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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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Tax Alert: Clarifications on Section 194Q-TDS on Purchase of Goods

The Central Board of Direct Taxes (CBDT) introduced a new Section 194Q in Finance Act, 2021, which is effective from 01st July 2021, for withholding tax at source on payments made for the purchase of goods.

The provision of Section 194Q states that:

  • Any person, being a Buyer, having a turnover or gross receipts exceeding INR 10 crores during the preceding financial year;
  • While making payment of any sum to any resident (Seller) for purchase of any goods of the value, where the aggregate of such value exceeds INR 50 lakhs in the previous year
  • Shall at the time of credit of such sum to the account of the Seller or at the time of payment, whichever is earlier, deduct an amount equal to 0.1% percent as income tax.

The above provision is not applicable, where:

  • Tax is deductible under any other provision of the Act; or
  • Tax is collectible under the provision of section 206C of the Act, other than transactions covered u/s. 206C(1H) therein.

The CBDT has received several representations with respect to practical challenges that may arise in the implementation of section 194Q. To address the difficulties that may arise, the CBDT has issued Circular No 13[1] of 2021 providing various clarifications regarding section 194Q.

194Q is not applicable in the following situations:

As per the Circular, ambiguity is removed on the applicability of section 194Q in a number of cases. CBDT has clarified that section 194Q is not applicable in the following situations:

  • Transactions relating to securities and commodities, which are carried through recognized stock exchanges, including exchanges that are located in the International Financial Service Centre.
  • Transactions in electricity, renewable energy certificates, or energy certificates traded through registered power exchanges.
  • Payments by non-resident Buyers unless if the purchase of goods is not effectively connected with the Permanent Establishment / fixed place of business of such non-resident in India.
  • On purchase of goods from a Seller whose income is exempt from tax. Similarly, it is clarified that tax collection at source (TCS) provisions under section 206C (1H) of the Act would not be applicable if the Buyer’s income is exempt from tax. However, these exemptions would not be applicable if only part of the Seller’s/Buyer’s income is exempt.
  • In the year of incorporation of the Buyer, the threshold of INR 10 crore would not be satisfied.
  • Transactions, where either payment or credit for the transaction happened before 1st July 2021.
  • TDS would not be applicable on the GST amount if the GST amount is separately indicated in the invoice. However, in the case of advance payments, the TDS under section 194Q will have to be discharged on the entire amount, as it is not possible to identify the GST component.

Calculation related clarifications

  • It has been clarified that for calculating the threshold of INR 50 lakhs in respect of a particular Seller, the transaction for the whole FY 2021-22 shall be considered, starting from 1st April 2021 and not from 1st July 2021.
  • For computing threshold of INR 10 crore in respect of the Buyer, only business turnover or gross receipts from business activities is to be considered. As such, turnover or gross receipts from non-business activities would not require to be taken into consideration.
  • In case of purchase returns, the TDS deducted on such purchases under section 194Q shall need to be adjusted against subsequent purchases from the same Seller, if the money is refunded by the Seller to the Buyer. However, no adjustment will be required in cases where the purchase return is replaced by goods by the Seller.

The interplay between sections 194O, 194Q, and 206C(1H) of the Act:

  • If Section 194O is applicable on any particular transaction, then Section 194Q shall not be applicable;
  • If both section 194O and section 194Q are applicable, then section 194O will prevail;
  • Section 206C(1H) is not applicable if TDS is deductible u/s. 194O or Sec 194Q;
  • If both sections 194O and 206C(1H) are applicable, then 194O shall prevail. Even if TCS is collected by the Seller still tax deduction responsibility of the E-commerce operator under section 194O cannot be condoned; this is because the prescribed tax rate under section 194O is higher than the prescribed tax rate u/s. 206C(1H);
  • If both sections 194Q and 206C(1H) are applicable, then section 194Q shall prevail. However, for ease of business, if TCS under section 206C(1H) has already been collected by the Seller then section 194Q would not be applicable; this is because the prescribed tax rate for deduction under section 194O and the prescribed tax rate for collection under section 206C(1H) are the same.

Comments:

This Circular is an extremely welcome one and has several important clarifications that have been issued by the CBDT before the enactment of the provisions of sections 194Q and 206C(1H). The Circular provides clarity vis-à-vis the scope of the relevant provisions, calculation of thresholds, interplay between overlapping provisions etc.

