Can the global tax deal usher in a new era?


Radically reforming the international tax system and addressing the tax challenges arising from the digitization of the global economy, a broad framework was adopted by OECD / G20 members in July 2021, accepting the two-pillar solution. Among the various parameters left open for negotiation, some key factors, including thresholds and tax rates, have now been agreed upon by the 136 participating countries, well on schedule for October.

Broadly speaking, the first pillar seeks to create a new link rule, allowing a reallocation of residual profits from 100 of the largest and most profitable multinational enterprises (MNEs) to their market jurisdictions, i.e. jurisdictions where companies create or exploit value without having a physical presence. All multinational groups, except those operating in the mining and regulated financial services sectors, with global sales exceeding 20 billion euros and profitability exceeding 10%, will be covered by the new rules. .

Profit to be reallocated to markets will be calculated as 25 percent of pre-tax profit in excess of 10 percent of sales. The second pillar, on the other hand, is a global minimum tax regime, intended to reduce the incentive for MNEs to shift their profits to low-tax or non-tax jurisdictions. The minimum tax rate has now also been agreed to at 15 percent, against open to a rate of “at least 15 percent” disclosed in the July statement.

Companies with a worldwide turnover of more than 750 million euros will fall under the scope of the second pillar, with the headquarters courts retaining the possibility of applying the rules to small national multinationals. The deal does not restrict a country’s flexibility to set its corporate tax rates, but if companies shift their profits to low or no tax jurisdictions, their country of residence would have the right to increase their taxes up to ‘at the agreed global minimum tax rate.

India’s position

Digital businesses have grown rapidly in recent years. Digital channels offer innovative ways to do business and nowadays the whole setup works without any physical presence requirement. The existing international tax rules, tax the profits of a foreign company, in a country other than the country of residence, only if the foreign company has a permanent establishment (PE) in another country.

The creation of PE largely depends on the physical link. Cataclysmic tax changes brought on by rapid digitization have made these tax rules redundant, forcing countries, including India, to put in place unilateral measures such as the Equalization Levy (EL) and Significant Economic Presence (SEP), to tax digital transactions.

Relevantly, the two-pillar solution requires the withdrawal of these unilateral tax measures on digital services. This could have revenue implications for India as the equalization tax captures more digital businesses in the tax net, due to a much lower threshold of ₹ 2 crore (€ 0.2 million ) against 20 billion euros agreed in the OECD agreement. However, it should also not be ignored that the digital tax provisions introduced by India have attracted a lot of criticism from businesses as well as governments around the world.

The equalization levy, when it was put in place, even raised questions about its constitutional validity and compliance with international obligations. Therefore, India is likely to adopt the coordinated approach, which would ensure significant and sustainable revenues in its tax pot against the proliferation of unilateral actions leading only to more uncertainty for taxpayers and retaliation. commercial.

In particular, the threshold of the first pillar will be reduced to 10 billion euros seven years after the implementation of the pact (i.e. in 2030) and this will gradually cover more companies. So, while waiting for the fine print, it can be said with certainty that India has nothing to lose over the next few years due to the implementation of the two-pillar approach. In fact, the tax deal can ensure tax certainty, end tariff wars between countries, and make tax competition between nations impractical by reducing these opportunities to a bare minimum.

The road ahead

The global tax deal is the culmination of years of proposals and negotiations. Its implementation is likely to be an important amendment in the tax code of most countries. It is important to note that a Multilateral Convention (MLC) is being developed which would be signed by all participating countries during 2022 to apply the new rules from 2023. In addition, model rules will also be developed. by the OECD to integrate the second pillar into national legislation in 2022..

Essentially, the MLC will be the mechanism for implementing the newly agreed taxing rights under the first pillar, as well as for the removal of provisions relating to all existing digital service taxes and other unilateral measures. The approach of the convention and how its provisions will affect tax agreements are still not mapped. It would be interesting to see the possible interaction of three treaties simultaneously – the bilateral treaties between two nations, the MLI if it is in force and the MLC for digital taxation.

The global compact decision is a step forward towards the global consensus needed to modernize the international tax system. However, a significant amount of work is underway. More importantly, in order to levy taxes, a defined standard base / taxable income must be defined. However, the accounting rules / standards to be followed for the calculation of the “tax base” have yet to be prescribed.

In addition, it has been foreseen that the “extractions” and “regulated financial services” sectors will not be subject to the requirements of the first pillar. However, more clarity in understanding the scope of these terms is needed in due course.

Discussions and negotiations on how transfer pricing provisions and dispute settlement mechanisms such as advanced price agreements (APAs) would coexist with the newly introduced proposals are also imminent. All these issues will need to be addressed in a timely manner to ensure the effective implementation of the proposed rules.

Businesses have rooted for the “unified approach”. It is hoped that the new global framework will help put in place a uniform tax regime for the digital economy, making management and compliance easier and more efficient. If implemented successfully, it can help avoid unfair one-sided taxation on global technology companies and potentially lead to lower overall tax costs.

(The authors are respectively President and Director of Nangia Andersen LLP, a law firm)

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