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OECD BEPS Framework: Recent Development

Addressing tax issues arising in the digital economy has been a priority of the international community since past several years. It aims to deliver a consensus-based solution and ensure Multinational Enterprises (MNEs) pay a fair share of tax in the jurisdiction they operate. After years of intensive negotiations, the Organization for Export Co-operation and Development (OECD) / G20 has recently introduced a major reform in the international tax framework for taxing the Digital Economy.

The OECD / G20 inclusive framework on Base Erosion and Profit Shifting (BEPS) [“IF”] has issued a Statement, on 8th October 2021, agreeing on a two pillar-solution to address the tax challenges arising from the digitalization of the economy. There are 136 countries, including India, out of a total of 140 countries, representing more than 90% of the global GDP, that have agreed to this Statement. All members of the OECD countries have joined in this initiative and there are four G20 country members  (i.e. Kenya, Nigeria, Pakistan & Sri Lanka) who have not yet joined. The broad framework of the two-pillar approach as per the Statement is as follows:

 

Pillar One

 

Introduction and applicability:

  • Pillar One focuses on fairer distribution of revenue and allocation of taxing rights between the market jurisdictions (where the users are located), based on a ‘’special purpose nexus’’ rule, using a revenue-based allocation.
  • Applicable to large MNEs with a global turnover in excess of  Euro 20 Billion and profitability above 10% (i.e. profit before tax)[1]. This revenue threshold is expected to be reduced to Euro 10 Billion, upon successful review, after 7 years of the IF coming into force.
  • The regulated financial services sector and extractive industries are kept out of the scope of Pillar One.

 

Calculation Methodology:

  • Such allocation will help determine the ‘’Amount A’’ under Pillar one.
  • The special-purpose nexus rule will apply solely to determine whether a jurisdiction qualifies for Amount A allocation based on which 25% of residual profits, defined as profit in excess of 10% of revenue, would be allocated to the market jurisdictions using a revenue-based allocation key.
  • Allocation vis-à-vis nexus rule will be provided for market jurisdictions in which the MNE derives at least Euro 1 Million  of revenue  [Euro 250,000  for smaller jurisdictions (i.e. jurisdiction having  GDP lower than Euro 40 Billion )]
  • Profits will be based on financial accounting income, subject to:
    • Minimal adjustments; and
    • Carry forward of losses
  • Detailed revenue sourcing rules for specific categories of transactions shall be developed to ensure that revenues are sourced to end market jurisdiction, where goods or services are consumed.
  • Safe harbour rules will be separately notified, so as to cap the allocation of baseline marketing and distribution profits of the MNE, which may otherwise already be taxed in the market jurisdiction.

 

Tax Certainty:

  • Rules will be developed to ensure that no double taxation of profits gets allocated to the market jurisdiction, by using either the exemption or the credit method.
  • Commitment has been provided to have mandatory and binding dispute prevention and resolution mechanisms to eliminate double taxation of Amount A and also resolve issues w.r.t transfer pricing and business profits disputes.
  • An elective binding dispute resolution mechanism for issues related to Amount A will be available only for developing economies, in certain cases. The eligibility of jurisdiction for this elective mechanism will be reviewed regularly.

 

Implementation:

  • Amount A will be implemented through a Multilateral Convention (MLC), which will be developed to introduce a multilateral framework for all the jurisdictions that join the IF.
  • The IF has mandated the Task Force on the Digital Economy (TFDE) to define and clarify the features of Amount A (e.g. elimination of double taxation, Marketing and Distribution Profits Safe Harbour), develop the MLC, and negotiate its content so that all jurisdictions that have committed to the Statement will be able to participate.
  • MLC will be developed and is expected to be open for signature in the year 2022, with Amount A expected to come into effect in the year 2023.
  • IF members may need to make changes to domestic law to implement the new taxing rights over Amount A. To facilitate consistency in the approach taken by jurisdictions and to support domestic implementation consistent with the agreed timelines and their domestic legislative procedures, the IF has mandated the TFDE to develop model rules for domestic legislation by early 2022 to give effect to Amount A.
  • The tax compliance will be streamlined allowing in-scope MNEs to manage the process through a single entity.

 

Unilateral Measures:

  • The MLC will require all parties to remove all digital service tax (DST) and other similar taxes (eg: Equalisation levy from India perspective) with respect to all companies and to commit not to introduce such measures in the future.
  • No newly enacted DST or other relevant similar measures will be imposed on any company from 8 October 2021 and until earlier than 31 December 2023 or coming into force of the MLC.

