India must lead way for egalitarian tax system for MNCs

Companies and govts have been playing the cat-and-mouse game for several decades on transfer pricing

Only a naivete would think of Hilary Clinton’s proposal last week to scale up the rate of capital gains tax as a mere concept to streamline America’s tax rate structure. It is being perceived as a proposal to tax the rich. Tax certainly has a traditional relationship with politics. India’s salt tax and Mahatma Gandhi’s Satyagraha is an example.

It appears Clinton’s proposal has something to do with her election campaign. Global political commentators, reading the undercurrents of America’s political campaigns, have aggressively concluded that the pre-election campaign of Clinton would be on an anti-capitalist and pro-poor flank.

Giving expression to the general anger against the privileged few, the continuing unemployment and the resultant helplessness, all fallout of the slow-paced economic recovery there, is a short cut to lubricate her campaign for Democratic nomination for presidentship. It is the common thread found in most comments that came in response to Clinton’s capital gains tax proposal.

Politicians know the easiest way to handle the desperation of the people, which is to convert that desperation into anger. Anger at anything that is more vocal or more visible. And the rich are both.

Clinton’s proposal is for doubling US capital gains tax rate on short-term investments to 39.6 per cent. This would clearly affect investments held between one and two years, which are currently taxed at a 20 per cent capital gains rate.

There is also another proposal from a senator to raise tax up to 70 per cent on the rich. Just when one is tempted to conclude that the world has reached that phase of its evolution to agree with the norm that tax levied at a lesser rate leads to more collection, a different view emerged from the US.

These proposals certainly may have to do with politics. Politics is invariably and compellingly influenced by the aspirations of the people it represents and smart politicians who know their pulse feel it much before others.

These developments also prove that there is nothing conclusive about tax laws. The tax rates some politicians seek to bring into the US financial system are the ones that were considered harsh and regressive in the past. A concept abandoned in the past may be brought back if there is a need to do so and the dynamics of taxation is vulnerable to change to suit the needs of the time.

In the global context of taxes, it is now almost certain that there would soon be a demand for finding an alternative to transfer pricing, which most of its critics believe are in fact transfer mispricing. The tax system, its detractors allege, favours multinationals and rich businessmen to accumulate wealth and shift it to advantageous locations.

Therefore, it is not surprising that a new concept of taxation, unitary taxation, is being discussed among tax professionals the world over to replace the existing system based on the transfer pricing (TP) rules.

It is high time India led the way for a worldwide discussion to review the international taxation rules, especially TP rules. The TP laws have been influenced by the convenience and profit of the developed countries. That the developed countries have taken a pro-active role in creating these laws cannot be held against them, but one cannot be too off the mark in concluding that over a period of time the rules have come to favour the developed more than the developing nations.

Even the concept of vesting the right to tax with the resident country has been taken advantage of by large MNCs, which have created a multitude of residence destinations, which are low tax or zero tax destinations. The obvious fallout of such ambiguous manoeuvres is denial of revenue to the countries that need most.

The current global tax system has been in existence for over 100 years now. Since 1930s, transfer-pricing adjustments have been part of the global tax system. Both the US and the Organisation for Economic Cooperation and Development had formulated the TP guidelines by 1979. The US had successfully put in place the transfer pricing regulations in 1994. The following year OECD drafted “the OECD guidelines.” The OECD and the US systems allow prices to be set by the associate enterprises, but these prices need to conform to an arm’s length standard.

There are certain points worth mentioning here. When the west controlled major part of the globe, it was agreed that companies would be taxed at their residence instead of the location where the economic activity took place. Most transnational companies have headquarters in the western world.

Another cardinal feature of the current system is companies are taxed as separate entities, even though they are under the umbrella of a single transnational entity. Thus a company with subsidiaries in 50 countries will be treated as 50 separate entities for tax purpose.

There has been ambiguity of how associate enterprises transactions were assessed for tax purposes. Corporations have been known for setting up operations and subsidiaries in other countries and transferring goods and services between each other.

Capitalism is marked by its tendency to create monopolies. Those who have opposed capitalism had done so mostly because of its tendency to create monopolies, which potentially disturb the ideal market equilibrium. The modern global market is dominated by monopolies. It is being estimated that 10 corporations control 55 per cent of the global trade in pharmaceuticals; 67 per cent of the trade in seeds and fertilisers and 66 per cent of the global biotechnology industry.

Therefore, companies and governments have been playing the cat-and-mouse game for several decades. Governments want to protect their revenue, while companies want to dodge. Fighting such transfer-pricing cases have been proving costly for both companies and governments. At this level, cost of litigation can be killing.

The idea of taxing companies at their place of residence is the reason for the emergence of tax havens. Allowing a group of companies under common control to be treated as hundreds of separate taxpaying entities is another folly as profits escape taxes altogether.

How to address these issues? It is in this context that the concept of unitary taxation has emerged. Profits accrue to MNCs irrespective of the locations of its operation. The question is how can you access the information about a corporation’s global profit.

It is in this context that India needs to provide leadership in a global scenario to create binding conditions for multinational companies by which they are required to reveal their consolidated profits and accounts. This would enable tax authorities to treat the entire group of companies as a single global unit.

The base of taxation is the global profit. Once this is done, there would be a need to allocate the global profit to each country by the quantum of the company’s operations in that location. This is a matter of detail that can be determined by collective discussions and consensus. Number of employees in each country and their cost to the company, valuation of assets and sales activity can be a measure of a company’s quantum of operation in a particular location.

Unitary taxation has its own strong points though it cannot be free from loopholes. Under this system, profits shifted to tax havens are of no significance since a corporation’s global profit is what would be of importance for levying tax. Therefore, it is high time India took serious goal-oriented and proactive steps to evolve international tax laws that are egalitarian, more balanced and not tilting towards a few powerful nations.