On December 20, 2021, the OECD released the model Anti Global Base Erosion Rules. The Model Rules (also referred to as the “GloBE” Rules) are part of a two-pillar solution—Pillar 1 gives taxing rights to market jurisdictions and Pillar 2 establishes a global minimum corporate tax of 15%—to address the tax challenges arising from the digitalisation of the global economy.
The two-pillar solution has been agreed upon by 137 out of 141 member jurisdictions of the OECD/G20 Inclusive Framework on BEPS—India is a member of the Inclusive Framework.
The Model Rules are complex, but will bring into existence a set of common principles at the domestic-law and treaty levels to tax income of specified businesses hitherto either not taxed or taxed at lower rates. The three principles supporting the global minimum tax comprise two—Income Inclusion Rule (IIR) and Undertaxed Payment Rule (UTPR)—that can be implemented as part of the domestic framework, and one, the Subject to Tax Rules (STTR), as part of the treaty framework.
The Rules have been designed as a “common approach”, leaving the decision to individual nations to adopt the Rules, meaning that they must necessarily accept its application by other members. They provide a template that jurisdictions can translate into domestic-law changes, to implement Pillar Two within an agreed timeframe.
GloBE Rules apply to MNEs with annual global revenues of 750 million euros, with certain governmental, not-for-profit entities and pension funds excluded. The global minimum tax thrusts a responsibility on MNEs to pay on excess profits a top-up tax rate representing the difference between their effective tax rate (for each jurisdiction) and prevailing domestic tax rate. The primary liability to pay such tax is on the jurisdictional entity of the MNE which has implemented the IIR. To the extent a portion of the top-up tax is not paid under IIR, the UTPR shall apply on residual profits, which shall be allocated amongst jurisdictions that have implemented changes in the domestic law framework. A complex set of rules is prescribed for allocation, including for corporate restructuring, holding structures, etc.
The implementation of Model Rules could face challenges, including the ambitious timelines for domestic-law change by 2023. Another important challenge is the willingness on part of the US lawmakers to embrace a modified GILTI (Global Intangible Low Taxed Income)—a domestic US anti-abuse rule concerning overseas Controlled Foreign Companies of US companies. The US has been the primary driver since July 2021, when the new administration expressed its support. So, the apparent delay or possible potential failure in enacting a legislation that revamps its domestic GILTI rules has raised doubts.
It is widely speculated that India will accept the GloBE rules, but the timing of its adoption remains uncertain. I do not anticipate changes in the domestic law in Budget FY23, and it is likely that India will wait and watch implementation by others. Having said that, numerous differences between India’s tax system and the design aspects of GloBE will have to be dealt with, apart from aligning definitions used in the Model Rules with definitions in India’s domestic law. To illustrate, India does not have Control Foreign Corporation (CFC) rules and these will have to be legislated into its income tax law. Another illustration: India does not rely on consolidation of income for tax purposes, a concept central to adoption of the GLoBE model. Instead, India’s domestic law recognises income computation on legal entity basis and after carrying out adjustments to book profits computed under Indian GAAP/IFRS. India could be at an advantage compared to nations that have an existing CFC regime, provided its new CFC regime is aligned to the GloBE framework.
Though changes in the international tax framework and India’s staunch support to OECD’s 2 Pillar solution shall put pressure to carry out changes to the domestic law, it is advisable to not rush into it, particularly on the GloBE proposals. Besides the complexity of implementation, all eyes are on the US taking the first step to amend its domestic rules, as a stalled process could lead to scepticism about global implementation by 2023. The complex US law-making process is expected to face hurdles as its enters the Senate-approval stage.
In conclusion, the world in 2022 appears to be changing more rapidly in terms of embracing multilateralism and in ways that would have been difficult to predict few years back. This also puts the onus on nations like India to align its domestic rules with international framework. A plain reading of the Model Rules suggests many variables, though, the outcome seems difficult to process and hence, the Commentary is eagerly awaited. A wholesome solution will depend upon (a) effective incorporation in the domestic law (b) countries staying committed to consistently implementation of Two-Pillar solution (c) adoption of Pillar 1 by the US, as Pillar 2’s acceptance by developing countries is largely contingent on Pillar 1 going ahead.
While this may not be a wholesome solution to the challenge of taxing digital companies, it establishes a floor for competition among nations on tax rates.
The author is Partner, BMR Legal
Views are personal