India's tax authority is now considering a revamp of the rules for taxing multinational companies as well as digital firms, with a committee of the Central Board of Direct Taxes recommending changes to protect the country's revenue interests. At the core of this move is the issue of taxation rights on income generated by global firms operating across various jurisdictions in an age of digitalisation and profit shifting or tax avoidance strategies marked by exploiting loopholes to transfer profits to low tax destinations.
The rise of the digital and the gig economy in particular, has made the concept of a physical presence as a threshold for taxation redundant, posing challenges to governments and fiscal experts. The OECD (Organisation for Economic Co-operation and Development)/ G-20 Base Erosion and Profit Sharing Project recognises this situation and envisages a global consensus on tax rules by 2020. It has now forced governments to consider fundamental changes to taxation rules to ensure that tax revenues are not eroded. Indian authorities, like some of their peers globally, will now have to firm up their approach on profit attribution - the allocation of profits between jurisdictions where customers are located and where factors of production are located and where supply side activities are carried out. The OECD model tax convention favours granting taxation rights to the country of residence of the taxpayer, an approach which India and some other countries do not agree with. Rather, they argue taxation rights should be allowed in jurisdictions where value is created and which contributes to demand by economic activity. The other proposal which is now being considered is a formula for allocation of such taxes among countries based on sales, payroll or wages besides assets and property.
Indian authorities have argued rightly that adopting the OECD model will mean not just losing revenues but also taxing local firms, putting them at a disadvantage compared to their foreign firms, with an adverse impact on competitiveness, demand, revenues and profits. For a country like India, which needs greater inflow of capital to boost growth and create more jobs, what will count more is not the new formula or rules for taxing cross-broader activities, but the stability and predicatability of its tax regime. That's what foreign investors fret about.