[2021] 

125 taxmann.com 321 (Article)

Date of Publishing: March 22, 2021

The Case for Minimum Taxation

image

PRIYA MORYANI
Chartered Accountant

The financial safes for innumerable entities and individuals, popularly known as Tax Havens, may be
situated abroad, but the concept is not foreign. The term itself, though not having a universal or formal
definition, is associated with a country or a place with very low or insignificant effective tax rates or no
taxes at all, becoming attractive destinations for businesses to be set up there. With the motive to lure
investment, these regimes, in some cases, have purposefully constructed opaque and impenetrable
laws, created as barriers to information exchange. They also aid in reducing tax payments and limit
disclosures about entities situated in the respective jurisdictions.

Often synonymous with financial secrecy, Tax Haven jurisdictions have contributed in distorting the
line between tax avoidance and tax evasion. Where the former is associated with utilisation of existing
legal gaps in tax laws to minimize/ mitigate tax payments, the latter is out-an-out an illegal activity.

Usage of such jurisdictions by the wealthy and influential, individuals and multinationals has had
adverse consequences including undermining the effectiveness of the global tax system. Operation in
these jurisdictions is usually carried out through shell companies. Now, prima facie, incorporation of a
shell company or a company not undertaking real activities may not always be illegal. The mala fide
intent and purpose behind the incorporation of the said company is what steals its authenticity.
Multinational corporations having businesses spanning the globe, may enjoy massive tax savings by
routing receipts, profits or investments through subsidiaries in Tax Havens.

As per the Corporate Tax Haven Index of 2021 released by the Tax Justice Network 1

A basic example of the working of a Tax Haven is represented below through a simple illustration:

Let's consider Company A located in Country X which has two operational subsidiaries in Country Y
and Country Z. Neither of the above-mentioned countries, for the sake of our example, is a Tax Haven.
The investors in Company A decide to shift their shareholding and route it into Company A by creation
of new entity in Tax Haven jurisdiction. The new entity for the purpose of this illustration is called
Investment Holding Company. The Tax Haven jurisdiction is well known for a having low corporate tax
rates and has no capital gains as well.

The corporate structure would now look something like this:

image

The implications of this are multi-fold:

 (a)   Dividends, if any, flowing from Company A to the Investment Holding Company
may not be subject to tax;
(b)   If in the future, the investors want to liquidate their holdings in Company A and
transfer it to another party/ entity, they can simply do this by transferring their
shareholding in the Investment Holding Company. Since the Tax Haven jurisdiction
does not have tax on capital gains, the transfer would not be subject to any tax.

While it serves as an advantage for the influential, shifting taxable profits by creation of shell companies
is in turn disadvantageous for the many taxable jurisdictions whose governments heavily rely on tax as
budgetary revenue i.e., mostly developing nations, British Virgin Islands rank highest, followed by
Cayman Islands, Bermuda, Netherlands, Switzerland, Luxembourg, Hong Kong, Jersey, Singapore and
UAE.2, including India. Development and sustenance of Tax Havens is not only dangerous for its
present effects i.e., the immediate loss of tax revenue and the future inflows, it may also lead to a
disastrous race to the bottom3

In the diplomatic urge to become an attractive business destination, developing nations that thrive on
tax revenue may have tax cuts to make the nations more attractive to foreign investment. It is
imperative to note that along with the corporate income tax rate cuts, tax incentives including
depreciation and other allowances also play an important consideration in the real investment made by
multinationals. Over time, more countries have shifted to a tax rate below 30%. In 2020, the average
corporate tax rate measured across 177 jurisdictions is 23.85 percent. The burden of these harmful tax
regimes may see the tax burden shift to smaller income groups in developing nations. 4

Over the years, several measures have been taken globally, to develop transparency with regards to the
location where real operations are undertaken by the employees, where decisions are being taken by the
management, the location of value creation, etc. India has also made efforts with regards to the above
by incorporating the concept of Place of Effective Management (POEM) within its direct tax law with
effect from April 2017. The Indian tax authorities also issued Guiding Principles for determination of
POEM of a Company. By incorporating the concept of "control and management" which was
subsequently substituted for POEM, India has distinctly shown its intent to identify the real control and
management of shell companies located in Tax Havens. These efforts, while being in line with the
international consensus are a small step towards the bigger picture of tax reform.

In the wake of scandals, lost revenue and the overall income inequality stemming from usage of Tax
Havens, measures are being undertaken to introduce a new global tax system by Organisation for
Economic Co-operation and Development (OECD) through its Base Erosion and Profit Shifting (BEPS)
Action Plan 1(Pillar 1 and Pillar 2).

Initially aimed at tackling primarily the issue of virtual presences, BEPS Action Plan 1 (Pillar 1 and
Pillar 2), with its far-reaching impact, envisages the need for an updated outlook to international
taxation which is in line with the businesses being undertaken today. Pillar 1 would focus on creation of
nexus rules requiring group profits to be allocated basis certain formulae in different market
jurisdictions. Pillar 2 includes a system of global minimum tax rules to ensure that multinationals pay a
minimum level of tax.

