Two pillar solution to tax challenges for digital economy – Part 2

Implementation plan for the two-pillar solution to address tax challenges of a digital economy

Background

In my earlier article dated July 19, 2021, I have given a brief overview of the Statement on a two‑pillar solution to address the tax challenges arising from the digitalisation of the economy (the Statement) that was agreed by 130 out of 139 member countries of OECD/G20’s Inclusive Framework (IF) on Base Erosion Profit Shifting (BEPS).  As of today, 136[1] out 140 member countries have agreed to the IF, which indicates the need of successful implementation of the IF.

As mentioned in that article, a detailed implementation plan was expected to be finalised in October 2021, which shall be implemented through multilateral conventions (MLCs) during 2022-23. A premeditated implementation is the key to success for every regulation. To this end, 136 countries expressed their agreement for the updated Statement on October 8, 2021, which contains a detailed implementation plan; finalises certain quantitative aspects of the Statement which were pending in the Statement released in July 2021; and highlights a target effective date of 2023 for most of the aspects of both Pillar One and Pillar Two. The agreement is expected to make the international transactions/ arrangements fairer and work better.

This article summarises the highlights of the Updated Statement and timelines of the detailed implementation plan agreed by the countries on October 8, 2021. OECD has released a brochure containing background of introduction of two-pillar solution, text of Updated Statement along with the detailed implementation plan and answers to few FAQs.

Updates to the Statement

Highlights of the updated Statement are summarised below:

• Pillar One will ensure a fairer distribution of profits and taxing rights among countries with respect to the largest and most profitable multinational enterprises. It will 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 or not.
  • Multinational enterprises (MNEs) with global sales above EUR 20 billion and profitability above 10% will be covered by the new rules, with 25% of profit above the 10% threshold to be reallocated to market jurisdictions. This is referred to as Amount A. As a first step, the tax certainty on this Amount A is going to be introduced. With this, taxing rights on more than USD 125 billion of profit are expected to be reallocated to market jurisdictions each year. Developing country revenue gains are expected to be greater than those in more advanced economies, as a proportion of existing revenues.
  • As a second step, the tax charged by way of application of arm’s length principle to in-country baseline marketing and distribution activities will be simplified and streamlined with focus on low capacity countries. This is referred to as Amount B.
• Pillar Two introduces a global minimum corporate tax rate set at 15%. The new minimum tax rate will apply to companies with revenue above EUR 750 million and is estimated to generate around USD 150 billion in additional global tax revenues annually. Further benefits will also arise from the stabilisation of the international tax system and the increased tax certainty for taxpayers and tax administrations.

Timelines of the detailed implementation plan

The detailed implementation plan contains ambitious deadlines to complete work on the rules and instruments needed to bring the Two-Pillar Solution into effect by 2023

Impact and way forward

The countries are aiming to sign an MLC during 2022, with effective implementation in 2023. The MLC is already under development and will be the vehicle for implementation of the newly agreed taxing right under Pillar One, as well as for the standstill and removal provisions in relation to all existing Digital Service Taxes and other similar relevant unilateral measures. This will bring more certainty and help ease trade tensions. The OECD will develop model rules for bringing Pillar Two into domestic legislation during 2022, to be effective in 2023.

As India is one of the member countries agreeing to the Statement, India is required to withdraw the equalisation levy, once the MLC is signed for implementing the global minimum tax of 15% and such other measures that may be included in the MLC. This enables resolving of various ambiguities and controversies around the applicability of equalisation levy on the digital transactions of MNEs, thereby attracting MNEs to invest in India.

[1] Kenya, Nigeria, Pakistan and Sri Lanka – have not yet joined the agreement.