 

Pillar Two

 

Introduction:

 

  • Pillar Two consists of Global anti-Base Erosion Rules (GloBE) to ensure large MNEs pay a minimum level of tax thereby removing the tax arbitrage benefit which arises by artificially shifting the base from high tax jurisdiction to low tax jurisdiction with no economic substance.
  • Pillar Two is a mix of several rules, viz. (i) Income Inclusion Rule (IIR); (ii) Undertaxed Payment Rule (UTPR); and (iii) Subject to Tax Rule (STTR).
  • IIR imposes a top-up tax on parent entity in respect of low taxed income of a constituent entity
  • UTPR denies deductions or requires an equivalent adjustment to the extent low tax income of a constituent entity is not subject to tax under an IIR.
  • STTR is a treaty-based rule which allows source jurisdiction to impose limited source taxation on certain related-party payments subject to tax below a minimum rate. The STTR will be creditable as a covered tax under the GloBE rules.
  • There would be a 10-year transition period for exclusion of a certain percentage of the income of intangibles and payroll which will be reduced on year on year basis
  • GloBE provides de minimis exclusion where the MNE has revenue of less than Euro 10 Million and profit of less than Euro 1 Million and also provides exclusion of income from international shipping.

 

Calculation Methodology:

 

  • Pillar Two introduces a minimum effective tax rate (ETR) of 15% on companies for the purpose of IIR and UTPR and would apply to MNEs reporting a global turnover above Euro 750 Million under country-by-country report.
  • The IIR allocates top-up tax based on a top-down approach, subject to a split-ownership rule for shareholdings below 80%. The UTPR allocates top-up tax from low-tax constituent entities, including those located in the Ultimate Parent Entities (UPE) jurisdiction. However, MNEs that have a maximum of EUR 50 million tangible assets abroad and that operate in no more than 5 other jurisdictions, would be excluded from the UTPR GloBE rules in the initial phase of their international activity.
  • IF members recognize that STTR is an integral part of Pillar Two for developing countries and applies to payments like interest, royalties, and a defined set of other payments. The minimum rate for STTR will be 9%, however, the tax rights will be limited to the difference between the minimum rate and tax rate on payment.
  • GloBE rules would not be applicable to Government entities, international organizations, non-profit organizations, pension funds or investment funds that are UPE of an MNE Group or any holding vehicle used by such entities, organizations, or funds.

 

Implementation:

  • Model rules to give effect to the GloBE rules are expected to be developed by the end of November 2021. These model rules will define the scope and set out the mechanics of the GloBE rules. They will include the rules for determining the ETR on a jurisdictional basis and the relevant exclusions, such as the formulaic substance-based carve-out.
  • An implementation framework that facilitates the coordinated implementation of the GloBE rules is proposed to be developed by the end of 2022. This implementation framework will cover agreed administrative procedures (e.g. detailed filing obligations, multilateral review processes) and safe-harbors to facilitate both compliance by MNEs and administration by tax authorities.
  • Pillar Two is proposed to be effective in the year 2023, with the UTPR coming into effect in the year 2024.

 

FM Comments :

 

With the introduction of the OECD/G20 inclusive framework on BEPS, OECD expects revenues of developing countries to go up by 1.5-2% and increase in overall reallocation of profits to developing countries of about USD 125 Billion. India, being a huge market to large MNEs, has always endorsed this global tax deal. However, with the introduction of this framework, India will have to abolish all unilateral measures, such as equalization levy tax and Significant Economic Presence (digital permanent establishment) provisions. MNEs will also have to re-visit their structure to ring-fence their tax positions based on the revised digital tax norms.  This Statement lays down a road map for a robust international tax framework w.r.t taxing of the digital economy,  not restricted to online digital transactions.

References

[1] Calculated, using an “averaging mechanism”, details of which are awaited.

Image Credits: Photo by Nataliya Vaitkevich from Pexels

With the introduction of the OECD/G20 inclusive framework on BEPS, OECD expects revenues of developing countries to go up by 1.5-2% and increase in overall reallocation of profits to developing countries of about USD 125 Billion. India, being a huge market to large MNEs, has always endorsed this global tax deal.

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CBDT notifies thresholds for determining ‘Significant Economic Presence’ in India

The concept of Significant Economic Presence (SEP) was introduced under Income-tax Act, 1961 (“the Act”) vide Finance Act, 2018, by way of insertion of Explanation 2A to section 9 of the Act, to expand the scope of the term ‘Business Connection’ and includes:

 

  • transaction in respect of any goods, services or property carried out by a non-resident with any person in India including provision of download of data or software in India, if the aggregate of payments arising from such transaction or transactions during the previous year exceeds such amount as may be prescribed; or
  • systematic and continuous soliciting of business activities or engaging in interaction with such number of users in India, as may be prescribed.