However, there are still some niggling doubts that prevail, requiring further clarity. For instance, while calculating the threshold of turnover or gross receipts of INR 10 crore w.r.t the Buyer, whether the amount considered should include or exclude the GST component.  

Also, it would help if it is prescribed for the Seller to obtain a “no deduction” declaration from the Buyer w.r.t TDS under section 194Q, in a situation where both sections 194Q and section 206C(1H) are jointly applicable on the same transaction and tax has already been collected and paid under section 206C(1H) by the Seller.

References

[1] Circular No 13 of 2021 dated 30th June 2021 (F No. 370142/26/2021 – TPL

 

Image Credits: Photo by Kelly Sikkema on Unsplash

This Circular is an extremely welcome one and has several important clarifications that have been issued by the CBDT before the enactment of the provisions of sections 194Q and 206C(1H). The Circular provides clarity vis-à-vis the scope of the relevant provisions, calculation of thresholds, interplay between overlapping provisions etc.

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'Honoring the Honest'- A Perspective on Transparent Taxation

The administration of a country makes headway with fiscal reforms when the revenue framework starts hindering effectiveness. Further, the redesigning of tax administration is done to widen the tax base and to achieve budgetary objectives.

Over the years, policymakers have understood the need for having a balance between innovation and compliance systems. The Tax Administration Reform Strategy that has been adopted, therefore, entails a simplified compliance system. At the innovation front, it has prompted the introduction of E-assessments; revamping of the E-filling portal and strengthening of Central Processing Centers (CPCs) for processing the ITRs. 

In addition, mandating the need for computer-generated Unique Document Identification Number (DIN) followed by the announcement by the Finance Minister of Faceless Assessment Scheme in her Budget Speech on July 5th, 2019, has sequentially nourished the Tax administration with a unique technological advancement, the “Transparent Taxation System”. 

Now India has embraced its policy reforms by introducing a scheme to “Honour the Honest” and to balance automation with compliance. By adopting a system of process simplification, India has become the first on an International platform to set a unique practice of “Faceless Assessment Scheme.” 

 

 

Need for Transparent Taxation 

 

The policymakers widely felt that the current tax system had components of arbitrary use of power, and direly needed to have fair play and transparency. The human interface and the multiplicity of visits to tax offices were prejudicial to the spirit of an honest taxpayer paving the way for corruption and favoritism.  

The tax system was called for and the Government also recognized the need for having an administrative mechanism with a minimal interface between a Tax-officer and a Taxpayer.  

The complications in efficiency and effectiveness demanded a transparent taxation system. Thus, the Government presented before us a Faceless Assessment Scheme and a scheme of Faceless Appeals at the level of Commissioner of Income Tax (Appeals).  

Towards the Transparent Taxation regime, the Hon’ble Prime Minister on August 13th, 2020, on behalf of the Central Board of Direct Taxes launched a new platform to meet the requirements of the 21st-century Taxation system. The New facilities launched are a part of the Government’s initiative to provide “Maximum Governance with Minimum Government”. 

The platform, apart from being faceless, is also aimed at boosting the confidence of the Taxpayer and making him/her fearless. It aims to make the tax system indefectible, faceless and painless for the Assessee. After Banking the Unbanked, Securing the Unsecured and Funding the Unfunded”, the “Honoring the Honest” initiative by the Tax Department has given the Indian Tax system, global recognition. 

 

 

Elements & Features of Faceless Assessment 

 

In respect of the features of the scheme, it enumerates the selection of a case for scrutiny through Data Analytics and Artificial Intelligence. The approach is to abolish Territorial Jurisdiction for assessment proceedings. It prescribes automated and random allocation of cases where notices, when served, will have Document Identification No. (DIN).  

The scheme provides for team-based assessments and team-based review whereby draft assessment orders from one city will undergo review in a different City and finally be issued by the Nodal Agency located in Delhi. The Government has made the facility of Faceless Appeal available from September 25th, 2020, and it will randomly allot such Appeals to any Tax officer in the country. The identity of officers deciding an appeal will remain unknown, and the appellate decisions will be team-based and reviewed.  

