India Joins Consensus on OECD Tax Deal Ahead of G20 Meeting in Venice

Ahead of the G20 meeting, we examine the OECD/G20 global tax reform plan and India’s position on the proposed measures. We briefly explain what the tax measures entail for large multinational enterprises as well as the withdrawal of unilateral tax policies like the digital services tax in India by 2023.

What is in the OECD/G20 tax deal?

The OECD/G20 Inclusive Framework Tax Deal proposes two main elements – Pillar One, which calls for the redistribution of profits generated by the largest companies to the domicile markets where they actually make their sales instead of simply where they are headquartered and Pillar Two, which establishes a global minimum effective tax rate of 15 percent determined on a country-by-country basis.  

Elements of this deal were previously proposed at the G7 meeting in June. However, the OECD tax plan has added special rules for some sectors and companies.

Finance ministers and central bank chiefs from the Group of 20 (G20) countries, whose membership includes the world’s 19 biggest economies and the European Union (EU), will meet in Venice, Italy on July 9 and 10, and attempt to forge a political agreement on the global tax deal. This is bound to get contentious, not least because the reforms could play spoiler to the post-pandemic economic recovery plans of several tax-friendly states.

Pillar One

This has three components – new taxing rights for market jurisdictions, that is where customers are located, to access a share of the residual profit of a multinational enterprise (MNE); the calculation of a fixed return for certain baseline and marketing and distribution activities in jurisdictions where the MNE holds a physical presence; and establishing dispute prevention and resolution mechanisms to achieve ‘tax certainty’.

The scope of Pillar One will apply to the largest and most profitable multinationals, and not just digital businesses. Its scope will not cover extractive industries and regulated financial services.

Pillar Two

Pillar Two (or the Global Anti-Base Erosion / GloBE proposal) consists of the following.

Two domestic rules:

1. An income inclusion rule (IIR) that will impose tax on the income of a foreign-controlled entity (or foreign branch) if that income benefited from an effective tax rate below a certain minimum rate.
2. An undertaxed payments rule (UTPR) that will either deny a deduction or potentially impose a withholding tax (WHT) on base eroding payments – unless that payment is taxed at or above a specified minimum rate in the recipient’s jurisdiction.

A treaty-based rule:

The subject to tax rule (STTR) will ensure that treaty benefits for certain related party payments, such as interest and royalty payments, are granted to MNEs only if an item of income is taxed at a minimum rate in the recipient jurisdiction.

Pillar Two exclusions are being considered for government entities, international organizations, non-profit organizations, etc. Outstanding issues under Pillar Two negotiations include reconciling the implementation of Global Anti-Base Erosion measures and the Global Intangible Low-Taxed Income (GILTI) regime – the latter subjects US-controlled foreign corporations to special treatment under the US tax code.

What is India’s position on the OECD/G20 tax deal?

India joined OECD members in endorsing the global tax reform – in principle – on July 1 and has committed to working towards the deal’s final approval.

As per a statement released by the Ministry of Finance on July 2: “Some significant issues including share of profit allocation and scope of subject to tax rules, remain open and need to be addressed. Further, the technical details of the proposal will be worked out in the coming months and a consensus agreement is expected by October [2021]. The principles underlying the solution vindicates India’s stand for a greater share of profits for the markets, consideration of demand side factors in profit allocation, the need to seriously address the issue of cross border profit shifting and need for subject to tax rule to stop treaty shopping.”

Which countries do not support the OECD/G20 global tax plan?

While most of the G20, including India, backed the global tax plan at the OECD meeting on July 1, smaller, low-tax EU-member countries like Hungary, Estonia, and Ireland have declined to support the 15 percent minimum corporate tax rate. The EU needs complete consensus among its members to implement the tax reform as EU law.

Interestingly, Poland, an early detractor, came around to the OECD plan when recent negotiations allowed the country to gain instruments to incentivize businesses to locate there. Speaking to the Financial Times, the Polish finance minister Tadeusz Koscinski stated: “I’m not interested in companies from France or Germany coming into Poland to sell back into France and Germany and transferring the profits to Poland,” Koscinski added. “But I am for them coming to Poland to help us build our innovation capabilities and to sell into the local and third markets. That has to be accounted for in a minimum global tax.”

Position of emerging economies

Besides Estonia, Hungary, and Ireland, six countries in the OECD/G20 Inclusive Framework – Barbados, Kenya, Nigeria, Peru, Saint Vincent and the Grenadines, and Sri Lanka – have yet to get on board with the proposed measures.

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Moreover, the 15 percent minimum corporate tax rate is simply not high enough for several emerging economies, like Argentina, which has called for a 21 or 25 percent tax rate. India’s recently lowered corporate tax rate is around 25.17 percent inclusive of surcharge and cess; the CIT was historically cut in 2019 and beneficiaries of the concessional tax regime cannot avail specific tax incentives or deductions.

