Uncertainty on the process and outcome await the Indian tax authorities and businesses covered under OECD pillar one & two

By Mukesh Butani & Tarun Jain

The OECD, on July 1, issued a statement indicating consensus amongst 130 nations (out of 139 participants) on a “two-pillar plan to reform international taxation rules and ensure that multinational enterprises pay a fair share of tax wherever they operate.” Summarising the consensus, the OCED communique states that “Pillar One will ensure a fairer distribution of profits and taxing rights among countries with respect to the largest MNEs, including digital companies. It would re-allocate some taxing rights over MNEs from their home countries to the markets where they have business activities and earn profits, regardless of whether firms have a physical presence there. Pillar Two seeks to put a floor on competition over corporate income tax, through the introduction of a global minimum corporate tax rate that countries can use to protect their tax bases.” OECD further claims that “the two-pillar package will provide much-needed support to governments needing to raise necessary revenues to repair their budgets and their balance sheets while investing in essential public services, infrastructure and the measures necessary to help optimize the strength and the quality of the post-COVID recovery.”

The development is good news and not so good news for India. Let us first enlist the reasons to cheer. This announcement marks the culmination of hectic international negotiations since the BEPS 2015 reports and have overcome the shock due to the previous US dispensation withdrawing from the inclusive framework discussions. Despite knowing futility of a global consensus without the US, the rest of the world continued to engage in hope and anticipation that a change of guard in political dispensation would turn the wheels. The July 1 statement reveals that such hope was not without basis. This consensus also builds upon the recent G7 vow to bring fundamental changes to international tax rules given that most large MNEs are headquartered in these countries and thus their buy-in was a prerequisite for successful implementation of the new rules.

For India, the outcome is crucial because of its active engagement in the OECD-led deliberations. India had strongly advocated greater taxing rights to source or market jurisdictions—a stand shared by most developing countries—given that new-age MNEs have figured out the basis to limit their global tax incidence through innovative tax structures and invisible presence due to digital technologies, of course, within the framework of the current treaty principles. India, in the interim, has proactively engaged with domestic and MNE players to formulate its position on the proposals. Given the insights Indian policy-makers have gained from participating in these deliberations, it is expected that the law-makers will unveil a refined and nuanced direct taxation law.

The not-so-good-news in is inherent in the design of the two pillars. These are complex rules which presuppose applying formulas to data relating to global business revenue of the MNE group. The complexity is writ large with international tax community and leading experts being equally sceptical on the pragmatic success of these proposals. Furthermore, its application requires real-time information sharing and conjoint implementation by the tax-authorities across the globe. Only time will prove if such shared tax-assessment can be achieved in practice, despite the policy level alignment of the participating countries. In any case, uncertainty on the process and outcome await the Indian tax authorities and businesses covered under these pillars.

Assuming a paradigm where the pillars are indeed successful in attaining their objectives, concerns remain on the limited ‘scope’ of these pillars. By design, the two pillars cover a small class of taxpayers—MNEs which have a global turnover above 20 billion euros and net profitability above 10% for Pillar One. This is not to the liking of several emerging economies, besides the obvious discrimination between class of taxpayers. Given that the coverage is limited disputes and differences in approach are likely to continue for taxing smaller players. The next crucial question is the net benefit from applying these rules, given that accepting the two-pillar solution brings taxing rights for the participating nations and, simultaneously, it implies foregoing the taxing rights for others. In other words, accepting the two-pillar solution is a trade-off, of taxing the big to spare the poor. This sounds wise on a progressive-taxation scale and horizontal equity ideal but may not be fair since it is not necessary that the biggest MNEs earn from India more and it also discounts the possibility of taxing the smaller MNEs who earn big from India. The outcome appears to be uncertain given no economist has been able to precisely estimate the revenue figures for each jurisdiction or for India.

Specifically for India, accepting the two-pillar solution implies it being under pressure to undo its new international tax measures, particularly the equalisation levy, and possibly modify its nexus-based Significant Economic Presence. The US policy-makers can be expected to continue leveraging from the ongoing 301 proceedings, which may stifle India’s attempts to garner a fair share of tax but may not qualify for two-pillar taxability.

One is guided by the addendum to the communication “detailed implementation plan together with remaining issues will be finalized by October 2021.” Thus, details remain to be fleshed out. It is anyone’s guess how far the developed countries will be sympathetic to allow market economies greater taxation rights, which is the crux of the ongoing negotiations. One would hope the spirit of bonhomie would prevail to allow a mutually-acceptable solution emerging from opposing interest groups within the participants. The global order would do well to assert hegemonic identities in international tax policy, which have continued to elude. Perhaps Covid-induced pangs for economic revival would bring the change. The good news for Indian business remains that they will not be impacted by the two-pillar solution till they compete with the biggest MNEs in revenue and presence.

The authors are Partners, BMR Legal
Views are personal