Taxation of the digital economy has been a vexed topic and under the aegis of Inclusive Framework on BEPS, OECD did a lot of hard work in try to come to a consensus on how to tax digital companies. After years of deliberation and negotiation a breakthrough came on July 1, 2021, when 131 out of 139 members of the Inclusive Framework, representing more than 90 percent of global GDP accepted the global minimum tax proposal. This consensus is a landmark development towards addressing the challenges due to digitalization in market jurisdictions from the taxation standpoint. It is expected that this deal will result in additional annual tax revenues of around $ 150 billion with most of it accruing to market jurisdictions.
This proposal works on two pillars out of which Pillar 1 deals with fairer profit allocation to the market jurisdictions regardless of the physical presence of the entities there for which a multilateral convention can be implemented from 2023 whereas Pillar 2 has introduced a global minimum tax of 15 percent. The salient features of Pillar 1 and Pillar 2 are as follows:
Pillar 1 would apply to MNEs meeting the criteria of global turnover exceeding 20 billion Euros along with a profitability of 10 percent (i.e., PBT/revenue). The turnover threshold is to be reduced to 10 billion euros going forward. The revenues from Extractives and Regulated Financial Services will remain excluded. 25 percent of residual profit i.e. profit in excess of 10 percent of revenue will be allocated to market jurisdictions with certain nexus. This is referred to as Amount A.
Nexus will be said to be established when the MNE derives at least 1 million Euros in revenue from that jurisdiction. For smaller jurisdictions with a GDP lower than 40 billion euros, the nexus will be set at 250,000 euros.
The work on Amount B i.e. the streamlining of the arm’s length principle to in-country baseline marketing and distribution activities will be completed by the end of 2022.
Members have agreed not to levy any other similar tax on digital services from 8th October 2021 and 31st December 2023 as it is expected that by that time, the Multilateral convention incorporating the proposals will be put into effect.
Pillar 1 will be effective through Multi-Lateral Convention to be developed & signed in 2022, with Amount A coming to effect from 2023. The MLC will contain the rules necessary to determine and allocate Amount A and eliminate double taxation, as well as the process of simplified administration exchange of information and dispute prevention and resolution.
Pillar 2 is a mix of several rules like Income Inclusion Rules (IIR i.e. the tax on parent entity for low taxed income of one of its constituent), Undertaxed payment rule (UTPR i.e. denial of deduction to the extent low taxed constituent is not subject to tax under IIR) and Subject to Tax Rule (STTR i.e. tax by source country on some related-party payments subject to tax below a minimum rate). There would be a 10-year transition period for certain exclusion of a certain percentage of income, the exclusion is reduced from year to year. Certain other thresholds for exclusion of certain MNEs are also prescribed.
Furthermore, the Model treaty provision for the subject to tax rule is to be developed by November 2021. Pillar 2 will be brought into law in 2022, to be effective in 2023, with the UTPR coming into effect in 2024.
Several countries including India had proposed some kind of unilateral measure to tax the digital economy as an interim solution. In fact, India’s Equivalization Levy was subject to US investigation u/s 301 of US Trade Act, 1974. This was considered discriminatory and against international principles by the US. The US however kept on hold the retaliatory tariffs since this deal was around the corner.
India, being a big market for large tech companies has always endorsed the global tax deal and was expected to join this OECD/G20 Inclusive Framework.
Consensus on profit allocation was an important part of the deal. With this consensus getting achieved, the Equalization Levy, which was imposed as a unilateral measure by India on digital transactions will be rolled back once the Multilateral convention comes into effect. The provisions of Significant Economic Presence (SEP) could also meet the same fate.
This is a welcome step aiming towards tax certainty and in line with upgrading the international tax systems to become suitable for the tax challenges in today’s digital world. India’s revenue from EL currently stands at around Rs 1,618 crore for the current fiscal year. It is expected that the revenues agreed measures would surpass and would bring certainty to the taxation on the digital economy at a global level.
The author, Amit Maheshwari is Partner at AKM Global. Also, assisted by Sandeep Sehgal and Yeeshu Sehgal. The views expressed are personal
First Published: IST