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Decoding the India - US Transitional Approach on 2% Equalization Levy

Addressing tax issues arising in the digital economy has been a priority of the international community since past few years. In order to deliver a consensus-based solution and ensure that Multinational Enterprises (MNEs) pay a fair share of tax in the jurisdiction they operate, the Organization for Export Co-operation and Development (OECD) / G20, by way of a Statement/Deal had, on the 8th of October 2021, introduced a major reform in the international tax framework.  In all, 136 countries, including India and the USA, out of a total of 140 countries, have agreed to this Statement.

The Statement/Deal provides for an Inclusive Framework that requires countries to remove all digital services tax and other similar unilateral measures and provide for a Two-pillar solution, consisting of two components viz: Pillar One, which is about reallocation of an additional share of profit to the market jurisdictions and Pillar Two, consisting of minimum tax and subject to tax rules. For a detailed discussion on the OECD/G20 inclusive framework, kindly refer our article on OECD BEPS Framework: Recent Development.  

 

Post the issuance of the said Statement/Deal, on October 21, 2021, the United States of America (US), Austria, France, Italy, Spain, and the United Kingdom reached an agreement on a transitional approach to the existing Unilateral Measures, while implementing Pillar One. A similar transitional approach has been agreed by India and the US on the 24th of November and notified by way of a Press Release by the Government of India- Ministry of Finance, the same has been elaborated below: 

 

Press Release dated 24th November on India and USA Agreement on Equalization Levy 

 

As per the Press Release, India and the US have agreed that the same terms that apply under the joint statement released by the US with five European countries on 21 October 2021, shall apply between the US and India, during the interim period before Pillar One rules comes into effect.

 In light of the Press Release and 21 October joint statement, impact on India’s 2% EL could be as follows:  

 

  • India will not be required to withdraw the 2% EL until Pillar One takes effect.
  • India will allow a credit of the excess of 2% EL chargeable on non-resident (NR) e-commerce operator (NR EOP), belonging to a multinational enterprise (MNE), during the “interim period”, vis-a-vis the tax liability determined under Pillar One – Amount A, for the said interim period, once Pillar One rules are in effect. As per the Press Release, this interim period will begin from 1 April 2022, till the implementation of Pillar One or 31 March 2024, whichever is earlier.
  • The US will terminate its proposed trade actions against India regarding the 2% EL.
  • India and the US will remain in close contact to ensure that there is a common understanding of the respective commitments and endeavour to resolve any further differences of views on this matter through constructive dialogue.
  • The final terms of the India-US agreement are awaited and is expected to be issued by 1 February 2022.

 

FM Comments: 

While the fine print of this agreement between the India and US is still awaited, it would be interesting to see how the 6% EL on online advertisement revenues, are proposed to be dealt with, as apparently, the same does not seem to form a part of the deal. 

It also remains to be seen what kind of potential hiccups this deal would entail, should there be a delay in the implementation of Pillar One, beyond the time provided in the deal, and the potential impact of this on the business of MNEs. 

At the given point of time, the above seems to be merely a statement of intent by the two major economies, so as to streamline the long pending issues of digital taxation. One can only hope that the said deal is not a result of threat of trade actions by the US and would indeed be a win- win for both the countries. 

Image Credits: Photo by Antonio Quagliata from Pexels

Post the issuance of the said Statement/Deal, on October 21, 2021, the United States of America (US), Austria, France, Italy, Spain, and the United Kingdom reached an agreement on a transitional approach to the existing Unilateral Measures, while implementing Pillar One. A similar transitional approach has been agreed by India and the US on the 24th of November and notified by way of a Press Release by the Government of India- Ministry of Finance

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The Other Face of Digitalization: Changes to Tax Laws and More

Very often, speeches and articles begin by alluding to an environment of significant change, that brings in its wake, opportunities as well as higher levels of uncertainty. The wave of digitalization triggered by the emergence of various technologies is often cited as a prime example of this change. Digitalization has undoubtedly proved its worth in the past 18 months. Enabling remote working for millions of employees in various industries, enhancing the convenience of online banking, creation of new mobile payment options, virtual video/audio conferences are all examples of how digitalization has transformed the global society.

