Smarak Swain

Smarak Swain
Joint Commissioner, Income Tax
(Headquarters), New Delhi
[email protected]

Smarak Swain graduated in Electrical Engineering from Indian Institute of Technology, Kharagpur in 2006, and joined the IndianRevenue Service (IRS) in 2008. He has also done Masters in Taxation and Business Laws (MTBL) from NALSAR University, Hyderabad. He is author of the bestselling books, Loophole Games: A Treatise on Tax Avoidance Strategies, followed by (among others) departmental officers working in investigation and corporate assessment roles, and Tangible Guide to Intangibles: Identification, Valuation, Taxation & Transfer Pricing, followed by Transfer Pricing Officers across the country.

Executive Summary

The author states that the present world order is dominated by a conflict between two ideologies and their proponents: globalisation and local sovereignty. Globalists advocate borderless commerce, homogeneous world culture, and a rules-based world order (political globalisation). Whereas, nationalists resist these moves by advocating protectionism (a reaction to economic globalisation), fundamentalism (a reaction to uniform world culture) and strong national governments. The author examines the conflict between the two groups on one front, i.e. taxation of digital economy. The author highlights the problems for a national government in taxing the digital economy. He goes on to demonstrate how an international rules-based system has to be devised in order to tax the digital economy.

The rising polarisation and/or extremism of views (on both side of the spectrum) we see in many countries in recent times is a symptom of a larger struggle. The larger struggle is between Globalists and Nationalists. In fact, it is a civil war, and we are living in times of a great global civil war.

All forms of local right-wing or conservative polarisation are forms of resistance against the pace of globalisation and homogenisation. Be it white supremacy, Hindu supremacy, Islamic extremism, or Brexit, these are attempts by local groups to challenge the might of globalisation.

On the other side are Globalists, who do not believe in boundaries or state laws. Multinational Corporations and their bureaucrats drive the agenda for economic globalisation. A cult/belief group called Humanitarians drive the agenda for cultural globalisation. They believe in women rights, human rights, gay rights, transsexual rights etc (not being a sociologist, I will not explore the relation between the liberal ideologies and humanitarianism, and whether humanitarianism is a belief system, value system, or religion).

We are in the middle of a civil war. Globalists as a group are like an octopus, and have spread their tentacles everywhere. They promise greater trade and more economic activity to national governments. But they also want to impose a rule-based world order, thus eroding the authority of nations. Nationalists are fragmented. They are fighting globalists on their own; they have no common ‘class consciousness’. Interestingly, they are also a divided lot. White supremacists in America want China to give greater access to foreign businesses, but advocate protectionism in America. So while a government supported by their ideology is pressurising China to open up to Globalists, they themselves want to build walls against Globalists.

Now comes a pertinent question: how come we are in the midst of a global war and are not aware about it? Karl Marx had once explained the basis of American Civil War. History books tell us that American Civil War was about abolishing slavery and giving human rights to African Americans. But the reality exposed by Karl Marx was somewhat different. The North took an anti-slavery stance because it was dominated by industrialists who prefer free labour for factories (that require some skillsets to work in). The South was pro-slavery because it was dominated by large cultivators who prefer bonded labour to work in farms. The civil war was a class conflict between the Capitalist North and the Feudal South.

Very similarly, we are seeing a class conflict between the Globalists and the Nationalists in contemporary times. The invisible force of globalisation is everywhere. The world is divided into two:

  • Those who have been indoctrinated into the Humanitarian ideology and/or have benefited from globalisation, and
  • Those who have been left behind in the fast pace of globalisation and yearn for a more pristine past.

Those who have been left behind in the fast pace of globalisation and yearn for a more pristine past support ideologies that revere historical and mythological times as best time on earth. This is called fundamentalism. Fundamentalism is primarily borne out of globalisation, but takes specific, local, ethnic colour. For instance, the Iranian revolution of 1979 was against Western capitalists (basically early economic Globalists) and their control over Iran’s Shah and oil wells. But people were mobilised in the name of a fundamentalist Shia ideology.

Almost all forms of fundamentalism around the world are a reaction to the invisible forces of globalisation.

Evidence from the frontier: Taxing the digital economy

Globalisation has many fronts: economic globalisation, cultural globalisation, political globalisation being the prominent ones. Economic globalisation is the fastest, as it is driven by a profit motive. It is followed by cultural globalisation. Cultural globalisation leads to homogenisation, i.e. widespread prevalence of a global culture. It puts local cultures and mores, that many cherish, at risk. Political globalisation is the slowest of all major forms of globalisation, as it ultimately means dissolution/weakening of sovereign governments in favour of a global rule-based world order. Powerful national governments resist political globalisation.

Through the example of taxation of digital economy and avoidance through tax havens, I seek to demonstrate how authority of national governments is ultimately going to be eroded. I am a frontiersman; as an agent reposed with responsibilities to enforce government authority, I see how economic globalisation has led to businesses that circumvent national laws, but cannot circumvent effective global laws.

Taxation is the most basic function of a sovereignty. In fact, right to tax citizens of a territory is usually seen as the surest sign of a sovereignty. In modern democracies, provincial governments focus on service delivery, while national governments focus on a limited number of activities: taxation, defence, and international relations.

Traditional tax laws in most countries are based on the concept of territorial nexus. That is, a business is taxable in (say) India if the business has a territorial nexus with the State of India. This territorial nexus is variously called Business Connection and Permanent Establishment as well.

The advent of digital economy has brought about new business models that can do business in a country without any physical presence in the country. For example, I can run a video streaming website from Cayman Islands. Viewers based in India can pay me through their credit card and watch the videos on their laptop or smart TV. I don’t need any physical office in India to run this business. If consumers need assistance, I can set up a subsidiary in India to provide customer support service. My core business need not be in India. Hence, my core business is not taxable in India on its profits from India.

