Context: A milestone global deal to ensure big companies pay a minimum tax rate of 15% and make it harder to avoid taxation has been agreed after Ireland, Estonia and Hungary signed up to an accord, which U.S. President stated levelled the playing field.
- The deal aims to end a four-decade-long “race to the bottom” by governments that have sought to attract investment and jobs by taxing multinational companies only lightly and allowing them to shop around for low tax rates.
- Central to the agreement is a minimum corporate tax rate of 15% and allowing governments to tax a greater share of foreign multinationals’ profits.
- Ireland, Estonia and Hungary, all low tax countries, dropped their objections this week as a compromise emerged on a deduction from the minimum rate for multinationals with real physical business activities abroad.
- Negotiations have been going on for four years, moving online during the pandemic, with support for a deal from the U.S. and the costs of the COVID-19 crisis giving it additional impetus in recent months.
- The deal aims to prevent large firms from booking profits in low-tax countries like Ireland regardless of where their clients are, an issue that has become ever more pressing with the rise of “Big Tech” giants that can easily do business across borders.
- Out of the 140 countries involved, 136 supported the deal, with Kenya, Nigeria, Pakistan and Sri Lanka abstaining for now.
- The Paris-based Organisation for Economic Cooperation and Development (OECD), which has been leading the talks, stated the deal would cover 90% of the global economy.
- According to the OECD the minimum rate would see countries collect around $150 billion in new revenues annually while taxing rights on more than $125 billion of profit would be shifted to countries where big multinationals earn their income.
Countries raising concerns about its implementation.
- The Swiss Finance Ministry demanded in a statement that the interests of small economies be taken into account, and stated that the 2023 implementation date was impossible.
- Poland, which has concerns over the impact on foreign investors, said it would keep working on the deal.
- U.S. Treasury Secretary hailed it as a victory for American families as well as international business.
- Some developing countries seeking a higher minimum tax rate say their interests have been sidelined to accommodate the interests of richer countries like Ireland, which had refused to sign a deal with a minimum tax rate higher than 15%.
- Argentina cited that proposals on the table forced developing countries to chose between “something bad and something worse”.
- Kenya, Nigeria and Sri Lanka did not back a previous version of the deal, Pakistan’s abstention came as a surprise, one official briefed on the talks said. India also had qualms up to the last minute, but ultimately backed the deal.
Impact on India
- The Organisation of Economic Cooperation and Development (OECD) stated in its implementation plan that the deal requires countries to remove all digital services tax and other similar measures and to commit not to introduce such measures in the future.
- India may have to withdraw digital services tax or the equalisation levy and give a commitment not to introduce such measures in the future if the global minimum tax deal comes through.
- India is balancing its interests both as an importer and an exporter of capital, goods and services. The deal will prevent a race to the bottom among countries.
- Losing out on revenues: Despite the equalization levy, India is still losing out on tax revenues since it is not valid on services such as annual or monthly subscriptions to streaming websites, or paid promotions done through platforms such as Facebook.
- Tax loss for India: The State of Tax Justice report of 2020 notes that India loses over $10 billion in tax revenue due to the use of offshore structures, particularly through investments made by Indian residents through Mauritius, Singapore and the Netherlands.
- Investments moving out: The overseas direct investment (ODI) data from 2000 to 2021 published by the Reserve Bank of India, shows that the cumulative ODI for the period primarily went through Singapore, Mauritius, the U.S., the Netherlands, and the United Kingdom.
- Issues with Income Tax Amendment Act, 2018:
- For the law to be applicable, treaties would have to be suitably amended.
- The more fundamental issue of what size of operations would qualify as economic presence needs to be answered.
- Even if a business qualifies as having economic presence in India, how much of its profits should be taxable in India.
- Issue of the redistribution of taxing rights: OECD’s rules proposed splitting up of global profits of a corporation into routine and non-routine. This would require serious effort and harder consensus on issues such as what constitutes routine profit.
- Nexus rules: A unified approach backing the new nexus rule is only a partial win for India. The reliance placed on conventional transfer pricing could make taxation of digital companies more messy for India as it offers a wide user-base and thus a large market for digital companies.
- The idea of consensus, though critical for international relations, must also be evaluated in light of the misalignment of economic interests between developing and developed countries.
