Come Friday, representatives from 139 countries, accounting for over 90 per cent of global GDP, will be huddled in Paris to finalise a global tax deal which will give rights to countries, including India, to tax large digital players including Google, Facebook, Netflix, and Microsoft. The outline of the framework was finalised in July and a consensus-based agreement is expected on October 8 for the deal to come into effect from 2023.
The OECD base erosion and profit shifting (BEPS) deal is intended to ensure that these large multinational digital entities pay more taxes in countries where they have customers or users regardless of where they operate from. Several internet companies operate out of low-tax jurisdictions, but do business in several others without having a physical presence and end up avoiding taxes. The deal will also ensure that countries will withdraw unilateral measures like equalization levy to tax these digital companies.
The second part of the two-pillar package deal will see countries setting a global minimum corporate tax of 15 per cent.
The meeting will be followed by a G20 finance ministers meet the following week, and a G20 summit at the end of October. Let’s take a look some of the key issues related to the deal:
What is the two-pillar solution being negotiated?
The proposed solution under the OECD BEPS consists of two components. Pillar 1 deals with reallocation of additional share of profit to the market jurisdictions where the users are. The second pillar relates to a global minimum tax at 15 per cent. Estimates suggest that $150 billion of additional tax revenues should be mobilised under the second pillar. BEPS refers to the exploitation by multinational companies of gaps and mismatches in tax rules in order to shift their profits to low-tax regimes
Why is the deal important for India?
India took a lead in 2016 with the proposal to tax internet giants that earn substantial revenues from India but end up not paying any taxes to New Delhi as they operate without any physical presence in the country. Traditional taxation rules require a physical presence. India also introduced unilateral measures such as equalization levy and significant economic presence to tax these non-resident digital entities.
What is pillar 1 of the proposal?
Pillar 1 of the proposal talks about taxing companies with 20 billion euro revenues and a profit margin above 10 per cent. These largely cover the top 100 companies. The threshold will be reviewed after seven years to cut it to 10 billion euros. This is much higher than the 1 billion euro revenue threshold pressed by developing countries, including India, to cover 5,000 global companies.
What is pillar 2 of the proposal?
Pillar 2 aims to eliminate the concept of race to the bottom in terms of tax competition. It aims to ensure that multinational businesses are subject to a minimum effective level of tax on all of their profits each year. Ireland, which has a corporate tax rate of just 12.5 per cent, has so far declined to sign up to OECD proposals.
What will be the share of profits allocated to the market jurisdictions like India?
The share of profits to be reallocated to market jurisdictions will be between 20 per cent and 30 per cent of the 'residual profits' of companies. This will be defined as profits above 10 per cent return on sales. For example if a company has a 50 billion euros of annual turnover and 10 billion euros of annual profit, it would get covered as the profitability is at 20 per cent. Of the 10 billion euros annual profit, say, 4 billion euros are normal profits and 6 billion euros are residual profits. So, of those 6 billion euros residual profits, a certain share (of at least 20 per cent, or at least 1.2 billion euros) would get redistributed.
This, the developing countries, including India have argued will not result in any significant revenues for them. However, the OECD has estimated that developing countries are expected to gain an additional 1 per cent of corporate income tax (CIT) revenues, on average. On pillar two, the minimum tax is expected to increase revenue of developing countries by approximately 1.5-2 per cent of CIT revenues on average.
Is India satisfied with the proposal?
India has been fighting for taxing rights for source countries where the markets are on the basis of sales in their territories, despite no physical presence. However, the outline of the proposal only talks about top 100 companies as against top 5,000 countries pitched by India and other developing countries. However, the government has justified agreeing to a higher threshold to protect its own revenues from large Indian multinationals like TCS and Infosys. India will also press for a higher profit allocation of at least 30 per cent of the ‘residual profits’ of the company.
What are the unilateral measures to tax digital entities imposed by India?
India introduced equalization levy for digital advertising services in 2016 at the rate of 6 per cent. The government in April 2020-21 widened the scope to impose a 2 per cent tax on non-resident e-commerce players with a turnover of Rs 2 crore. It covers players including Adobe, Uber, Udemy, Zoom.us, Expedia, Alibaba, Ikea, LinkedIn, Spotify, and eBay. This has become a bone of contention between India and US, with the latter holding the levy actionable under the Section 301 of the Trade Act for being unreasonable, burdensome and discriminatory against American companies like Amazon, Google, and Facebook and inconsistent with international tax principles. India collected Rs 2,057 crore from equalization levy in 2020-21, a growth of 85 per cent over Rs 1,136 crore in the previous fiscal.
Will the global tax deal mean an end to equalization levy?
Worried that the proposed global digital tax deal covering only top 100 companies may not lead to sufficient revenue for developing countries, India, along with other Group of 24 (G24) member nations, has pressed against the withdrawal of unilateral measures like the equalization levy (EL) in one go.
The G24 now pressed for a gradual removal of unilateral measures, simultaneous to revenue gains from the implementation of pillar 1. According to the OECD, there will be no rationale for these unilateral taxes with the new rules coming in, but the timing of withdrawal may be negotiated. The US, on the other hand will press for immediate withdrawal of equalization levy and digital services taxes.
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