The government relies on tax revenues as its primary source of income. Most governments do. Nearly 99% of the Government of India’s total revenue comes from the taxes it collects. It needs this money to conduct its daily affairs, to pay for infrastructure, to fund social programmes, and so on. Whatever money it fails to collect is money that could have been used to pay for the things that could potentially make a difference in the lives of Indians i.e, its opportunity cost. The opportunity cost of the foregone tax revenue in India is enormous, according to the ‘State of Tax Justice 2020’ report.
This is a study conducted by the Tax Justice Network, an organisation that studies global tax avoidance. This report is the first of its kind and offers some concerning insights about the extent to which multinational corporations go to avoid paying taxes. They usually owe the most, too.
At a glance, we see that the world loses about $427 billion annually thanks to tax fraud/abuse committed by the rich and powerful. $245 billion is a result of tax avoidance by corporations. Higher incomes countries lose more in absolute terms, but lower-income countries lose a higher percentage of their total revenue
While the US and the UK are the two biggest losers in terms of their revenue, they also contribute significantly to the losses of other countries, by facilitating tax avoidance on a large scale.
India is estimated to lose around $10.3 billion a year to tax avoidance. To put that into some context, it makes up roughly 45% of our total healthcare budget or 11% of our annual spending on education. (According to the 2020 Union Budget, however, the government has earmarked only $10.05 billion for healthcare in 2020-21, and close to $14 billion for education. The report uses data from the World Bank, and as such its estimates are different).
These are massive losses of income for a country where the number of taxpayers is already very small. Only 2.5% of Indians pay income tax at all. Out of those, 4% contribute more than 60% of the total income tax paid in the country. What’s more, is that the tax avoidance is coming from the formal sector where most employees contribute but their employers seem to be doing their best not to.
The report also points out the countries who are responsible for inflicting this loss of tax revenue on other nations. The likes of the US, Switzerland, Netherlands, all provide services for individuals and organisations that help them achieve their aims of paying as little as possible. One such ‘network’, or so to say, is known as the UK’s ‘Spider Web’. This essentially comprises the UK and its Overseas Territories and Crown Dependencies, the latter of which serve as satellite jurisdictions that can be used to shift profits and help assist the flow of illicit wealth. These comprise of the British Virgin Islands, Bermuda, Cayman, the Isle of Man, Turks and Caicos, Anguilla, Jersey, and Guernsey. The City of London, which is a financial district at the heart of the greater London area, is at the center of it all. This tiny jurisdiction contributes to about 2.5% of the UKs GDP. Such is the amount of wealth that can be found here. The UKs Spider Web reportedly contributes to about $70 billion in lost corporate tax, which makes 28.5% of total annual loss.
Beyond the UK and its Spider Web, are other tax havens like the Netherlands, Switzerland, and Luxembourg who are reportedly responsible for half the world’s tax avoidance risk and as such the authors refer to them as the ‘Axis of Tax Avoidance’. The report estimates that these nations contribute to about $116 billion in lost tax revenue around the world, which accounts for about 47.6% of the total corporate tax abuse each year.
Together, the UKs Spider Web and the Axis of Tax Avoidance are responsible for 76.1% of the worlds corporate tax losses. These countries make up a very small portion of the world in terms of land mass and population, and yet they have extraordinary influence over the finances of much of the world, most of which are poorer countries.
There are 3 main ways in which MNCs avoid playing taxes:
IP Structuring – This is when a business structures itself in such a way that all the valuable patents and knowledge is owned by another company, called the ‘intangible principal’, which is set up in a jurisdiction with low taxes. MNCs simply borrow the patents from these companies and use it in other parts of the world.
By law, the MNCs are required to pay a certain amount of their profits to the owners of the patents. So by doing this, they reduce their profits in the country that they are actually operating in, thereby playing fewer taxes. Since the taxes are low wherever the intangible principal is set up, they don’t lose much there either
Thin Capitalisation – This is when the capital of an MNC is concentrated in a low tax jurisdiction. Capital is required to purchase assets and grow the business. Instead of keeping the capital in the country of business, MNCs keep it in another company that they set up in a region with low taxes, and finance their purchases via debt (borrowing).
So they are basically ‘borrowing’ their own money. They have to pay interest on this capital, which is paid using the profits they earn. Again, their profits in the country of business reduce, enabling them to pay less taxes.
Base Erosion – This is how companies like Uber avoid paying taxes in India. They generally do not have any permanent establishment in the country, so when Indians pay their taxi fares via the Uber app, the payment actually goes to another country.
In this case, the Netherlands. Since the company is set up in Europe, it is not required to pay any taxes here in India. Instead, they pay the drivers directly and it pays a subsidiary in India for ‘support services’.
Another report released in 2016 estimated that India loses nearly Rs. 69,000 crore a year (or the entirety of our health budget) to tax havens around the world. The main destinations are Belgium, the Netherlands, Malta, Ireland, Switzerland, Hong Kong, Singapore, and Bermuda
Tax avoidance is a serious issue and needs to be addressed by governments around the world by holding corporations accountable. Stricter policy changes might help achieve this. Countries like India, however, need to focus on other areas as well. While India does lose a considerable amount of corporate tax every year, it also loses out in other ways. In the build up to the 2019 general elections in India, the current government decided to exempt all those earning less than Rs. 5 lakhs from paying incomes tax. This means that a little less than 1.5 crore people in the country are even eligible to pay taxes.
Most other countries tax those who earn at or above the median income of the nation. In India, the median income level is at Rs. 1.4 lakhs, which is far lower than the taxable threshold. The tax system here is designed to only really collect taxes from those at the very top, since India has been a very poor country ever since independence. But that is beginning to change. We can start taxing people at a lower income level, at low rates. After referring to data published by the Government, we find that if we taxed all those individuals earning above Rs. 2 lakh as well, there would be an increase in government revenue by about $2.5-$2.7 billion, which is approximately Rs. 20,000 crores. This would make up a fifth of our current education budget and more than a quarter of our current spend on healthcare.
There is a myth that most Indians do not pay taxes when the truth is that most Indians do not earn enough to pay income taxes. Compliance is likely to be higher than people expect.