- The potential ramifications of these digital taxes could be over-taxation or a pass through of costs to consumers.
- Concerns with equalisation levy:
- Burden on Indian firms: Indian startups are requesting reduction in the equalization levy on the advertising revenue that overseas firms generate from India as the burden is shouldered by local startups and SMEs who advertise on these platforms.
- Double taxation: It could discourage foreign firms from indulging in activities in India as they might not be liable for a tax deduction in their home country and can face double taxation.
- Diplomatic fallouts: The USTR is initiating a probe into the imposition of digital taxes on firms like Facebook, Netflix and Google in the EU and nine countries, including India, under the equalization levy, even as India witnesses increasing investments.
About the Global Minimum deal
- The proposed two-pillar solution of the global tax deal consists of two components —
- Pillar One which is about reallocation of additional share of profit to the market jurisdictions and
- Pillar Two consisting of minimum tax subject to tax rules.
- The Finance Ministry had earlier stated that India was “very close” to arriving at the specifics of the two-pillar taxation proposition at the G-20 and was in the last stage of finalising the details.
- The Finance Ministers of G-20 countries are scheduled to meet on October 13 in Washington and finalise it.
- As a significant move, the OECD has sought for an immediate and upfront withdrawal of unilateral digital services tax and a commitment not to introduce such measures in the future.
- The modality for the removal of existing digital services taxes and other similar measures needs to be appropriately coordinated.
- Pillar Two which was initially proposed to be brought into effect from 2023 has now been deferred to 2024.
- A consensus was key to securing a more stable tax regime for multinationals and governments.
OECD BEPS Project:
- The OECD, under the authority of the Group of 20 countries, has considered ways to revise tax treaties, tighten rules, and to share more government tax information under the BEPS project, and has issued action plans.
- As part of the action plan, the OECD framed following two complementary pillars to address the issue:
Pillar 1: Re-allocation of profit and revised nexus rules:
- New nexus rule to be based on sales and not on physical presence. The new nexus rules would apply even where goods are sold remotely or through distributors.
- New profit allocation rules to increase tax certainty: This new profit allocation rule would be applicable to organization having ‘nexus’ in a jurisdiction.
- The rules recommend a three-tier profit allocation mechanism.
Pillar 2: Global anti-base erosion mechanism: intended to identify and tackle remaining issues identified by OECD under the BEPS framework.
- The Pillar Two proposal was the Organisation for Economic Co-operation and Development’s (OECD) plan to plug the remaining Base Erosion and Profit Shifting (BEPS) issues.
- Objectives: It aims to provide jurisdictions the right to “tax back” where other jurisdictions have either not exercised their primary taxing right or have exercised it at low levels of effective taxation.
- The move intends to achieve minimum effective taxation of more than 10%, possibly up to 15%.
- The objective is to minimise tax incentives and ensure that companies choose to be situated in a particular country based on other commercial benefits.
India & BEPS
- In 2016, India was the first to apply an equalisation levy. The levy was introduced outside the scope of the Income Tax Act and is applicable to a small set of companies operating in digital advertising.
- Then in 2018, to be able to tax digital companies appropriately in India, the Income Tax Act was amended to add an explanation to the definition of business connection, in 2018.
- Enhancing transparency: India and the U.S. signed an inter-government agreement for the automatic exchange of country-by-country (CbC) reports, which will reduce the compliance burden for Indian subsidiary companies of U.S. parent companies.
- This is a key step in making India compliant with the Base Erosion and Profit Shifting (BEPS) project, of which it is an active participant.
- Data localization rules: India may be pushing Internet firms such as Facebook and Google to store data locally not just to safeguard critical data of its citizens but also to ensure due taxes are paid by these digital firms for services including advertisements sold to local clients
What’s Base Erosion and Profit Shifting?
- Multinational Firms make profits in one jurisdiction, and shift them across borders by exploiting gaps and mismatches in tax rules, to take advantage of lower tax rates and, thus, not paying taxes to the country where the profit is made.
Significance of BEPS:
- The Organization for Economic Cooperation and Development (OECD) states that BEPS is of major significance for developing countries due to their heavy reliance on corporate income tax, particularly from multinational enterprises.
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