New G7 Proposals on Taxing Multinationals: Implications for Foreign Entities, Digital Companies in India

The G7 tax proposals, if approved globally, will impact India’s taxation of foreign or non-resident companies and digital enterprises without a physical presence. The proposals call for a global minimum corporate tax rate, puts forth a formula for taxation, and demands the elimination of digital services tax or equalization levy. India and other countries will be assessing if the gains from the measures, intended to prevent international tax avoidance, will suffice or prove more costly.

On Saturday, the Group of G7 advanced economies – US, UK, Germany, France, Canada, Italy, and Japan – announced two major proposals that will impact the tax liabilities of multinational companies.

These proposals, namely taxation based on area of operation and the provision of a minimum corporate tax rate, could have revolutionary consequences for several countries, especially those that serve as tax havens, including the Netherlands, Ireland, and Luxembourg and some countries in the Caribbean.

After all, some of the world’s largest corporations like Apple, Google, Nike, Facebook, Starbucks etc. effectively pay very little in taxes, by setting up a network of subsidiaries incorporated in jurisdictions that have low tax arbitrage to move their profits out of their major markets.

The G7 proposals are now set to be examined by the G20 countries meeting at Venice in July, which include India and China.

Meanwhile, the Organisation for Economic Cooperation and Development (OECD) is expected to reach a consensus on an inclusive framework on base erosion and profit sharing (BEPS) by October this year. The OECD comprises of over 130 members.

In this article, we briefly discuss the respective G7 tax proposals, the global consensus around them, and implications for various components of India’s corporate tax regime.

What are the new tax measures proposed by the G7?

At the latest G7 meeting in London, the finance ministers and central bank governors of some of the world’s most advanced economies came to an agreement over two proposals to counter international tax avoidance.

• The first measure is to mandate companies to pay taxes in the area where they conduct business.
• The second measure is to enforce a global minimum corporate tax rate of 15 percent to counter the presence of low-tax jurisdictions.

The G7 communiqué reads: “We commit to reaching an equitable solution on the allocation of taxing rights, with market countries awarded taxing rights on at least 20% of profit exceeding a 10% margin for the largest and most profitable multinational enterprises. We will provide for appropriate coordination between the application of the new international tax rules and the removal of all Digital Services Taxes, and other relevant similar measures, on all companies. We also commit to a global minimum tax of at least 15% on a country-by-country basis. We agree on the importance of progressing agreement in parallel on both Pillars and look forward to reaching an agreement at the July meeting of G20 Finance Ministers and Central Bank Governors.”

Is there a consensus around the G7 proposals?

In April, at a virtual speech given to the Chicago Council on Global Affairs, US Treasure Secretary Janet Yellen lay the task before countries – to reverse a “30-year race to the bottom” – which witnessed countries model their economies around low tax rates and minimal compliances to attract MNCs and create local jobs. This in turn resulted in major corporations not paying any taxes or minimal taxes in the multiple jurisdictions that they operated in, which meant market countries could not benefit from the high profit margins enjoyed by these MNCs.

That has disproportionately impacted advanced economies like the US, Germany, and France. As per findings from the Tax Justice Network Report, the US loses nearly US$50 billion a year due to corporate tax evasion; India’s annual tax loss is estimated at more than US$10 billion.

Nevertheless, the proposals to stabilize international taxation and check evasion by enforcing a global minimum will be expected to raise significant resistance by the G20 countries.

Many relatively lower-income and developing countries employ low tax regimes to attract multinational corporations to set up locally, which in turn creates positive externalities, such as through the growth of local service industries, reducing talent out-migration, and attracting much needed labor capital etc. Moreover, these countries may not be able to afford stimulus packages or engage in large public spending to plug gaps in productivity, boost consumption, and counter job losses, such as during the aftermath of the pandemic.

What are the implications for taxation in India?

As per the G7 proposals, India will be able to tax large MNCs doing business in the country – without a physical presence or permanent establishment – at 20 percent of their profits (exceeding a 10 percent margin). Thus, the measure, if globally approved, will impact digital companies in whichever markets they earn revenues and make profits based on their online presence. However, the G7 countries have also called for the elimination of the digital services tax or equalization levy.

Taxation of digital companies

Beginning April 1, 2020, India expanded the scope of its digital tax by imposing a two percent equalization levy on foreign entities selling goods and services online to customers in the country if they showed annual revenues more than INR 20 million (approx. US$275,404). In 2016, India had introduced a six percent equalization levy on the online advertising revenues of large MNCs like Google and Facebook. The taxes on cross-border digital transactions, in many cases, have been transferred onto consumers.

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Tax experts in India thus feel that the country will stand against such a low minimum tax floor if the equalization levy has to be rolled back as “taxing 20% of total net profits” may not be enough.

Interestingly, India is also making a case for its internet user base (used for company algorithms) to be factored into the calculation of taxing digital multinational enterprises, as per a source close to the government quoted in the media (likely in its discussions at the OECD and G20 levels). This is not a consideration in developed countries.

Concept of significant economic presence

In the Finance Act of 2018, India amended its tax law to widen the scope of the existing term ‘business connection’ to include the concept of significant economic presence (SEP).

Following a wait for a consensus to develop, which it did not, among OECD countries, India specified the threshold limits to implement the SEP principle in May (effective April 1, 2021).

SEP primarily targets digital multinationals operating without a permanent establishment in the country and the provisions stipulate the user base as a threshold for taxation.

India is setting a revenue threshold of INR 20 million (US$274,825.60) and a limit of 300,000 users for foreign technology firms to pay tax in India under the SEP principle. To quote directly, the threshold includes: “‘download of data or software’ worth revenues exceeding ₹2 crore from Indians or a threshold of 3 lakh number of Indian users with whom such companies ‘solicit systematic and continuous business activities or engage in interaction’.” (US$1=INR 72.77).

The legalistic ambiguity, however, in the SEP’s provisions could prove to be litigious, an outcome that India’s tax landscape cannot afford if the country is to improve its appeal as an investment destination. For example, experts critique that services like systematic and continuous business solicitation etc. needs to be clearly defined.

Corporate tax

India cut the corporate tax rate for domestic companies in 2019, whereby new companies would be subject to a 22 percent rate and new domestic manufacturing companies, 15 percent. The Taxation Laws (Amendment) Act, 2019 inserted Section 115BAA into the Income-tax Act, 1961, which provides the concessional tax regime (22 percent) for domestic enterprises if they do not avail of specific tax incentives or deductions. (The effective tax rate for these domestic companies is around 25.17 percent inclusive of surcharge and cess.)

Those companies opting for the concessional corporate tax rate also do not have to pay minimum alternate tax. As a result, India’s current effective tax rate brings it at par, on average, with leading Asian investment destinations and manufacturing hubs like China, Vietnam, Malaysia, Singapore, and South Korea.

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