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Why Are Indian MNCs Concerned about Joe Biden's Corporate Tax Policy?

Nov 13, 2020 8:31 AM 5 min read

After days of tense uncertainty, Joe Biden was declared the winner of the nail-biting US Presidential election on November 8th. This sent global stock markets climbing upwards, ceteris paribus .

Indian indices have been in the green too. However, there have been notable exceptions. The country’s bellwether technology stocks have dipped this week. In fact, tech topped the list of sectoral losers over the past few days.

That seems counterintuitive after all. Certainty in the US ought to be welcome news for Indian tech giants, no?

The reason Indian tech is not extremely enthused about a Biden presidency might have to do with taxation. Specifically, with the Base Erosion and Anti-Abuse Tax (BEAT) and the uncertainty around broader corporate tax restructuring.

What is BEAT?

Back in 2017, under the aegis of the Donald Trump administration, the US Congress passed the Tax Cuts and Jobs Act (TCJA). This slashed the corporate tax rate down to 21% from 35%.

Which was good news for Indian firms with US operations. This includes companies like Tata Motors, TCS, Wipro, Infosys, RIL, Mahindra & Mahindra, Asian Paints etc.

But the Act also introduced BEAT, a new tax that sought to discourage (1) US-based companies and (2) foreign companies with sizeable US operations, from eroding their taxable base by shifting profits to non-US jurisdictions.


How Does BEAT Work?

Essentially, what happens is that several large US corporations pay their affiliates in lower-taxed countries to use their patents and intellectual property. They make tax-deductible payments such as interest, royalties and service payments to the affiliates. While these practices may be fundamentally in-line with actual operating activity, there is clearly an incentive to escalate such payments since they all are made before arriving at the “Earnings Before Tax” number. This would depress the company’s taxable Income...and subsequently lower the actual Tax Outflow.

The US government was obviously concerned about this practice, which it viewed as an incentive for tax avoidance. BEAT was a way to fix these loopholes by enforcing an add back of these deductibles and consequently reverse some of the advantages that corporations would realise by inflating tax deductible expenses to related foreign parties.

A US corporation calculates its regular US tax, at 21%. It is then asked to recalculate the tax at the much lower BEAT rate after adding back the deductible payments. If the regular tax is lower than the BEAT, then the corporation must pay the regular tax plus the amount by which the BEAT exceeds the regular tax. More on this later...

The BEAT rate was 5% in 2018. It is 10% in 2019-2025, and will be 12.5% in 2026 and beyond.

The tax applies only to large enterprises - ones with gross receipts of more than $500m (averaged over the prior three years). It also applies only to a corporation that makes more than 3% of its total deductible payments to foreign affiliates.


How Does BEAT Affect Indian Companies?

Say you’re a large Indian company with sizable subsidiaries in the US. In 2019, your receipts totalled $1,000m. And your operating expenditure was $900m.

That means your taxable income was $100m. Under a 21% rate, you’re liable to pay $21m in corporate tax.

Enter, BEAT. This takes into account any payments you made to non-US-based affiliates by way of interest payments, royalty payments or consulting fees. Let’s say these payments added up to $200m (of the $900m overall). Now, your taxable income = $100m plus $200m = $300m.

And the BEAT rate in 2019 was 10%, So, you’re liable to pay 10% of $300m = $30m in corporate tax. 

Since the tax outgo under the BEAT regime is higher than the same without BEAT applied, you’ll have to pay the higher amount ($30m). $21m in regular tax and $9m in BEAT.

Therefore, thanks to BEAT, the Indian company will now have to shell out an additional $9m to Uncle Sam.


What Else?

American and Indian companies involved in offshoring operations have another headache - Global Intangible Low Tax Income (GILTI). This is the income earned by foreign affiliates of US companies from intangible assets such as patents, trademarks and copyrights.

Since 2017’s TCJA, GILTI has been imposed a minimum tax of 10.5%. Again, to discourage profit-shifting away from the US.

Additionally, there is now a disallowance of deduction for net business interest expense of a US company if it exceeds 30% of its adjusted taxable income. Bad news for Indian MNCs, for whom interest payments, management fees and royalties add up to 80-90% of EBITDA.

Not to forget that in the US, states also levy their own taxes. And most of them base their calculations on the federal-level taxable income. So as the scope of claiming deductibles and offshore expenses narrows, an increased level of taxable income invariably translates to increased state tax as well.

And who knows - in the near-term, some states may consider adopting a version of BEAT of their own!

But, wait. BEAT has been in place since 2017. And sure, when it was first introduced companies scrambled to revamp their holding structures, shareholding patterns and customer contracts so as to reduce their tax outgo.

But that was three years ago. Why are Indian companies worried again now?


Enter, Biden

President-elect Joe Biden wants to raise taxes on large corporations.

Remember the silver lining in Trump’s TCJA? The slash in corporate tax rates? Biden wants to undo that, raising it to 28%.

As for tackling profit-shifting, he is very much cast in the same mould as Trump. He wants to double the GILTI tax to 21% and assess it on a country-by-country basis.

When it comes to BEAT, while Biden may tweak the policy slightly, there’s no reason to expect him to withdraw it altogether. In fact, there might be an argument that he could tinker with the idea of upping the BEAT rate or widening its application. 

After all, it has been working - one estimate suggests that the new rules will result in a 20% decrease in profit-shifting. Economist Kimberly Clausing, who reportedly advised Biden on tax policy, has even said the TCJA “should be commended for providing some limits on tax avoidance through GILTI and BEAT”.

So, with the onset of the Biden era, multinationals might confront increased taxes and have to scramble again to revamp their holding structures, shareholding patterns and customer contracts.

That’s mayhem a business can do without. Especially during a pandemic-sparked recession!


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