[Opinion] Navigating the Future | Unveiling BEPS 2.0 – Pillar 1 and 2

CA Vidhi Shah & CA Tinu – [2024] 159 taxmann.com 136 (Article)

Recently, in the International-tax circles, there has been a lot of buzz around Organisation for Economic Development and Cooperation’s (‘OECD’) initiative on Pillar 1 and 2. Tax policymakers from various governments globally are engaged in collaborative efforts to formulate proposals for amendment in international tax framework, driven by the significant impact of globalization and digitalization of economy.

Background

Before deep-diving into the intricacies of the OECD proposals, it is important to understand the context of the proposed changes. The erosion of domestic tax base and profit shifting, commonly referred to as Base Erosion and Profit Shifting (‘BEPS’), stems from the strategic exploitation of gaps and mismatches within the tax systems of various countries by multinational enterprises (‘MNEs’). This phenomenon impacts all nations, with developing countries experiencing a disproportionate burden due to their increased dependence on corporate income tax.

There are mainly two problems in current International Taxation system:

• The first problem is that the old rules provide that the profits of a foreign company can only be taxed in another country if the foreign company has a Permanent Establishment/physical presence. But due to digitalization, firms are growing without physical presence by placing reliance on intangible assets and centrality of data.

For example, Companies like Facebook, Uber, etc have been providing their services and growing without any physical presence in countries which have huge customer base. They legally book profit and park assets like trademarks and patents in low tax countries like Ireland regardless of where their customers are. So, it becomes difficult to tax such companies since they are not physically present in countries which provides huge market to these MNEs.

• The second problem is that of tax rate difference in countries. For instance, the corporate tax rate in countries like USA is around 25% but in countries like Cayman Islands, Netherlands, Luxembourg tax rate is around 10 % or Nil in some cases. Companies such as Apple Inc. is based in USA where they have to pay taxes at higher rate. Hence, such companies used to shift profits through a tax havens country like Ireland in order to avoid paying taxes elsewhere like the United States or European Union.

Further, few countries tax only domestic business income of their MNEs, but not foreign income upon the assumption that foreign business profits would be taxed where they are earned. For example, Countries like Singapore, Zambia tax only domestic income of their residents but there is no tax on foreign income of their residents.

Accordingly, given the global nature of business operations in current times, collaborative efforts among governments have become imperative to effectively address BEPS and reinstate confidence in both domestic and international tax frameworks. Thus, Organisation for Economic Cooperation & Development (‘OECD’) / G20 Inclusive Framework have released a two-pillar solution to tackle tax challenges arising out of the digitalization of the economies.

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