G20 Finance Ministers endorse the Two Pillar approach and its impact across the world including India

In June, 2021, the Finance Ministers and the Central Bank Governors of the G7 group (consisting of U.S.A., Canada, France, Germany, Italy, Japan and the United Kingdom) met and agreed on some concrete actions to address ongoing historic challenges, which, inter alia, includes the tax challenges that i) impacted the revenues of the government’s across the globe and ii) impacted the course of cross border trade of the corporate Inc. Everyone has been waiting with bated breath to hear from the OECD/G20 group of nations to reach a consensus-based solution with an objective to arrest the alleged erosion of a country’s tax base the world over.

U.S.A. has been abstaining from committing to any of the OECD/G20 (BEPS) initiatives (15 Action Plans launched way back in 2015). In parallel, some of the measures like the Base Erosion Anti-Abuse Tax (BEAT), Global Intangible Low-taxed Income (GILTI), etc. have been introduced by the U.S.A. under the domestic law in its endeavor to arrest base erosion on its own soil. Since U.S.A. seems to have had an inclusive role to play in the G7 announcements made earlier in June, an alignment of the 130 plus G20/OECD’s inclusive framework members along with the agenda of the tax policy announcements made by the U.S.A. indicates in-roads being made on achieving the consensus-based measures.

On 10 July 2021, the G20 Finance Ministers and the Central Bank Governors issued a communique following their meeting in Venice, Italy. The communique endorsed the key components of the Two Pillars on the reallocation of profits of multinational enterprises and an effective global minimum tax as set out in the statement released by the Organisation for Economic Co-operation and Development (OECD)/G20 Inclusive Framework on Base Erosion and Profit Shifting (BEPS) on 1 July. In fact, 133 members of the OECD/G20 Inclusive Framework (IF) on BEPS out of the 139 members countries approved a statement providing a framework for reform of the international tax rules.

Allocation of taxing rights to market jurisdictions’

Pillar One (amount A) would provide a new taxing right to market jurisdictions, allocating between 20 and 30 percent of residual profit (defined as profit in excess of 10 percent of revenue) to market jurisdictions with nexus. For most jurisdictions, nexus will only exist if the in-scope MNE derives at least EUR 1 million in revenue from the jurisdiction. For smaller jurisdictions with gross domestic product (GDP) less than EUR 40 billion, the nexus threshold is reduced to EUR 250,000 in revenue. Pillar One will apply to multinational groups that have more than EUR 20 billion of global turnover and profitability above 10 percent (measured as profits before tax divided by revenue on a book basis).

The relevant measure of profit or loss of the in-scope MNE will be determined by reference to financial accounting income, with a small number of adjustments. There have been so much differences when it comes to reconciliation of tax profits with accounting profits in India, this itself may be a whole new area of dispute that perhaps may need an entirely separate redressal mechanism.

The commitment with regard to awarding of ‘the taxing right of 20 per cent of exceeding a 10 per cent margin’ seems to be in line with the Pillar One recommendations proposed earlier by OECD. This may provide holistic resolve for the challenges of the digitalized economy.

It has been stated that a marketing and distribution profits safe harbour will cap the residual profits allocated to the market jurisdiction through Amount A. Further the work on the design of the safe harbour will be undertaken, that would also consider the comprehensive scope. It would be interesting to see what the design elements of the safe harbour would be like with a view to have the exclusions established judiciously.

The allocation principles may appear to be achieving substantially in terms of the revenue that may be extracted from the larger in-scope MNE’s but from an India perspective, whether the not-so-big MNE’s earning exponential profits would get covered is a question that only time would answer.

Removal of all ‘Digital Services Taxes’

The statement approved on 1 July 2021 provides for an appropriate coordination between the application of the new international tax rules and the removal of all Digital Service Taxes (DST) and other relevant similar measures on all companies.

Several EU countries that have implemented DSTs include France, Italy, and the United Kingdom are prepared to eliminate such measures. Interestingly, the United Kingdom DST does not contain a hardwired sunset clause, rather, the legislation provides that the UK government will review the tax in 2025 in light of the global consensus that OECD is contemplating to achieve later.

