MNC taxation and India’s dilemma

Did you know India is being marked out as one of the stumbling blocks – along with the US and China – in eliminating corporate tax evasion and avoidance, particularly by multinationals? Consider three recent developments:

1. On May 24, 2024, Italy's Economy Minister Giancarlo Giorgetti, who chaired the G7 finance summit (G7 finance ministers and central bank governors), had warned in advance that there would be no accord on the global minimum 15% tax on multinationals at the G7 summit held in June 2024 because three countries – the US, China and India – had reservations about it. She named these three countries but didn’t spell out their reservations.

2. The very next day, on May 25, 2024, US Treasury Secretary Janet Allen confirmed it, stating that the US was not ready to sign the accord – until India and China did it. She said, "India, in particular, has been a holdout and China has not really engaged very much in these negotiations at all…We certainly need India and China to come on board in order to get this done."

3. Net result: The G7 summit in Italy – held during June 13-15, 2024 – failed to reach an agreement. The G7 leaders’ communique, issued on June 14, 2024, said: “We are committed to finalising the work within the OECD/G20 Inclusive Framework, with a view to open for signature the Multilateral Convention on Pillar One by the end of June 2024, and we call for further progress on the implementation of Pillar Two."

The G7 communique didn’t spell out “Pillar One” and “Pillar Two”. For the uninitiated, these two pillars refer to the twin goals of the OECD-G20 initiative called “Inclusive Framework on Base Erosion and Profit Shifting” or BEPS for short. The BEPS initiative is meant to check corporate tax evasion and avoidance (euphemistically described as “corporate tax planning” in corporate jargon). Broadly speaking, the goals of these two pillars are:

- Pillar One: Reallocation of taxing rights on corporate profits (over 25% of the residual profit) to the countries where corporates do business.

- Pillar Two: Global minimum tax of 15% for MNCs (with annual revenue over 750 million euros). It was first proposed by US President Joe Biden in 2021 to forge a consensus and was endorsed by the OECD-G20 and associate members (about 140 countries in all).

It has been 12 years since the BEPS initiative was adopted in 2012 – which has been signed by about 140 countries so far. But both the goals have been kicked down the road because negotiations, led by the OECD, are stuck at the modalities. Before getting into why so, here are the countries involved:

At the top is the G7 which forms the core of G20 – the US, the UK, Canada, France, Germany, Italy and Japan. The G20 members include the EU, India, China and Russia and a few others. The OECD’s 38 members (a mix of developed and developing countries but excluding India, China and Russia) are from North and South America, Europe and Asia-Pacific. Then there are about 90-odd other countries which are signatories called associate members.

Near impossible to tax MNCs right

It is not difficult to understand why taxing MNCs is so tough. They are the most powerful financial entities – the top three (Microsoft, Apple and Nvidia) have market capitalisation of over $3 trillion, as on June 2024 – a little less than India’s (nominal) GDP size of $3.6 trillion in FY24. Remember, India is the fifth largest economy in the world.

Big MNCs not only run global economy but also political system Writing about it in the context of money-driven politics of the US, Nobel laureate Joseph Stiglitz said (in his 2019 book “People, Power and Profits: Progressive Capitalism for an Age of Discontent”) the money power of MNCs “translates into political power” – ultimately “evolving into an economy and democracy of the 1%, for the 1% and by the 1%”.

Had that not been the case, the OECD-G20 or G7 would have dismantled tax havens – most of which operate from their own backyards (particularly the UK and the US), and so are global Big Banks and the Big 4 accounting and consulting firms which actively support these tax havens. A successful Pillar Two would mean automatic dismantling of tax havens.

This reluctance to tax corporates right goes against history. The period between 1950s and 1970s is considered the “Golden Period of Capitalism” for both developed and developing countries when GDP growth was highest ever at 3.8% and 3%, respectively. The average top corporate tax rate then was 70-80% in the US and 99.25-80% in the UK.

Sure, corporate “tax evasion” is rampant – but not all tax evasion is illegal, which is why “tax avoidance” or “tax planning” often go with it.

Multiple investigating reports have flagged how big US multinationals pay little or no tax – even after the massive corporate tax cut in 2017 (from 35% to 21%). These include the Silicon Six (Amazon, Facebook, Google’s owner, Alphabet, Netflix, Apple and Microsoft) and many others. The EU Tax Observatory’s Global Tax Evasion Report of 2024 said, $1 trillion of profits were shifted to tax havens in 2022 – “equivalent of 35% of all the profits booked by multinational companies outside of their headquarter country”. As for India, the report said, it could generate $2.4-7.3 billion in 2023 from multinationals operating from its soil.

No wonder, a new front has been opened in this fight – while the old one (BEPS) remains a work-in-progress: Global minimum tax on billionaires (“ultra-high-net-worth individuals”).

On June 25, 2024, “A Blueprint for a Coordinated Minimum Effective Taxation Standard for Ultra-High-Net-Worth Individuals” – a new report commissioned by the Brazilian G20 presidency – was released. It proposes “a minimum tax on billionaires equal to 2% of their wealth would raise $200-$250 billion per year globally from about 3,000 taxpayers”. The “goal”, the report said, is to “offer a basis for political discussions – to start a conversation, not to end it”.

The fate of this initiative would be known in November 2024 – when the next G20 summit is held in Rio de Janeiro.

