Tax laws need to keep up with the “digital economy”

The pandemic has severely dented government revenues worldwide, while expenses have ballooned. This has led to spiraling fiscal deficits, that have their own consequences. Given that most corporate tax regimes worldwide evolved keeping conventional businesses in mind, and that digital economy businesses are very different in nature, a new corporate tax playbook is clearly needed.

Given its large number of digitally-savvy consumers, a country like India is often one of the top three markets for digital economy companies such as Amazon, Facebook, Netflix, etc. But the nature of their business is such that they can carry out business in India (or any other jurisdiction) without having a significant place of business in that jurisdiction. So while countries like India contributed to revenues, low local operating costs meant higher profits. But this did not translate into higher taxes for India because MNCs registered companies in countries with lower tax rates and assigned IPR to these companies. The subsidiary operating in India would then pay a royalty to this overseas company. This is not illegal under the letter of existing tax laws, but it does lead to low tax revenues.

The Tax Justice Network estimates that India loses US$10.1 Billion annually due to abuse of tax laws; the US is believed to lose five times that amount (US$49.2 Billion). It is interesting that the same study identifies the Netherlands, the Cayman Islands, China, Hong Kong and the UK as the largest enablers of tax abuse. (source: “How global Tax Rules may reshape India”, The Mint, 23 September 2021).  

Change is already in the air

India was, in fact, a pioneer of sorts, when it introduced the equalization levy (a sort of digital service tax) in 2016 to bring some of the revenues of these digital companies into the tax net. Many other countries followed suit. Not surprisingly, there are now more concerted efforts to plug loopholes that Big Tech in particular is able to exploit to avoid tax in jurisdictions with higher tax rates. A major step to address this situation was announced in July 2021 by the OECD and G20. The move envisions a minimum corporate tax rate of 15% worldwide as well as a new framework for allocating more rights to tax digital economy companies to countries housing digital consumers- i.e., ensure fairer taxation of businesses in those jurisdictions where they earn profits.

Stop press!

Talk about timing! Just as I thought I had finished writing this blog, I saw the news that the OECD has finalized the framework for this major international tax reform. A new global minimum corporate tax rate of 15% has been set and will apply to companies whose revenues exceed 750 million Euros. Additionally, MNCs with global sales above 20 billion Euros and profitability above 10% will also be covered by the new rules. Model rules are expected to be formulated in 2022 and the new regime is to take effect in 2023.[2]

Including India 136 countries (that together account for 90% of global GDP) have backed this framework. Once such a regime comes into effect, individual countries will be required to withdraw any digital taxes they levy- e.g., India’s equalization levy.

While this kind of thinking will have a far-reaching impact on digital businesses and the global economy, new tax laws are not the only drivers of major change. If the recent testimony to the US Senate by whistleblower Ms. Frances Haugen is any indication, Facebook and other companies may soon face tougher laws around advertising and targeting specific segments of users. And given Google’s dominant position in the search business, competition laws too will inevitably get tougher. And as seen by India’s tough stand on Mastercard, data localization requirements too will become increasingly stringent. And finally, of course, data privacy laws too will evolve. The popular saying “May you live in interesting times” (incidentally, there’s no credible evidence that this was indeed a Chinese curse, as is often claimed) seems to have had the current period in mind. Even if it didn’t, we do live in interesting times- that’s for sure.

I wish you all a Happy Navratri/Durga Puja.