It was further provided that the transactions or activities shall constitute significant economic presence in India, whether:

 

  • the agreement for such transactions or activities is entered in India; or
  • the non-resident has a residence or place of business in India; or
  • the non-resident renders services in India.

The above-mentioned Explanation was inserted primarily for establishing Business Connection in India for Multinational entities carrying out business operations through digital means, without having any physical presence in India. However, its enforceability was deferred time and again as the discussion on this issue was ongoing under G20 – OECD BEPS project. 

Notification No 41/2021/F. No. 370142/11/2018-TPL on Significant Economic Presence in India:

 

The Central Board of Direct Taxes (CBDT), vide its notification dated 3 May 2021[1] has stipulated Rule 11UD to prescribe the ‘revenue’ and ‘users’ threshold for the purpose of determining Significant Economic Presence (SEP) of a non-resident entity in India. It has come into force with effect from 1 April 2022 (i.e., Financial Year 2021-22 or Assessment Year 2022-23 onwards).

The threshold limit notified by CBDT for the purpose of SEP has been tabulated as under:

Sr. No.NatureThreshold Limit
1

Revenue threshold –

Transaction in respect of any goods, services or property carried out by a non-resident with any person in India including provision of download of data or software in India.

INR 2 crores
2

Number of users threshold –

Systematic and continuous soliciting of business activities or engaging in interaction with users in India

3 lakhs users

If either one of the above-mentioned thresholds is met by a non-resident entity, then such entity shall be deemed to have a business connection in India and accordingly would be liable to pay tax on income attributable to transactions or activities mentioned above, subject to the beneficial provisions of tax treaties, as may be applicable.

 

FM Comments:

It may be noted that this Explanation was inserted primarily with an intention to tax digital transactions which otherwise escapes tax net due to absence of physical presence in India. However, on careful reading of the provisions, it is possible to infer that SEP provisions may even cover the transactions which are carried out through non-digital means (i.e., even on ‘physical’ buying and selling of goods and services).

At this juncture, it is also imperative to mention that UN tax committee has recently approved Article 12B (Income from automated digital services) in the UN Model Tax Convention. It would be interesting to watch whether India renegotiates its tax treaties to include this Article in its tax treaties and its interplay with the SEP provisions.

Further, from a practical perspective, this provision may not have much impact on non-resident entities based out of countries with whom India has executed tax treaties, due to existence of the conventional Permanent Establishment (PE) provisions in the tax treaty, where PE exists based on the physical presence in India. It would be worthwhile to note that the provisions of section 9 of the Act does not override the provisions of tax treaty and hence unless the tax treaty is renegotiated to include provisions that are like SEP, it would not have any impact on entities based out of tax treaty countries.

Having said the above, SEP provisions could have major impact on non-resident entities based out of non-tax treaty countries as well as tax treaty countries to whom benefit under the covered tax treaty may get denied, pursuant to application of, inter alia, Article 7 – Prevention of treaty abuse of Multilateral Instrument (MLI); considering the lower threshold prescribed by CBDT, such entities may then become liable to SEP provisions and may also have to pay incremental tax in India. Additionally, those entities may then also be under obligation to undertake various tax compliances in India (such as withholding tax, filing of return of income, etc.).

The non-resident entities may face various practical challenges in determining the “revenue” and “user” thresholds and in cases where existence of Business Connection is determined based on SEP, the challenges would be in relation to attribution of profits that would be chargeable to tax in India. Accordingly, it is of paramount importance that CBDT provides adequate guidance to determine the thresholds on how the profit would be attributed to such SEP activities in India.

Last but not the least, it would be interesting to examine the interplay and co-existence or otherwise of Equalization Levy (EQL) vis-à-vis the SEP provisions. For instance, in cases where the transaction falls specifically under the EQL provisions, then such income should be exempt from tax under the provisions of the Act and accordingly the expanded scope of business connection should not apply.

The non-resident entities may face various practical challenges in determining the “revenue” and “user” thresholds and in cases where existence of Business Connection is determined based on SEP, the challenges would be in relation to attribution of profits that would be chargeable to tax in India. Accordingly, it is of paramount importance that CBDT provides adequate guidance to determine the thresholds on how the profit would be attributed to such SEP activities in India.

References

[1] Notification No 41/2021/F. No. 370142/11/2018-TPL

Image Credits: Photo by Markus Winkler from Pexels

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