Aravind Srivatsan
Post the historical US presidential elections, it was evident that
getting the economy back on track would be number one on the agenda of
the new US President Barack Obama. The US is presently facing its
worst economic crisis in 50 years and the new government's revenue
proposals were keenly awaited. In this background, on May 4, 2009,
the US president introduced proposals relating changes in the tax law
for Fiscal Year 2010 and a week later (on May 11) the administration
issued general explanations for these revenue proposals (commonly
referred to as 'the Greenbook').
The present system of international taxation in the US is exceedingly
complex, a combination of high statutory rates and a host of
exemptions, deductions and special provisions for specific types of
businesses and entities. Thus, effective tax rates are much lower
than statutory tax rates. As per a 2004 study, US companies paid an
effective tax rate of 2.3% while statutory corporate tax is 35% (among
the highest in industrial countries)1. In these times of economic
turmoil, the new provisions are primarily at least in theory an
attempt to make US corporations shift business back to US, thereby
create employment and consequently improve the state of the US
economy.
In this context, it is also pertinent to note that, the US has been
taking other measures to curb international tax avoidance. For
example, the US has been inserting / strengthening the limitation of
benefit clause (LOB) in various treaties to curb tax benefits through
treaty shopping. For example, a new treaty between Hungary - US is
also expected to be signed which includes a LOB clause.
Immediate Industry reactions
The above proposals are expected to increase the cost of US
Corporations doing business outside the US (thereby encouraging
investments within the US). However, another view is that the above
proposals may have a negative impact on businesses by making US
multinationals less competitive in the global market. The deferral
provisions are particularly expected to impact many of the large
technology companies and have therefore attracted flak from companies
operating out of the Silicon Valley. Multinational groups (such as GE
and Microsoft) are now joining together as a coalition to lobby
against Obama's plan.
The US tax proposals could require multinational businesses to
restructure their global operations. However, these are early stages
of the proposal and it is not possible to predict which of these
proposals will be enacted into law and at what terms.
What does it augur for India
The immediate knee-jerk reaction has been that the tax proposals will
affect outsourcing to India. This can also be related to the fact
that Obama while introducing the proposals famously remarked that the
US tax code is "a tax code that says you should pay lower taxes if you
create a job in Bangalore, India, than if you create one in Buffalo,
N.Y".
In this regard, the questions that first come to the mind are: Whether
US multinational companies invest in India only to take advantage of a
favourable US tax system? Is India a tax haven? Is not the highly
skilled manpower pool, cheap labour and other cost reduction benefits
the main reason?
Therefore, even assuming that these proposals indeed get implemented
the advantage of locational savings from India would have to be
weighted against the tax impact in US. A cost-benefit evaluation
would be necessary before deciding on further investment into India.
New outsourcing contracts have clauses which mandate that certain work
be delivered onshore. If the new proposals are implemented it could
further impact the performance of these companies and their market
prices.
In this globalised world outsourcing assists in making US goods and
services cheaper, thereby making them more competitive. Though tax is
an important factor in making business decisions, companies will
continue making an exhaustive cost-benefit analysis before making
economic / business decisions. The Indian government could
independently consider extending or providing new incentives to ensure
the competitiveness of the Indian outsourcing industry considering the
importance of the service sector to GDP.
Key Trends in other countries
It is interesting to note that whereas the US administration is
proposing measures that may negatively impact captive investments of
US Corporations abroad, many European countries continue to exempt
foreign source income to facilitate accelerated repatriation of funds
from overseas investments in hopes of revival without attaching
strings like that proposed by the US. Countries such as United
Kingdom, Japan, and Canada are also considering similar proposals.
(From 1 April 2009, 95% of dividend income received by Japanese a
corporate will be exempt from corporate tax in Japan, if it owns at
least 25% of the shares in the foreign investment.)
Also, average corporate tax rates among the 106 countries surveyed
this year have fallen again, from 26.8 percent in 2007 to 25.9 percent
in 20082.
But it is not just in rate changes that government tax policies are
revealed. In a move that is being replicated elsewhere in the world,
both Singapore and Germany have introduced specialized groups within
their tax authorities, focused on helping businesses to improve their
handling of VAT/GST. This may reflect another growing trend, seen in
Europe in particular, towards greater co-operation and transparency
between tax authorities, businesses and their advisors. While this
process may result in improvements and simplifications, the ultimate
objective is clearly to ensure protection of the tax base and prevent
businesses from moving their tax structures to other locations.
India Budget 2009
India Budget 2009 would have to weigh the above global developments.
Taking a cue from the fact that US has provided an exemption for
research and experimentation expenses from the proposed deferral
rules; India should also consider extending the sun-set clause for tax
exemption on research and development expenditure beyond March 2012.
Also, going by the trend, reducing the tax rates would be imperative
to India to stay competitive.
In the context of international tax reforms it is also expected that
the government will usher such as anti-abuse rules that will empower
tax authorities to lift the corporate veil and look for what are
called 'avoidance' transactions. Other anti-avoidance measures could
include controlled foreign corporation (CFC) regulations and norms on
thin capitalisation.
India is well poised to be a safe reservoir for international funds.
Lessons from the global crisis clearly indicate that putting money
into India would be a safer bet especially for institutional investors
and pension funds. A fiscal policy which provides flexibility to
invest in banks/financial services and insurance could just help
recapitalise institutions operating in India and hasten the recovery
process in India including stabilising the dollar and the markets and
prove positive to implement the disinvestments in a positive
environment. The challenge for India would be to look more lucrative
to attract foreign investments and towards that our fiscal policies
need to be more supportive.
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