Many other models have come into existence, that are outside the jurisdiction of national taxmen. The opening of borders to facilitate economic globalisation has led to the proliferation of tax havens. Many multinational businesses are shifting their profits to tax havens to reduce their tax liability in countries they earn income from. Value of a business in today’s world lies in the intangibles that the business possesses. The intangibles are being concentrated in tax havens. As a result, all super-normal profits are being attributed to the entities registered in tax havens. For a detailed exposition of the modus operandi used, refer my book Loophole Games.

There is nothing new in businesses misusing loopholes to dodge tax. Government and businessmen follow a continuous cycle called the cycle of regulation. Businesses will keep finding innovative methods to dodge a regulation. After a time lapse, government catches up and formulates new rules.

But with globalisation, national governments are unable to cope with the new methods of tax avoidance. Big Tech companies have been dodging tax for the last two decades now by using these new models and tax havens. But national governments have still not been able to come out with new laws to regulate them. This is because technology has opened up new models that require countries to cooperate. The European Union wants to bring a new concept called the Virtual Permanent Establishment, which means digital nexus instead of territorial nexus to determine tax jurisdiction. Some members of EU are opposed to this, because they function as parasitic tax havens. America is against it as most Big Tech companies are America-based. The tax evaded by them will ultimately mean more profits, which means more dividend for American residents. As a result, they are unable to reach at a consensus.

To top it all, any new law takes long period of time to implement. Take, for example, the new law on Significant Economic Presence (SEP) that was introduced in Indian Budget in 2018. It was fervently talked about all over the world as a step in the right direction. But this law remains dormant as the law has been introduced only in the domestic tax code. Tax treaties with various countries have to be amended so as to bring an enabling clause for SEP. All tax treaties need to be amended; or else Big Tech will restructure their business to use a country that does not have a SEP-enabled-treaty with India as gateway to come to India. The process will take long time.

The BEPS Action Group of Organisation for Economic Cooperation and Development (OECD) found a solution to repeated renegotiation of bilateral treaties in Multilateral Instruments (MLI). However, options given to members of members of BEPS Action Group have diluted the MLI as well.

It has already been two decades since the new models of digital economy have come into prevalence. And national governments have not been able to bring them under the tax net. They know that in the largely interconnected world, they cannot act alone. Changes in domestic laws need to be supplemented by amendments in bilateral tax treaties. As a result, if any disruptive technology comes in year y, effective regulation comes in year y + 30. This significantly slows down the cycle of regulation. Newer technologies come in periods less than 30 years. In the present scenario, treasury can never keep up with tech companies.

Evidence from the frontier: Automatic Exchange of Information Agreements

Another vexing issue arising out of international business operations is for local investigators to collect data. A tax sleuth in Dhaka can investigate financial transactions anywhere in Bangladesh, and collect information from any bank, any shopkeeper, any authority in Bangladesh. But when investigating a cross-border business, the tax sleuth is impotent in receiving information. To remove this bottleneck, OECD has prepared a framework for countries to enter into bilateral treaties for exchange of information. A taxman in Dhaka can write to authorities in (say) Singapore to share information about businesses in France having nexus in Dhaka.

In the second-generation reforms, countries are entering into automatic exchange of information agreements (AEIA). That is, Singapore will automatically communicate to Bangladesh if it finds some transactions of its residents with Bangla residents suspicious. An international body of bureaucrats is being formed to facilitate AEIA. These international bureaucrats are still employed by national governments. For instance, the government of France has deputed a ‘tax attache’ in its embassy in Beijing to coordinate with Asian countries on seamless communication of tax-related intelligence.

If any country refuses to enter into Exchange of Information agreement with another, the later can impose punitive audits on transactions of its businesses with the former.

An International Revenue Service?

Policymakers are now proposing that the existing system of international taxation be re-tuned to go for a formulary apportionment method of taxation. A theoretical plea of tax academicians is that the value addition of various countries in making a product or in providing a service be calculated and the overall profits be apportioned to the countries based on value-drivers. But who will do the apportionment?

As can be seen from above, national governments’ power to tax has already been eroded to a significant extent. When you cannot tax an entity even after introducing a law in your domestic statute, it shows your utter dependence on international treaties.

National governments are also forced to cooperate with each other for gathering intelligence and financial information that can help them in enforcing their local tax laws. An international body of bureaucrats (albeit with national affiliation) has already been formed to facilitate exchange of information.

With increasing globalisation and newer technologies, governments will soon realise that an over-arching international taxing authority is required to tax multinational corporations. The international taxing authority will discipline tax havens and determine litigation-free apportionment of profits of a multinational to various countries on the basis of value addition in these countries. Governments will soon realise that the inordinate delay in Cycle of Regulation will remain unless they come together and form an international revenue authority.

They will also realise that their tax diplomats and their international bureaucrats will be doing work that is duplicative of the work done by international bureaucrats of other national governments. A better option will be the International Revenue Service.

Marx has largely been discredited. But scholars still accept some of his theories. For instance, his idea that economic sub-structure largely drives the super-structure is still referred to explain how economics influences political change. Economic globalisation is putting strains on local cultures and national governments. Economic globalisation is forcing national governments to cooperate and give up their sovereign rights. Newer technologies will define to what extent political globalisation will happen. For instance, blockchain technology promises a decentralised administration without the need for a central government (provincial governments will still be required to provide the beat police and municipality).

And Nationalists will keep resisting the invisible octopus called globalisation.

Source- Taxaloguue – Volume 1- Issue 2- OCT-Dec 2019 Issued by Directorate of Legal & Research -Central Board of Direct Taxes

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December 2021