided and abetted by large Wall Street banks, advising on mergers and acquisitions. Some estimates put the fees for such move-overs at close to $1 billion in the next three years. Goldman Sachs, JP Morgan Chase and Citibank are the triad who are reportedly active in this business. 

The move is unexceptionable on legal grounds and banks’ position is that just as you can shop at the cheapest price, companies should have the right to choose the lowest tax rates.. Any company can lawfully shift its base of operations at its own choice for any gain. However, large scale shifting can affect the local economy and create unemployment as well.

US corporate tax rate is 39 per cent on global profits of its companies. But when an American company chooses to move out of the country, it does not have to pay tax on its incomes in other countries at that rate. Since corporate tax rates are lower, in India for example, it pays to move out of US and set up its tax headquarters within a lower tax jurisdiction. In fact, the Pfizer-Astra Zeneca case had created some discomfort between the US and its most loyal ally, the United Kingdom. The UK is seeking to become a kind of tax haven to attract companies to move into that country. 

The International Chamber of Commerce is also seized of the matter and has done some exercises on the implications of these moves. ICC has however concluded that any restrictions on the freedom of the MNEs to move their bases would affect their operations. This can undermine their efficiency and financial planning. Above all, such restrictions would affect cross-border mergers and acquisitions, ICC has argued. 

For India, “profit shifting” moves could be beneficial. Lower tax rates, if we adopt that strategy, might just as well bring in some large MNEs. After all, these are high-stake games and any such move is good. The BEPS project is not exactly to the advantage of an emerging economy country. But for India the attraction is that once the other provisions like stopping “treaty shopping” would mean we should be able to avoid the kind of embarrassment we had recently. 

As India goes increasingly global, allowing more multinational companies to come into the country, the issue of their taxation would come to the fore. Companies with multiple bases of production could easily use the transfer pricing route for siphoning out incomes and avoid paying due taxes in this country. To have accepted global protocols could be useful in such cases. 

While supporting the BEPS project,  Nirmala Sitharaman, minister of state for finance, stated that the G20 ministers should also take certain interests of the emerging economy countries on board while finalising the BEPS agreement. She pointed out that the agreement as it was visualised now carries provisions regarding compulsory arbitration or adjudication in international forums. Such provisions could hurt the emerging and developing countries. These might prove to be costly and the developing countries would not often have the technical expertise to pursue such costly litigation abroad. Further, such provisions went against the sovereign rights of the countries as well.

At any rate, taxation of company profits by government and tax planning – which in effect means minimising incidence — by companies are on-going slugfests. In that competition it is difficult to keep pace with the latter.

The author is a Delhi-based analyst and commentator