Opinion

Towards a global minimum tax

Rohinton Sidhwa | Updated on October 21, 2021

OECD’s moves on corporate tax are welcome and long overdue

October 8 marked yet another step in a series of measures undertaken by the OECD as the international organisation released an updated summary on the progress being made on Pillar 1 and Pillar 2 solutions that are being pursued by the G7/G20.

These efforts represent the work of global governments in clawing back tax revenues that have either frittered away with the evolution of the global digitised economy (Pillar 1) or on the ceding of revenue to structures in tax havens and investment hubs (Pillar 2).

Pillar 1

The approach for Pillar 1 involves discarding the traditional nexus and allocation approach for tax revenues. The traditional approach relied on Functions, Assets and Risks to allocate revenues to participating jurisdictions. This failed when global economies digitised as with the mobility of their business models, multinational enterprises were able to neutralise the allocations under the traditional approach.

Pillar 1 now proposes that the revenue derived in market jurisdictions would really be the proxy for such allocations. Incidentally, this has been a long-advocated position by tax authorities in India.

While this appears a pretty straightforward way of solving the issue, the logistics of implementing it are complex and this is where consensus building is taking time. The revised approach calls for a 25 per cent allocation of “residual profits” to market jurisdictions. Most market countries (including India), are bandying for a higher allocation but this is what the consensus seems to be driving towards.

Remember, a country that hosts an enterprise is typically entitled to a higher share of revenue as a sovereign right. This may also be justified economically. Sharing these revenues by a host country is a first and will open the doors to this method of allocation of tax bases. All in all, it appears that unilateral digital service taxes have had their intended result of driving host jurisdictions to make this change. This is also evident in the concession to withdraw these taxes being promised on the transition to the new regime by 2023.

Pillar 2

Pillar 2 provides a global minimum tax rate that seeks to regulate tax competition amongst countries. The competition, by providing incentives and lowering rates, triggered a race to the bottom and allowed tax and investment hubs to flourish at the cost of other jurisdictions. Pillar 2 aims to stem the flow and in fact, reverse the tide. OECD’s estimates project a whopping $150 billion of new tax collections for participating countries, pursuant to implementation of the solution.

The Pillar 2 framework allows for application of a top-up tax where the effective tax rate (ETR) falls below the consensus tax rate of 15 per cent. Again, while the solution appears simplistic, the antecedent rules require standardisation to take into account complexities of the real world. There are now fairly detailed draft proposals on how the ETR is to be computed on a jurisdiction basis.

The road ahead continues to be that of a series of consultations and consensus building meetings. A detailed implementation plan lays down overall timelines for the release of more materials.

For Pillar 1, the text of the Multi-Lateral Convention (MLC) and the explanatory statement, are expected to be released by early 2022 with countries expected to sign up by mid-2022. Following this, countries will ratify the MLC with the objective to make it effective by 2023. An important aspect of the MLC will be the removal of all digital service taxes and a commitment to not re-introduce them in the future. Model tax rules for implementing changes under the domestic law, are also expected to be released within this time frame.

An interesting feature of the MLC is that it could be open for all jurisdictions to join irrespective of whether a tax treaty exists between those jurisdictions.

Model rules to give effect to Pillar 2 are expected to be developed by November 2021. These are the rules around how the ETR is to be computed, a Subject-To-Tax-Rule (STTR) treaty provision (fixing the rate at 9 per cent), exclusions and safe harbours that will apply, and a transition provision. An MLI for Pillar 2 is expected by mid-2022 and by the end of 2022 a detailed implementation framework covering administrative procedures is also expected.

Finally, while each release from the OECD seems to indicate incremental progress, there is a need to gear up for upcoming changes. Taxpayers have started to critically look at modelling the impact of the combined pillars on their businesses. At the same time, tax authorities are gearing up to make consequent changes to their domestic laws.

India is said to be actively considering at doing away with the equalisation levy that nets more than ₹4,000 crore in collections. The expectation is likely therefore that Pillar 1 and Pillar 2 would more than adequately make up this concession.

The writer is Partner with Deloitte India.

Published on October 21, 2021

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