Two-pillar tax deal can help countries but needs a rejig to suit India

Tax in the time of digital

India’s tryst with taxing of multina­t­ional corporations, or MNCs, is well documented, though not always in a kind way if you think about the so-called retrospective taxes. This must be seen in the context that emerging countries such as India have a high dependence on companies in their direct tax collections and therefore feel the brunt of tax planning by comp­anies to benefit from the gaps in rules.

The situation has become exacer­bated with the rise of digital technologies, which enable big global corporations to earn substantial revenues in a country without having to pay much, or any, tax. This is possible either because they have no physical presence in the country or be­cause the current rules make it possible for MNCs to pay only a small tax in a cert­ain country, despite earning huge reven­ues there, by parking most of their profits in countries that have low-tax regimes.

The move towards a global tax frame­work for MNCs, which has gathered mom­e­ntum since 2021, is expected to navigate the challenges of the rapidly growing digital economy by giving emerging market economies, including India, the right to tax large MNCs such as Apple and Amazon.

But this presents challenges of its own.

At the G20 summit in September, Ind­ia proposed increasing the tax on MNCs in countries where they make substan­tial profits, and sought support from other nations in reforming international tax norms. India’s fear is that it stands to get too little in return for scrapping the exist­ing digital taxes such as the equalisation levy, commonly called the Google Tax, which was introduced in 2016-17 to tax global digital giants that earned substantial revenues from Indian users but paid low or no taxes.

Scrapping of existing levies is one of the clauses in the global deal.

Two-pillar plan

The global tax pact consists of two pillars. Pillar 1 is about re-allocation of taxing rights. It aims to re-allocate a portion of “excess” profits of MNCs to the markets where they operate. Global companies with an annual turnover of more than 20 billion euros are considered to have ex­cess profits if their profits grow faster than 10 per cent a year. The redistribution will allow recipient countries to tax 25 per cent of the “excess” profit of large MNCs.

Pillar 2 aims to introduce a global minimum corporate income tax of 15 per cent. Together, the two pillars can generate $150 billion in additional global tax revenues annually.

However, the global tax deal requires countries to remove all digital service tax­es, like India’s equalisation levy and other similar measures, and give a com­m­it­ment not to introduce such measures in the future. India’s Google Tax garnered Rs 3,864 crore in 2022-23, slightly down from Rs 3,900 crore in the previous finan­cial year. The decline was attributed to the lower chargeable payments made by internet companies amid uncertainty over the global tax deal.

After several rounds of deliberations over a decade, the Organisation of Econo­mic Co-operation and Development (OECD)/G20 countries agreed on the two-pillar approach in October 2021 under their Base Erosion and Profit Shifting (BEPS) project.

BEPS refers to tax planning by MNCs to benefit from the gaps in tax rules. This has become exacerbated in the modern digital era. The project was triggered following governance and tax avoidance issues mostly ignored by countries prior to the 2008 financial crisis.
 

The OECD estimates that as much as $240 billion in global tax revenue is lost to BEPS every year.

From the outset, India has been at the forefront of the BEPS project and has been vocal about the overhaul of the international taxation framework from the perspective of emerging countries.

The question is, can India collect as much, if not more, under the proposed global pact than it does from its own levies?

Elusive consensus

Emerging countries including India bel­i­eve the two-pillar approach may not co­m­­pletely achieve the intended benefits.

“The concerns stem from the fact that low-tax jurisdictions may continue to collect residual tax by way of domestic minimum tax and thereby the proposed solutions may not be a game-changer for developing nations,” said Parikshit Datta, tax partner, EY India.

Pillar 2 is irrelevant to emerging coun­tries from a revenue perspective, as it aims at eliminating tax arbitrage and is meant to address the current setup of MNCs that allegedly park their profits in tax havens. The subject-to-tax rule (STTR), which is the second part of Pillar 2, will be of limited benefit due to its narrow scope.

STTR is a treaty-based rule, which may override the benefits in existing treaties in the case of payments that are not subject to a minimum tax in the recipient jurisdiction.

Pillar 1, on the other hand, could hin­der reserve taxing rights for emerging countries, which have sought a review of the profit allocation. Unlike the current proposal, which covers only the top 100 digital MNCs, India has proposed a lower threshold that would cover more global companies.

“Besides, formulas proposed for profit distribution may or may not align with the economic activities of the res­p­ective market jurisdiction. Also, there are para­meters that are subjective in nature and could lead to disputes both for MNCs and tax authorities,” govern­ment officials said. They believe the proposed tax agreement could reduce the tax collection from digital companies at least in the initial years, before stabilising.

“Irrespective of the con­cerns, the proposed solu­t­ion is a step in the right dire­c­t­ion and significantly broadens the conventional corners of international taxation. With the passage of time it may be further aligned to address the con­c­erns of developing countries,” Dutta said.

Pillar 2 is expected to be implemented by 2025 by all MNCs, but there is no clarity over implementing Pillar 1 due to the complexities.
 

“The OECD deal will suit US MNCs better than the several unilateral measures being imposed by disgruntled countries,” said an expert who does not want to be named.

However, in May this year, at the Wor­ld Economic Forum in Davos, a few pro­m­i­nent personalities representing the US voiced their concerns about implementing Pillar 1. This pillar is also facing op­position in the US Con­gress from Republican senators. Analysts say the deal could fall if the Democrats lost control of the House of Rep­resentatives in this Nove­mber’s midterm elections.

Prior to the 2021 agree­ment, the Uni­ted States Trade Representative had said that digital services taxes adopted by In­dia discriminated against American companies and the US would therefore continue to evaluate options, including trade tariff actions. 
 

However, the differ­ences were later resolved and India could continue to charge its equalisation levy till March 31, 2024, or till the imple­men­tation of Pillar 1. In return, the US will terminate any tariff action in response to the levy.

In the meantime, India is leading the United Nations’ Tax Committee’s tax treaty solution, known as “Article 12B” and finalised in April 2021, for withholding tax on a gross basis in order to tax income from automated digital services. Officials say this is expected to yield significantly higher revenues than the OECD approach. Besides, it preserves the sovereign taxation rights of source nations such as India.

Looks like there is a third pillar rising.