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:
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). 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.
- 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.
- 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.
- 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.
- 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 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.
- 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.
- 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.
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.