OECD published its Economic Impact Assessment of Pillar 1 and Pillar 2 in October 2020, which details
the effects of the proposals on the global tax revenues. As per the said assessment, the proposals could
increase global corporate income tax revenues by approximately USD 50-80 billion per year. While
Pillar 1 would not increase the tax base, it intends to expand the taxing rights of market jurisdictions by
reallocating the said taxing rights. This would, as per OECD, on an average benefit the corporate tax
revenue of low-, middle- and high-income economies. While the 'investment hubs' would tend to lose
tax revenues due to the said allocation. Pillar 2 would yield a significant increase in the corporate tax
revenues across low-, middle- and high-income economies, while negatively affecting the low-tax
jurisdictions. Among various other factors, the presence of Tax Havens may have also contributed to
this downward push, as mentioned above. Itis worthwhile to note that while there is a push to reduce
corporate taxes among the various countries, there is also an upward push to increase the tax rate for
multinationals operating out of Tax Havens. Among other aspects involved, this upward push is evident
in the consideration for corporate taxes in UAE, a jurisdiction known for having no corporate taxes
(except for specific businesses). This coupled with the growth of digitalization and the impact of lost
taxes from it over the years, has created a larger push for radical renovation of the global tax system. 5

India, being in the Lower Middle-Income group as per The World Bank. 6

A multinational based out of USA – America Co. has a digital presence and operates in various
countries including India, through its website. It provides accounting software packages and solutions
which are essentially intangibles. This removes the requirement of any face-to-face interaction between
America Co. and its clientele. Its global sales for a particular year were USD 30 million. Out of this
amount, sales from India based clients was USD 13 million. Currently, America Co. pays its corporate
taxes only in USA, on a residence basis. India does not earn any corporate tax in these situations even
though it contributes to the overall revenue earned by America Co. It is no doubt that America Co. earns
a certain portion of its revenue from India and accordingly, the appropriate portion of tax accrued
should be paid to India. However, in the current scenario, the tax treaties fall short in their ability to tax
this income.

The proposed concept of Pillar 1 would step in here and allocate through globally agreed formulae, a
portion of the revenue that is attributable to countries like India. Pillar 2 would step into a situation to
analyse whether on a global level if the multinational i.e., America Co. is paying a minimum tax., may
stand to benefit from the reallocation rights of Pillar 1 as well as the introduction of a 'minimum tax' in
Pillar 2. Based on the primary understanding of the concepts projected in Pillar 1 and Pillar 2, let us
consider a simple illustration of how it would benefit India. 7

India, being a densely populated country is looked at as large consumption market for various
multinationals. In the past few years, it has seen a boom of international digital services being provided
through various parts of the world. While individual efforts are being taken by India to tackle similar
digital issues in the form of Significant Economic Presence and Equalisation Levy, a global concerted
effort may reduce ambiguity and ensure that all nations are on the same wavelength about the
solutions. In the future, there may even be an interplay between the individual efforts of India along
with the rules at the global level. Needless to say, final implications can only be observed once there is a
final shape to the respective pillars.

It is imperative to note that substantial efforts have been taken in the past by OECD as well, to reduce
the income inequality and help tax certainty. That being said, the ambitious proposals in BEPS Action
Plan 1 intend to undertake a complete overhaul of the international tax system. With such large number
of parties involved, conclusion of this herculean task would involve wide scale cooperation,
coordination and a disciplined timeline. Recently, public consultations were held by OECD on the
functioning of the two pillars on January 14 and January 15, 2021. However, the finalisation of the
proposals, practical impact and issues at the time of implementation are yet to be determined and are
tasks of the near future. Since the proposals are still at the deliberation stage, we will have to wait and
watch for the upcoming developments.

■■

1. Corporate Tax Haven Index - 2021 Results by Tax Justice Network -

https://cthi.taxjustice.net/en/cthi/cthi-2021-results
2. Part IV- Conclusions of the IMF Working Paper on Base Erosion, Profit Shifting and
Developing Countries by Ernesto Crivelli, Ruud De Mooij and Michael Keen
3. For more information on this refer Tax competition and the race to the bottom by Tax
Justice Net - https://www.taxjustice.net/topics/tax-competition-and-the-race-to-the-bottom/
4. Corporate Tax Rates around the World, 2020 released by the Tax Foundation in December
2020
5. OECD/G20 Base Erosion and Profit ShiftingProject - Tax Challenges Arising from
Digitalisation – Economic Impact Assessment (Executive Summary)
https://www.oecd - ilibrary.org / sites/0e3cc2d4 - en/index.html?itemId= / content/publication /
0e3cc2d4-en
6. The World Bank - The World by Income and Region
https://datatopics.worldbank.org/world-development-indicators/the-world-by-income-and-
region.html
7. There may different point of views regarding the above illustration from the perspective of
Equalisation Levy and Significant Economic Presence introduced by India in its direct tax
laws. The illustration is solely focused on what could be the potential impact of Pillar 1 on
a similar issue. Further, the illustration is focused on the impact specifically on corporate
taxes and not prevalent withholding taxes.