High corporate taxes in India affect FDI levels
Given global concerns over what is called ‘base erosion and profit shifting’ (BEPS), finance minister Arun Jaitley will be pleased to know, an IMF study of spillovers in international corporate taxation seems to endorse a lot of what the government is doing. So, while not talking of the retrospective nature of taxes introduced when Pranab Mukherjee was the finance minister, the report says developing countries need to guard against companies selling the underlying Indian assets in tax-light countries to avoid paying the Indian government its due—in other words, India was right to change some of its laws; it is the retrospective nature that caused a problem. And though the report does not specifically acknowledge it, India’s solution to BEPS is probably the minimum alternative tax (MAT). The report points to interesting methods being used by companies to avoid paying taxes—fund large infrastructure projects through debt to lower tax outgo, for instance. All of which means that, apart from being an active participant in all international tax discussions, India needs to begin relooking several of its tax treaties—with Mauritius for instance—as well as build more expertise in areas like transfer pricing. For the latter, the argument is not that transfer pricing adjustments should not be made, only that the taxman must do his homework well.
That said, the report makes some other points that are worth keeping in mind. One, a 10 percentage points cut in corporate tax rates, can increase the FDI stock in country by around 30% in the long run. While that is one of the reasons behind the Chinese FDI surge, it is worth keeping in mind, as FE columnist Surjit S Bhalla pointed out last fortnight, at 30%, India’s effective corporate tax levels are among the highest in the world—the figure is 23% in the US and 21% for much of Europe. The second big finding flows from the first, a 1 percentage point cut in tax rates in other countries reduces a country’s corporate tax base by 3.7%—over the decade, the report says, corporate tax rates have fallen 5 percentage points. In other words, Jaitley’s budget needs to be looking at ways to cut corporate tax rates while looking at measures to catch BEPS by MNCs and others.