Yet, most economies are seriously committed to the cause of rehashing the prevailing century-old international tax norms especially given how modern multinational giants are able to avoid huge tax liabilities by shifting base to tax-friendly destinations or exploiting loopholes in bilateral tax treaties.

Negotiations to the OECD/G20 tax plan in the coming months will reveal whether the final implementation measures can live up to their original intentions, that is, without triggering imbalanced outcomes for emerging economies or creating confusion when computing tax owed in respective jurisdictions for MNEs with complex structures.

What is the expected timeline for implementing the global tax deal?

The OECD aims to gather full consensus and iron out any pending contentions to the OECD/G20 Inclusive Framework Tax Deal by the G20 Summit scheduled for the end of October 2021 in Rome.

The body has also set 2023 as the deadline by when countries will implement the new global tax regime. Once that is in place, respective unilateral national tax policies will be expected to get rolled back.

Currently, India, Canada, France, Italy, and Spain are among several countries that have imposed or intend to implement a digital services tax (DST). This has been fiercely contested by the US after pressure from its technology companies; the US Trade Representative has also threatened retaliatory tariffs – albeit temporarily suspended to facilitate the ongoing OECD/G20 talks.

Is the OECD tax reform exclusively targeting digital behemoths?

The OECD tax reform inescapably impacts the world’s largest digital companies like Google, Apple, Amazon, Facebook, etc. disproportionately. It merely reflects the changing nature of the global economy. The top technology giants represent MNEs that dominate several if not most sectors across global markets but have benefitted from traditional tax saving arrangements by locating their base in low-tax jurisdictions.

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For example, Google, Facebook, Tripadvisor, and AirBnB have their international headquarters in Ireland, which has a 12.5 percent corporate tax rate; Hungary’s corporate tax rate is nine percent and Estonia predominantly taxes only dividend payments. Its no wonder these countries have attracted a disproportionate number of multinationals, boosting their national economic growth and producer services industries.

Nevertheless, at a time when digital MNCs are making record levels of profit during the COVID-19 pandemic, most governments are not willing to let the status quo be. Their meagre to zero effective corporate tax liability in their biggest markets is a huge cause for concern as it effectively closes out major sources of revenue for several countries, including the US, ironically whose companies represent some of the world’s most profitable MNEs. That in turn compromises the scope of state spending plans, for example, on public infrastructure – whose importance to socioeconomic stability the pandemic has only laid bare.

What will happen to India’s digital services tax?

Several countries like India have unilaterally implemented a levy on digital services, which has primarily impacted highly digitized companies as they lead global market penetration and innovation.

Beyond the fact that IT-based innovation is changing how enterprises structure their presence in any market, the tax saving arrangements tapped by the world’s largest MNEs affect the profitability share and market scope of domestic players and breeds sector monopolies.

In the case of India, whose huge market base holds massive algorithmic appeal for global e-commerce giants, the DST / equalisation levy enables the Indian government to exercise some taxation rights over non-resident companies enjoying large profits in its market.

India first implemented a six percent equalisation levy (Section 165) on payments received by non-residents (subject to certain conditions) for online advertising and allied services in 2016. From April 1, 2020, the equalisation levy has been charged at two percent (Section 165A) on payment receivable by a non-resident e-commerce operator for e-commerce supply or services made or provided or facilitated by it.

To be clear, where the equalisation levy is leviable under Section 165 – the levy under Section 165A shall not be charged. Companies with a permanent establishment in India are not charged equalisation levy as they will be subject to the domestic corporate tax regime. Further, the 2021 Finance Act also clarified that offshore e-commerce firms that sell through an Indian arm will not have to pay the equalisation levy.

Impact on revenue key factor in negotiations

As mentioned earlier, if the OECD/G20 tax deal gets implemented by 2023, India will only be able to tax the top 100 digital companies like Google, Facebook, and Netflix, and will have to withdraw the two percent equalisation levy as it stands. Under the current OECD consensus, the annual revenue threshold for the global taxation pact is Euro 20 billion as opposed to India’s current threshold of Euro 0.2 million (INR 20 million).

India had been pitching for at least a Euro 1 billion threshold that could have covered over 5,000 global entities. In 2020-21, India collected INR 20.57 billion from the equalisation levy, which was an 85 percent growth over the INR 11.36 billion collected in the preceding fiscal year.

How India will negotiate its right to its tax base or whether it will devise new taxation norms before conceding to the withdrawal of the levy remains to be seen. Tax experts are of the view that by 2023, large technology firms may need a physical presence in India to be compliant.

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