But there is a flip side to this too. Big Tech companies are growing rapidly, not just in terms of influence but also their financial muscle. To put it in perspective, the combined market capitalization of the top five Big Tech companies- i.e., Apple, Microsoft, Alphabet (Google’s parent), Amazon and Facebook was around US$9 Trillion as of 1 October 2021[1]. By comparison, the market cap of India’s top five companies was around US$750 Billion.

Tax laws need to keep up with the “digital economy”

The pandemic has severely dented government revenues worldwide, while expenses have ballooned. This has led to spiraling fiscal deficits, that have their own consequences. Given that most corporate tax regimes worldwide evolved keeping conventional businesses in mind, and that digital economy businesses are very different in nature, a new corporate tax playbook is clearly needed.

Given its large number of digitally-savvy consumers, a country like India is often one of the top three markets for digital economy companies such as Amazon, Facebook, Netflix, etc. But the nature of their business is such that they can carry out business in India (or any other jurisdiction) without having a significant place of business in that jurisdiction. So while countries like India contributed to revenues, low local operating costs meant higher profits. But this did not translate into higher taxes for India because MNCs registered companies in countries with lower tax rates and assigned IPR to these companies. The subsidiary operating in India would then pay a royalty to this overseas company. This is not illegal under the letter of existing tax laws, but it does lead to low tax revenues.

The Tax Justice Network estimates that India loses US$10.1 Billion annually due to abuse of tax laws; the US is believed to lose five times that amount (US$49.2 Billion). It is interesting that the same study identifies the Netherlands, the Cayman Islands, China, Hong Kong and the UK as the largest enablers of tax abuse. (source: “How global Tax Rules may reshape India”, The Mint, 23 September 2021).  

Change is already in the air

India was, in fact, a pioneer of sorts, when it introduced the equalization levy (a sort of digital service tax) in 2016 to bring some of the revenues of these digital companies into the tax net. Many other countries followed suit. Not surprisingly, there are now more concerted efforts to plug loopholes that Big Tech in particular is able to exploit to avoid tax in jurisdictions with higher tax rates. A major step to address this situation was announced in July 2021 by the OECD and G20. The move envisions a minimum corporate tax rate of 15% worldwide as well as a new framework for allocating more rights to tax digital economy companies to countries housing digital consumers- i.e., ensure fairer taxation of businesses in those jurisdictions where they earn profits.

Stop press!

Talk about timing! Just as I thought I had finished writing this blog, I saw the news that the OECD has finalized the framework for this major international tax reform. A new global minimum corporate tax rate of 15% has been set and will apply to companies whose revenues exceed 750 million Euros. Additionally, MNCs with global sales above 20 billion Euros and profitability above 10% will also be covered by the new rules. Model rules are expected to be formulated in 2022 and the new regime is to take effect in 2023.[2]

Including India 136 countries (that together account for 90% of global GDP) have backed this framework. Once such a regime comes into effect, individual countries will be required to withdraw any digital taxes they levy- e.g., India’s equalization levy.

While this kind of thinking will have a far-reaching impact on digital businesses and the global economy, new tax laws are not the only drivers of major change. If the recent testimony to the US Senate by whistleblower Ms. Frances Haugen is any indication, Facebook and other companies may soon face tougher laws around advertising and targeting specific segments of users. And given Google’s dominant position in the search business, competition laws too will inevitably get tougher. And as seen by India’s tough stand on Mastercard, data localization requirements too will become increasingly stringent. And finally, of course, data privacy laws too will evolve. The popular saying “May you live in interesting times” (incidentally, there’s no credible evidence that this was indeed a Chinese curse, as is often claimed) seems to have had the current period in mind. Even if it didn’t, we do live in interesting times- that’s for sure.

I wish you all a Happy Navratri/Durga Puja.

  1. https://www.statista.com/statistics/1181188/sandp500-largest-companies-market-cap/
  2. https://economictimes.indiatimes.com/news/economy/policy/oecd-deal-mncs-will-be-subject-to-a-minimum-tax-of-15-from-2023/articleshow/86876192.cms?utm_source=contentofinterest&utm_medium=text&utm_campaign=cppst

Photo by fabio on Unsplash

The pandemic has severely dented government revenues worldwide, while expenses have ballooned. This has led to spiraling fiscal deficits, that have their own consequences. Given that most corporate tax regimes worldwide evolved keeping conventional businesses in mind, and that digital economy businesses are very different in nature, a new corporate tax playbook is clearly needed.

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