Dawn of new era in International tax Policy
Last week, a group of 130 countries accounting for more than 90% of the world’s GDP, arrived at a policy consensus on the two-pillar solution developed by G20/OECD’s Inclusive Framework (IF). The solution, a package of two different yet complimenting tax rules (pillars), is intended to address the tax challenges of rapid digitalisation of world economies whereby multinationals have been able to generate significant profits from market jurisdictions without necessarily creating any degree of physical presence; hitherto, majority of these profits have remained untaxed in market jurisdictions for want of contemporary legislations like digital tax et al.
By all measures, this development is historical and represents remarkably successful multilateralism helmed by Paris-based OECD that has been working tirelessly in tandem with the G20 leadership to come up with common rulesets for ending the menace of ‘race to the bottom’ insofar as corporate tax cuts are concerned, across countries. As a member of the OECD’s Inclusive Framework, India has played a pivotal role in shaping the contours of global solution that will eventually rewrite almost the century-old international tax rules. Over the next few months, painstaking details of the two pillars are to be drawn out together with an implementation plan to be readied by October 2021. The implementation of the global agreement on the two-pillar solution is targeted for 2023 through a multilateral instrument; a parallel set of legislative changes will be necessitated too under domestic tax law and bilateral tax treaties for implementing global minimum tax proposal under Pillar 2.
The solution embedded in this global consensus ought to ensure that large multinational enterprises pay their fair share of tax bills across geographies, and that they do so in a manner that doesn’t create artificial competition amongst these countries in driving corporate tax rates to the bottom. To this extent, the global agreement reached by OECD/G20 underpins the spirit of multilateral cooperation despite the strong undercurrent of protectionism and trade tensions brewing in the past couple of years. Under the two-pillar solution, Pillar 1 lays out a new purpose-driven nexus rule to redistribute taxing rights among countries in respect of super normal profits of large, internationally operating and profitable MNEs, predominantly those who have the winners of globalisation. Pillar 1 solution is also predicated on the principle that once the global solution is put into implementation, countries will withdraw Digital Service Taxes, and other relevant similar unilateral measures put into place to shadow Pillar 1 discussions. In the Indian context, that would mean the much talked about Equalisation levy will have to eventually give way to new nexus and profit allocation rules.
Pillar 2, on the other hand, seeks to lay boundaries on global tax competition amongst countries by introducing a global minimum corporate tax (agreed at 15%) that will prevent base erosion through operation of a set of interlocking rules under domestic law and the bilateral tax treaties. It is important to also recognise that Pillar 2 does not eliminate tax competition altogether but defines limitations which have now been agreed more widely amongst more than 130 countries.
Ongoing global reset of tax rules is expected to yield additional US$ 100 billion profits of large MNEs to be reallocated amongst market jurisdictions each year (under Pillar 1 solution). Under Pillar 2, implementation of the minimum tax rule is estimated to generate additional US$ 150 billion global tax revenues per year (based on 20 to 30% of the profits in excess of 10% routine profits). Amongst other benefits, beside annual uptick in tax revenues, the new international tax policy ought to bring enhanced stability to international tax system by defining boundaries of tax competition and foster a fairer principle for allocation of taxing rights in a more digitalised economy. At the same time, the proposal for more effective dispute resolution mechanism either under mandatory arbitration or equally effective means, will help provide more certaintyby way of reduced tax litigation for taxpayers globally.
If one was to zoom in more on the architecture of the two pillars, Pillar 1 is predicated on a global consensus approach and is sought to be made applicable to fewer number of multinational enterprises, given that the size and profitability threshold (ie Euro 20billion+ >10% Profit Before Tax) has since been revised by the OECD’s IF, to align with proposal of G7 Finance Ministers’ and Central Bank Governors’ proposal set out in June. This is an important shift from the original proposal in the IF’s blueprint advocating Pillar 1 to be applied to all AFS and CFS businesses regardless of their size. Extractive and Financial services were already excluded from the new profit allocation rules under Pillar 1.
On the other hand, Pillar 2 is likely to apply to a wider set of multinationals with global revenue in excess of Euro 750 Million. Consisting of two interlocking domestic rules – Income Inclusion Rule and Undertaxed Payment Rule – Pillar 2 solution is not based on global consensus but linked to common approach for implementation; the reason being Pillar 2 will necessitate legislative changes to domestic laws of countries and will be an effective coordination with the overarching ‘subject to tax’ rule to be introduced under the tax treaties.
From India’s vantage point, the two-pillar solution is a significant outcome as this helps India assert its claim of fair share in taxing profits of large MNEs which are raking in volumes of sale without having to create physical presence. Pillar 2 ruleset will level the playing field for India inasmuch as ‘minimum tax’ solution will prevent, if not entirely eradicate, treaty shopping behaviours amongst MNEs. Clearly, the global consensus reached in this respect vindicates India’s decade-long tax policy stand to discourage harmful tax practices by leveraging the mismatch between bilateral tax treaties and domestic tax law that has been traditionally slow to react to emerging business realities.
(Sumit Singhania is partner, with Deloitte India. The views expressed are his own and not necessarily that of Financial Express Online.)
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