For the record, the last G20 summit was held in New Delhi in September 2023, under Indian presidency. It had a cursory mention of the BEPS. It said it was committed to “the swift implementation of the two-pillar international tax package” and listed its achievement as preparation of “Subject to Tax Rule (STTR) under Pillar Two” – a “framework” for imposing additional tax (one of many modalities).

Why India must raise corporate tax

India has shown little appetite for taxing corporate entities or billionaires – despite ratifying the BEPS in 2017 and framing the General Anti Avoidance Rules (GAAR) to check tax evasion by domestic corporates on its own in 2012 (which was operationalised from April 2022 but nothing more is known about its implementation).

On the contrary, it (a) abolished wealth tax in 2017 and (b) cut corporate tax in September 2019 amidst a fiscal crisis (no money to pay GST compensation to states) – from 32% to 22% for existing manufacturing units and from 18% to 15% for new manufacturing units.

This corporate tax cut had several adverse consequences:

It led to loss of ₹2.28 lakh crore in revenue in FY20 and FY21 (parliamentary panel reports) – and the same continues though no further data is available.

Corporate tax collections fell below personal income tax collections in three fiscals of FY21, FY23, FY24 (P) and is headed for the fourth in FY25 (BE).

Centre’s gross tax-to-GDP has risen marginally – from 10% in FY20 (when corporate tax was cut) and 10.2% in FY21 to 11.6% in FY24 (RE) and 11.7% in FY25 (BE). But this improvement is due to (indirect tax) GST. GST’s share in gross tax collection was highest in FY20 (29.8%), FY21 (27.1%) and FY23 (27.8%); second to personal income tax in FY24 (27.8%) and in FY25 (estimated at 27.9%). Corporate tax contributed the most in FY22 at 26.3% – when GST share was 25.8% and personal income tax was 25.7%.

Effective tax rate for corporates with maximum profit – PBT of more than ₹500 crore (constituting 62% of total PBT in FY21) – was the lowest at 19.14% (as against statutory 25.2% with Cess and Surcharge) in FY21. For those with lowest PBT (₹0-1 crore), effective rate was a high of 24.8%. Budget document of 2023-24 said, the lowest effective tax for largest corporates “highlights” that “larger companies are availing higher deductions and incentives or have shifted to the new regime of lower tax rate of 22% plus cess and surcharge”. Incidentally, there is no data on effective tax rate after FY21 and what FY21 shows is the normal trend.

No wonder, corporate profits have soared to historic levels – but corporate capex has stagnated or fallen. Here is how.

(i) Corporate profits reached historic high in the pandemic fiscals of FY21 and FY22 – when millions lost their jobs and small, informal businesses. But that didn’t lead to higher private capex.

The dream-run continues since then and so does the sluggish growth in private capex. Here is evidence for FY24:

(ii) Analysis by the Motilal Oswal Financial Services found corporate profit-to-GDP of Nifty500 companies and listed entities (both BFSI and non-BFSI) (“swelled” to 4.8% and 5.2%, respectively, in FY24 – “scaling a 15-year high”.

(iii) RBI’s June 28, 2024 data (Performance of Private Corporate Business Sector during 2023-24) shows, net profits in non-BFSI entities grew (Y-on-Y) by 18% in FY24 – as against a loss of (-)0.2% in FY23. This happened despite sales growth “moderating” to 4.7% in FY24 – from 19.8% in FY23.

(iv)As for private corporate capex, a national daily analysed listed non-BFSI (non-finance companies) for capacity expansion and new projects to find slowed down in FY24 to 7.6% – after a pick-up to 12.2% in FY23.

(v) It is government capex which is driving GDP growth since the pandemic. Growth in two engines, consumption (PFCE) and exports, sputtered in FY24 – PFCE’s falling to 3% and exports falling to 1.5% when the GDP grew at 8.2%. Growth in private GFCF fell to 19.6% in FY23 (up to which data is available) – from 24.4% in FY22 (RE2, Feb 2024).

(vi) For three consecutive fiscals (a) equity FDI inflows fell by (-)1%, (-)22% and (-)3% in FY22, FY23 and FY24, respectively. For two consecutive fiscals, (b) total FDI inflows fell by (-)16% and (-)1% in FY23 and FY24, respectively. (DPIIT, May 2024)

(vii) Centre’s disinvestment drive has dried up. Hence, the interim budget for FY25 didn’t even set a target – but put the combined proceeds from disinvestment and asset monetisation (NMP) at ₹50,000 crore. Full budget for FY25 is unlikely to be different – because its disinvestment plans have received several setbacks (CEL, PHL, BPCL, CONCOR, NMDC etc.).

(viii) Raising the GST rate is no more an option. It already is doing heavy-lifting (explained earlier) and since PFCE growth nosedived in FY24 (reflecting weakening of household finances), it being an indirect tax can’t be pushed further. In fact, the GST Council recommended several reliefs – waiving interest and penalties; exemptions from Compensation Cess on imports in SEZ and accommodation services; reliefs for students and working professionals etc. at its June 22, 2024 meeting.

(ix) Raising income tax is also not an option (PFCE growth nosedived in FY24 and peak personal income tax rate of 30% (for taxable income above ₹15 lakh) is already higher than that of corporate tax.

(x) Centre’s debt skyrocketed (three times in ten fiscals of FY15-FY24) – from ₹56.7 lakh crore until FY14 (previous 63 fiscals) to ₹170.6 lakh crore in FY24 (RE) or 58% of the GDP when the Centre’s FRBM limit is 40%. No scope for more debts.

Will the Centre take the bait or leave it to fait?