Will India gain by withdrawing equalisation levy in exchange for OECD deal?

While 136 nations have agreed to a global agreement under the platform of OECD to ensure large multinational enterprises (MNEs) with no permanent establishments in the countries in which they operate pay tax in those jurisdictions, India is treading cautiously and wants to see the final outcome of the deal to withdraw the equalisation levy, one of the conditions of the agreement.

There is little consensus among experts on whether or not the deal will bring in more revenues to India than the equalisation levy.

For instance, Amit Maheshwari, tax partner at AKM Global, a tax and consulting firm, said India’s current threshold for equalisation levy is about €230,000 (Rs 20 million). On the other hand, the annual global turnover threshold to fall under the scope of Pillar-1 is €20 billion, which raises significant concerns as to the tax collections which are likely to be lower now.

"Hence it is difficult that this (the deal) will garner more revenues for India," he said.

Rakesh Nangia, chairman, Nangia Andersen India, said markedly, the two-pillar approach seeks to tax only the ‘largest and most profitable MNEs’, while the prevailing equalisation levy  in India captures more companies in the tax net on account of lower threshold.

While more companies will stay out of the purview of the new framework, the OECD estimates that developing countries will garner more revenue on account of Pillar-2, he said.

Tax revenue is expected go up by approximately 1.5-2 per cent of corporate tax revenues on an average, Nangia said, adding since corporate tax collection was around Rs 3.02 trillion this fiscal, a revenue of Rs 4,500 crore is expected from digital taxes, which is higher that the digital-tax revenue of Rs 3,000 crore envisaged for FY 2022.

India introduced a six per cent equalisation levy for digital advertising services in 2016. Later in April 2020, it widened the scope to impose a 2 per cent tax on non-resident e-commerce players. India has so far collected over Rs 1,600 crore by way of the levy this fiscal, which is almost twice last year's figure.

Nangia also noted that India levies GST on Online Information Database Access and Retrieval (OIDAR) on non-resident service providers at the rate of 18 per cent. The GST collections may not be impacted under the new proposals and may continue to yield significant revenues.

Gouri Puri, partner at Shardul Amarchand Mangaldas & Co, said it is too early to comment on the revenue tradeoff between equalization levy and the OECD deal.

"Any such analysis will only be possible once OECD fine print is out and rules have been implemented. The revenue trade off should also factor in the economic costs of averting a trade conflict and the additional revenues that Indian will gain from the implementation of Pillar-2 as a package deal," she said.

Yashesh Ashar, partner at Bhuta Shah & Co LLP, said it remains to be seen whether any country specific rules for computation of tax profits will be acceptable or whether the profits as calculated by the enterprise in its home country would have to be adopted.

Also, many critical items such as deduction of advertising and marketing expenses, research and development expenses, and transfer pricing would play a major role in determining the profit allocation, he said.

"The multilateral convention (MLC) proposed to be developed will contain all the modalities. It is still a long-drawn process including development of MLC, negotiation of its contents and building a consensus. Also, the source rules to be determined will also play a role in allocation of revenue," he said.

Last week, the deal was agreed by 136 countries, representing 90 per cent of global GDP.

The deal is based on a two-pillar solution and is being deliberated by the G20 Finance Ministers' meeting in Washington. It will then be referred to the G20 Leaders Summit in Rome at the end of the month.

 

Under Pillar-1, MNEs with global sales above €20 billion and profitability above 10 per cent--the kind of companies that can be regarded as the winners of globalisation--will be covered by the new rules, with 25 per cent of profit above the 10 per cent threshold to be reallocated to market jurisdictions. This will generate additional tax revenues of $125 billion annually.

This is much higher than the €1-billion revenue threshold pressed by developing countries to cover 5,000 global companies.

The G24, a grouping of developing nations, had pressed for a gradual removal of unilateral measures such as the equalisation levy in India, simultaneous to revenue gains from the implementation of Pillar-1.

Pillar-2 introduces a global minimum corporate tax rate set at 15 per cent. The new minimum tax rate will apply to companies with revenue above €750 million and is estimated to generate around $150 billion in additional global tax revenues annually. Further benefits will also arise from the stabilisation of the international tax system and the increased tax certainty for taxpayers and tax administrations.

Pillar-2 will help fight the tendencies among MNEs to set up their operations in low-tax jurisdictions. Since the minimum tax rate will be 15 per cent, MNEs can think of relocating their businesses. In India, the corporate tax rate is 15 per cent for those setting up new manufacturing units. Otherwise, it is around 22-25 per cent. So, Pillar-2 can benefit India only if MNEs come to India to set up operations.

The OECD will develop model rules for bringing Pillar-2 into domestic legislation during 2022, to be effective in 2023.

It is essentially Pillar-1 that will help India and other developing countries, depending on the revenue garnered from the global tax. Besides, the threat of the United States imposing counter-tariffs under section 301 of the US Trade Act, 1973 on India and other countries which had imposed unilateral digital service tax (equalisation levy in case of India) is likely to be over.

Said Maheshwari," Now, with this consensus getting achieved and the commitment by India of consequent rolling back of EL in due course, the US may give away the thought of imposing any additional tariffs."

Nangia said it is most likely that upon successful implementation, the US will not impose tariffs on countries that have unilaterally imposed digital service tax.

Ashar said once a consensus is reached and India agrees to withdraw digital services tax, the threat of counter tariff measures by the US should also be withdrawn.

A paper, co-authored by Puri and Kinshuk Jha, associate professor and executive director, Centre for Comparative & International Taxation, Jindal Global Law School, said the proliferation of digital service taxes (such as the equalisation levy in India) absent a multilateral consensus on addressing tax challenges of digitalization can trigger a global trade war.

India’s commitment to a multilateral solution may also facilitate India’s ongoing trade deals with other allies, such as the UK, US and EU, said the paper, submitted to Niti Aayog. "On the other hand a trade war or a decline in international trade relations could be a major setback for businesses, investments flows and the Indian economy, which is eyeing a $ 1 trillion target for exports by 2025," the paper noted.