While the business world witnessed exponential growth with globalisation and digitalisation, the international tax system continued to grasp on age-old tax architecture which was inept of keeping up with the 21st-century global economy. Taking cognizance of the rising of highly profitable, technology-driven, digital-heavy and complex business models, exploiting the international tax systems, OECD and G20 member countries undertook the ambitious BEPS project to device measures and policies in international taxation to plug tax avoidance. 136 countries including India, representing more than 90 percent of the global economy have conceded to a "seismic global tax agreement" providing a two-pillar solution to address the tax challenges arising from the digitalisation of the economy.
Pillar-one targets top multinational enterprises (MNEs) having global turnover over EUR 20 billion and profitability above 10 percent by providing new taxing rights to market jurisdiction to re-allocate 25 percent of residual profits in excess of 10 percent of the revenue of the MNEs deriving at least EUR 1 million in revenue from that market jurisdiction. India being a developing country poised for growth and a lucrative destination for housing businesses on account of the myriad of non-tax considerations, has a large consumer market or user base and had, therefore, pressed for a lower (EUR 1 billion) global turnover threshold for considering a company as an in-scope MNE to cover top 5,000 global companies and an allocation of a minimum 30 percent of MNEs non-routine profits as anything lesser may not ensure fair revenue allocation to developing countries. However, this does not seem to have found its place in the recent statement issued by OECD yesterday and could have the effect of dampening spirits of developing nations including India. While the objective of the re-distribution of taxing rights is to benefit source countries, the benefit is likely to be skewed towards high-income countries vis-à-vis middle and low-income countries albeit such developing countries are sufferers to the highest proportion of tax avoidance. This aside, having a common threshold that may not be commensurate with the type of business or size of the economy could be seen as antithetical to the goal of achieving tax neutrality amongst different jurisdictions. Further, as unilateral measures such as digital services tax (alias equalisation levy) is set to be discontinued with immediate effect, revenue from Pillar One may not be as appealing as equalisation levy collection for the Indian tax administration. Also, the statement released by OECD yesterday mentions that no newly enacted digital services tax or other relevant similar measures would be imposed on any company from October 8, 2021, and until the earlier of December 31, 2023, or coming into force of MLC, which raises doubt if equalisation levy already stands suspended effective yesterday until coming into force of MLC.
A lot will remain fluidic until the final mechanism of determining revenue sourcing and the tax base is formalised. It is stated that sourcing rules for tagging the market jurisdiction would be developed for specific categories of transactions and the methodology to be adopted by the in-scope MNEs must be based on MNE specific facts and circumstances. Such subjectiveness could give room to divergent views and permeate uncertainties than easing headwinds caused by the already existing complex international tax framework. It is also indicated that relevant measure of profit or loss of the in-scope MNE would be determined by reference to financial accounting income, with a small number of adjustments. The Indian taxing system prescribed its own set of adjustments to the accounting income and any deviation from this would trigger turmoil for taxpayers who are already grappling with multi-fold tax provisions requiring reconciliations.
Pillar Two aims to tax MNEs with revenues above EUR 750 million, at a minimum tax rate of 15 percent. Pillar-two includes 2 interlocking domestic rules referred to as the GloBE Rules and a treaty-based rule allowing source jurisdiction to impose a tax on certain related-party payments. These rules operate in a manner to bring into account a proportionate share of income of a corporation to tax if that income was not subject to an effective rate of tax above a minimum rate. Pillar Two is welcome by most jurisdictions as it provides a fair footing to them against low tax jurisdictions for its investment lucrativeness. Even so, India will have an advantage in implementing Pillar Two based GloBE rules in its domestic tax legislation as India is not encumbered with an existing Controlled Foreign Company (CFC) regime. Further, a global minimum corporate tax rate of 15 percent is expected to be favourable to India as reports suggest that India is to gain at least $4 billion, equivalent to almost 6 percent of FY 21 corporate tax collection. Also, it may not have any impact on foreign direct investment into India as it would not create any adverse or incremental tax liability in the hands of foreign investors.
It will be interesting to watch how the implementation of the two-pillar solution is going to be carried out, given the hard timelines and geopolitical tensions around the world. Few recommendations of Pillar Two, say, STTR have to be implemented via bilateral treaties. This could be a challenge where there are no existing tax treaties between countries. Considering the complexity of tax jurisdiction and pendency of tax litigation in India, companies would have to proactively undertake an impact analysis to determine 'in-scope' businesses and probable taxable amounts under this global overhaul. This could be the beginning of a new tax era where companies need to be ready with a fresh set of data to comply with the new regime of global taxation.
The author, Sandeep Jhunjhunwala is Partner at Nangia Andersen LLP. With inputs from Amita Jivrajani and Abhishek Mehta. The views expressed are personal.