Most importantly, the scheme of both the Faceless Assessment and Faceless Appeal, curbs the practice of physical interface. Therefore, from now, there is no need for an assessee to visit the Income Tax Office. 

In respect of efficiency and effectiveness, the scheme intends to benefit the Taxpayer through the ease of compliance, functional specialization, improved quality of assessments, and most notably expeditious disposal of cases.  

 

 

Implementation and Execution

 

The scheme prescribes the constitution of the National E-assessment Centre (NeAC) & Regional E-assessment Centres (ReAc). The NeAC will function as a nodal agency in coordination with the ReACs located at different places supported by Assessment Units (AUs), Verification Units (VUs), Review Units (RUs), and Technical Units (TUs). Towards the completion of the Assessment, NeAc will pass and issue final orders.  

In respect of the operational perspective of the scheme, the new set-up formulated under the Faceless Assessment Scheme will administer all assessment proceedings u/s 143, 144, 148 read with 143(2)/ 142(1) of the Income-Tax Act 1961. 

However, the scheme holds exceptions as well. It would not apply to cases assigned to Central Circles, matters related to International Taxation, and facts constituting offenses under the Black Money Act and the Benami Property Act.  

Henceforth two-third of the department officers will be deputed to perform the functions of faceless assessments. The balance one third will perform residual functions enumerated under the Act including rectification proceedings, statutory powers u/s 263/264 of the Act, handling of grievances, demand management, recovery, collection, prosecution, and compounding and administrative/HRD matters. The Officers of the Directorate of Investigation and TDS units will exercise power to conduct survey u/s 133A of the Act. 

Within the folds of the new system lies the roots of the Tax Charter, which addresses the expectations of both the Revenue Department and the Assessee. The Revenue Department by way of the Charter assures fair, courteous and rational behaviour towards the Assessee. The Charter holds statutory backing with a binding character anticipating a commitment from the Assessee to fulfill the expectations of the Income Tax Department.  

 

 

Incidental Tools, towards Transparency 

 

Alongside the reforms pertaining to tax administration, the Government also revived the existing framework in terms of disclosure and reporting of transactions.  

Accordingly, Income Tax Return will now seek details of House ownership, Passport number and details of Cash deposit exceeding prescribed limits. An Assessee must now also disclose expenditure incurred on foreign travel if it exceeds INR 2 lakh and even aspects of spending on electricity bills exceeding INR 1 lakh during a Financial Year.  

Under the newly developed Tax Regime, Form 26AS (Form) will now be a complete profile of the taxpayer w.e.f. June 1st, 2020. It will cover under its scope “Specified financial transactions” covering transactions of purchase/ sale of goods, property, services, works contract, investment, expenditure, taking or accepting any loan or deposits.  

Furthermore, the Form will include information about income tax demand, refunds, pending proceedings, and proceedings completed under section 148,153A 153C of the Act. 

Revision to an assessment and details of an appeal will also be shared under the new format of the Form and it will not be a one-time affair anymore, it will be live and updated quarterly. The Form will also address information received by the Tax Department from any other country under a Tax Treaty/Tax Information Exchange Agreements. 

The Government has also proposed to expand the scope of Section 285BA of the Act for reporting of Specified Financial Transactions following which the Revenue Department may have on record the payment towards educational fee/donation and purchase of jewelry and paintings exceeding a value of INR 1 lakh.  

Thus, in a nutshell, the consumption and investment patterns of the Taxpayer will fall under the tax radar. It will now be difficult for any taxpayer to hide any transaction with a vendor, Bank/Financial Institution, etc. notified under the Income Tax Law.  

 

 

Conclusion  

 

On the face of it, the initiative is promising. Keeping in view, the intended simplicity and structure of the new administrative regime introduced for inducing better tax compliance in the Country. The question is how effectively it will overcome the challenges of and meet the intended objectives of the policymakers. The answer would depend on how seamlessly is the plan executed.   

Image Credits: Photo by Samantha Borges on Unsplash

On the face of it, the initiative is promising. Keeping in view, the intended simplicity and structure of the new administrative regime introduced for inducing better tax compliance in the Country. The question is how effectively it will overcome the challenges of and meet the intended objectives of the policymakers.

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