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Global Minimum Tax proposals: ‘Great Expectations’ from G20 roundtable

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The OECD mentions that global minimum tax proposals will lead to a more favourable environment for investment and economic growth.

Global Minimum Tax proposals: ‘Great Expectations’ from G20 roundtable
As the proverbial character of ‘Pip’ in Charles Dickens ‘Great Expectations’, the young child of the Organisation for Economic Co-operation and Development (OECD) in the form of Base Erosion & Profit Shift (BEPS), global tax proposals will be wishing for the mysterious large tax fortune from the proposed global minimum tax policy measures that found their way from the G7 to the G20 roundtable in early July.
The stage was set in October 2020 by the BEPS 2.0 project on tax challenges of the digitalisation of the economy. These included ‘Blueprints on Pillar One’ dealing with the allocation of global profits of MNE groups to market jurisdictions and ‘Pillar Two’ dealing with global minimum tax rules.
As per the OECD, ‘Pillar Two’ proposals are estimated to generate around $150 billion in additional global tax revenues annually and under Pillar One, taxing rights on more than $100 billion of profit are expected to be reallocated to market jurisdictions each year, leading to (admittedly) a modest increase in global tax revenues. On average, most countries would benefit while ‘investment hubs’ would tend to lose tax revenues.
Pillar Two, on the other hand, would yield a significant increase in corporate tax revenues across all countries as it would significantly reduce the incentives for MNEs to shift profits to low-tax jurisdictions.
The OECD also mentions that these proposals will lead to a more favourable environment for investment and economic growth as, amongst other things, it would enhance the efficiency of global capital allocations by increasing the importance of non-tax factors like infrastructure, education levels and labour costs.
Regarding Pillar One proposals, a large majority of the BEPS inclusive framework (IF) consisting of 139 jurisdictions (including G7 and G 20), seem to have accepted that 10 percent of global profits earned by an M&E shall be deemed to be routine profits and 20-30 percent of balance ‘upside’ profits will be allocated to market jurisdictions. This is illustrated below:-
As per the above formulation, 2300 MNE groups were sought to be covered under the original proposals of Pillar One but, based on the USA’s suggestion, the consensus under the IF seems to have settled for the US proposal of restricting this measure to the top 100 MNEs.
If this is the case, the potential incremental revenues for a country like India may be relatively modest. It is also interesting to note that the European Commission (EC) has agreed to ‘put on ice’ a pan Europe proposal for digital service tax in view of the global resolution on Pillar One.
This would mean that India too may have to withdraw the Equalisation Levy and Digital tax provisions recently introduced in the domestic tax laws.
Another important factor is the proposed dispute resolution mechanism, originally outlined in the Blueprint of October 2020. It may be difficult to arrive at a consensus on a ‘mandatory and binding’ dispute resolution mechanism as countries like India will likely stress on Mutual Agreement Process (MAP) under double tax avoidance treaties (DTATs) as a more acceptable option.
As regards Pillar Two proposal, the crux is centered around the Income Inclusion Rule (IIR) that will trigger an inclusion at the level of the shareholder where the income of a controlled foreign entity is taxed at below the effective minimum tax rate. With a minimum tax threshold of 15 percent agreed by the IF, this should be almost neutral for India as far as inbound investments are concerned.
India’s recently introduced incentive tax rate of 15 percent for new manufacturing units, should not fall under the IIR of overseas parent jurisdictions, as and when implemented. On the other hand, as far as India headquartered MNEs are concerned, the proposed 15 percent global minimum tax would be beneficial for India as the incentive for routing outbound investments through low-taxed intermediary locations like UAE, Ireland and Mauritius will considerably diminish.
It is significant to note that in the entire history of global taxation, this is the first time that a global consensus has been forged on a baseline minimum global tax rate. Obviously, global tax principles have considerably evolved from the days of the celebrated Duke of Westminister case, where the English High Court famously held that every taxpayer is entitled to arrange his affairs to result in a lower tax burden.
The latest OECD global tax proposals have the promising potential of removing the unhealthy ‘race to the bottom’ of the corporate tax rates amongst nations competing for investments and getting countries to focus on broader investment conducive factors. Thus, a level playing field for all businesses will be ensured with a minimum global tax rate and will benefit both developed as well as emerging economies.
In conclusion, after decades of largely unsuccessful attempts, the latest OECD Pillar One and Pillar Two proposals have generated great expectations of a turnaround in the fortunes of the revenue treasuries of all nations. Let us all hope that, like in the case of the proverbial, ‘Pip’ in the novel by Charles Dickens, these expectations are largely fulfilled.
Authors Sudhir Kapadia and Aastha Jain are Tax Leader and Director, Tax Knowledge & Solutions, respectively at EY India.
Views expressed are personal