Starting 2016, the measures adopted by India viz. i) the ‘Equalisation Levy’ (EL) [on advertising and specified services @ 6 per cent as introduced by the Finance Act, 2016]; ii) the Significant Economic Presence (SEP) provisions [introduced by the Finance Act, 2020] that would constitute business connection under the provisions of the Income-tax Act, 1961, emanate out of the BEPS Action Plan 1 of the OECD. Even EL 2.0 [on e-commerce supply or services @ 2 per cent as introduced by the Finance Act, 2020] has taken its colour from the BEPS Action Plan1. There is no clause in any of the EL/SEP related amendments introduced by India which provides for a re-look of these provisions if and when global consensus is reached. With the statement providing for a co-ordination for removal of all such measures, probably a consensus-based agreement to be in effect from a certain date may not happen any time soon. Further, it would be interesting to see how India responds to these measures and whether a sunset clause, if any, is brought on the statute books considering the agenda to protect the tax base amidst the global taxation challenges or if a wait and watch approach is adopted for the measures to be fully implemented. Further, one also awaits the final rules on ‘Attribution of Profits’ that are to be notified yet.

In addition, the reference to other relevant similar measures represents agreement that the commitment to remove unilateral measures is not limited to DSTs, though it remains to be seen which other measures would be relevant and whether it could include something like the U.S. measures viz. the Base Erosion and Anti-abuse Tax (BEAT). The statement issued also does not lay emphasis on the timing for the removal of such measures It would be interesting to see if the U.S.A. would make any amendments to these measures introduced and realign with the larger OECD BEPS measures.

Global minimum tax

Pillar Two secures agreement on a global minimum level of taxation through:

The minimum tax rate envisaged for purposes of the GloBE Rules will be at least 15%. The GloBE rules will apply to MNEs with revenues exceeding the EUR 750m threshold as determined under BEPS Action 13 (country by country reporting). Countries are, however, noted to be free to apply the IIR to MNEs headquartered in their countries whose revenue fall below this threshold. It is also interesting to note that carve outs have been established that are not subject to the GloBE rules.

While there has been a commitment to a global minimum tax of at least 15% on a country by country basis, the mechanics of this proposal would be having diverse impact on the economies of different countries.

Since India has a corporate tax rate which is not below the 15 per cent benchmark, it should not be a big reason to worry if the global minimum tax threshold is finally crystalised, subject to rules discussed therein (subject-to-tax rule, etc.) covered under the ambit of Pillar Two.

The statements also mentions about consideration being given to the conditions under which the US GILTI regime will co-exist with the GloBE rules, to ensure a level playing field. Again in case of the U.S.A., a reduction in the corporate tax rate to 21 per cent from 35 per cent which is the largest in the nation’s history may have to be aligned with the agreed figure of 15 per cent targeted to cover large MNE’s.

Way forward

Finally, the BEPS 2.0 initiatives (Pillar One and Pillar Two) have seen the light of the day probably due to the fact that there existed inherent shortcomings of BEPS 1.0 project that has still not seen concrete action on some of the BEPS measures viz. Addressing the Tax Challenges of the Digital Economy (Action Plan 1). Some of the issue that need greater focus are the level of commitment to tax certainty for implementing the agreed dispute prevention and resolution structure, the final agreement on the acceptable minimum rate for taxation, etc.

The communique released in the 3^rd meeting of the G20 and Finance Ministers earlier this month calls on the OECD/G20 Inclusive Framework on BEPS to swiftly address the remaining issues and finalise the design elements within the agreed framework together with a detailed plan for the implementation of the two pillars by the next meeting in October later this year. In its statement released on 1 July 2021, the IF has also committed to opening the Pillar One multilateral instrument for signature in 2022, with Amount A anticipated to take effect beginning in 2023. Pillar Two would be brought into law in 2022 and made effective beginning in 2023.

It would be interesting to see how the new ‘Multilateral Instrument’ (MLI) to incorporate the amendments contemplated to be introduced under ‘Pillar One’ and ‘Pillar Two’ proposals would operate along with the existing MLI (under BEPS Action Plan 15) and harmoniously operate along-side the existing tax treaties. If that be the case, the finer nuances with regard to the minimum standards and the opt-ins and opt-outs, etc. of the new MLI would be truly mesmerizing. The new MLI may then entail a full exercise to decipher all the finer gradations of the provisions and put it into effect.