Taxation Aspects of Multinational Corporations in India

Foreign non-resident business entities may have business activities in a variety of ways. In its simplest form this can take the form of individual transactions in the nature of exports or import of goods, lending or borrowing of money, sale of technical know how to an Indian enterprise, a foreign air-liner touching an Indian airport and booking cargo or passengers, etc. various tax issues arise on accounts of such activities.

The government wants to encourage foreign enterprises to engage in certain types of business activities in India, which in its opinion its desirable for achieving a balanced economic growth. This takes us to the last aspect of activities which enjoy tax incentives in India. The related issues about the taxation of the Multinational Corporations (MNCs) are as follows:

1. Taxation of Transactions and Operations of MNCs in India

Taxation of transactions and operations of MNCs fully depends on the definition of income that is taxable in India, qualification of taxable income and the tax rates.

Income that is taxable in India

All Income accruing or arising whether directly or indirectly through or from any business connection in India

  1. Salary is deemed to be earned in India if it is either payable for services rendered in India or payable by Indian Government to a citizen of India for services rendered outside India.
  2. Dividend paid by Indian Company outside India
  3. Income by the ways of interest by Indian Government.
  4. Income by the way of Royalty
  5. Income by the way of fees for technical services.
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Objectives of International Taxation

The main objectives of International Taxation are the Neutrality and Equity.

Tax Neutrality

A neutral tax is one that would not influence any aspect of the investment decision such as the location of the investment or the nationality or the investor. The basis justification for tax neutrality is economy efficiency. World welfare will be increase if capital is free to move from countries were the rate of return is low to those where it is high. Therefore, if the tax system distorts the after-tax profitability between two investments or between two investor leading to a different set of investments being undertaken, then gross world product will be reduced. Tax neutrality can be separated into domestic and foreign neutrality. Domestic neutrality is an compasses the equal treatment of any citizen investing at home and citizen investing abroad. The key issues to consider here are whether the marginal tax burden is equalized between home and host countries and whether such equalization is desirable.

Foreign neutrality: The theory behind Foreign neutrality in international taxation is that the tax burden placed on the foreign subsidiaries of domestic companies should equal that imposed on foreign-owned competitor operating in the same country.

Tax Equity

The basis of tax equity is the criterion that all tax payers in a similar situation be subject to the same rules. All Companies should be taxed on income, regardless of where it is earned. This, the income of a foreign branch should be taxed in the same manner that the income of a domestic branch is taxed.… Read the rest

Principles of a Sound Tax System

According to Mrs. Hicks, a sound tax system should have the following characteristics:

  1. It should facilitate financing of public services.
  2. Tax, should be levied according to the ability of the people, the index of ability being income and family circumstances and
  3. Similarly placed persons should pay similar taxes to avoid any discrimination.

From the discussion above, we may lay down the following four broad characteristics as the principles of a sound tax system.

  1. Equality in Tax Burdens: This principle suggests that when the taxes are levied they ensure equality in tax burdens. In other words, through taxes the government can ensure that the tax burden is spread in such a way that persons who are placed in similar positions are made to bear the same burden of taxes. This implies that people who are better-off should bear more tax burden than those who are worse-off. Though this principle is universal, yet in the implementation of this principle problem like indicators of equality, effectiveness in practice, the method of achieving this equality, etc., will all be faced.
  2. Productivity: With the ever increasing responsibility of modern welfare state, the need for financial resources is always felt. As the modern governments spend huge amounts of money on public projects to maintain high level of public welfare, they have to raise enormous funds through taxation. Unless taxes are productive, the governments will find it difficult to implement public projects. Especially in a developing country, taxes are to be highly productive so that country can achieve growth with stability.
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Adam Smith’s Canons of Taxation

Canons of taxation are sets of criteria by which to judge taxes. These canons are still widely accepted as providing a good basis by which to judge taxes. Adam Smith laid down four canons of taxation. They are:

  1. Canon of Ability: According to this principle of taxation, the people in a country should contribute towards the government expenditure. Their contribution should be according to the ability to pay of each individual. A rich man should contribute more and the poor either should contribute less  or can be exempted. This principle of taxation will ensure that the cost of public expenditure is shared by the people in accordance with their individual ability.
  2. Canon of Certainty: Adam Smith insisted that the government should know in advance the amount of revenue that it could raise and the time when it could mobilize the revenue. On the part of individual tax payers, they must know clearly the amount of tax that they have to pay, the time when they should pay and the method of paying the tax. Adam smith felt that it is necessary that the people should be certain about their tax commitment, so that there cannot be any exploitation of the tax payers either by the government or by the tax collectors.  This implies, once the people are clear about the amount of lax, they will plan their expenditure accordingly so that tax payment will not be felt a penalty.
  3. Canon of Convenience: According to this canon, the tax should be such that it is levied at the time when it is convenient for the people to pay.
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Basic Principles of International Taxation

Rapid economic development happens to be one of the primary objectives of all developing economies and India is not an exception. This is possible mainly through the accumulation and proper use of capital. The developing economies lack adequate basic infrastructural facilities. In order to develop these, the government takes upon itself the responsibility for building up capital formation, through sound taxation policies.

There are two basic principles followed by different countries in International taxation

1) Residence Based Taxation

The principle of residence-based taxation asserts that natural persons or individuals are taxable in the country or tax jurisdiction in which they establish their residence or domicile, regardless of the source of income. In the case of non-natural persons such as companies or firms, the place of incorporation or the place where control or management is exercised is deemed to be the place of residence. In the context of income tax, the ability to pay the tax in a country is fully measured by their global income. Therefore, the principle of residence-based taxation of income envisages the taxation of global income. Accordingly, India follows residence based taxation in case of Residents.

2) Source Based Taxation

There are individuals/entities whose “residence” is in one country but their business is actually carried on in another country and their income is earned in the latter country. In such cases, the principle of residence-based taxation would be inappropriate. Therefore, there is a view that the country which provides the opportunity and facilities to generate income or profits should also have the right to tax the same.… Read the rest

Features of Goods and Services Tax (GST)

Goods and Services Tax (GST) is consumption tax that charged the buyers to pay for a wide range of domestic & international products, goods and services. In some countries it is also called Value Added Tax. It is a multi-stage tax on domestic consumption levied on taxable supplies of goods and services. GST imposed on every level of a product from raw materials all the way to finished goods. Consumers still need to pay income tax as GST and income tax is totally different. It is a consumption tax charged on imports items and also value added to goods and services provided by a business to the end user. Goods And Services Tax will be borne by the end-user or consumer and is not intended to add burden to businesses.

Benefits of Goods and Services Tax (GST) Eliminates cascading effects

Goods and Services Tax (GST) also enable the minimization of distortions, therefore GST is preferable. The simple excises or the turnover taxes results in the unintended effect of taxing an output together with its input content more than once. Furthermore, it is also applying a tax on the earlier paid input tax leading to cascading. It causes producers to move their capital or resources away from the production of one output to another one which does not suffer from cascading. GST gives credit for input tax earlier paid, avoid the distortion as represented by misallocation or redirection of resources from one economic activity to another.

In addition, GST is the only tax that offers positive alternatives to the negative impact of indirect taxation.… Read the rest