I. Introduction:
On July 1, 2021, out of the 141 participating members constituting the OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting (commonly referred to as the BEPS 2.0 project), a total of 137 members affixed their signatures to the declaration outlining the fundamental terms governing a two-pillar framework intended for the comprehensive reform of international tax regulations.
Tax policymakers from various governments globally are engaging in collaborative efforts to formulate proposals for substantial modifications to international tax regulations, spurred by the profound impacts of globalization and digitalization on the economy. The inception of the G20/OECD project focused on addressing the taxation of the digital economy dates back to 2019, drawing upon the conclusive reports released in 2015 during the prior Base Erosion and Profit Shifting (BEPS) project.
The initiative, denoted as BEPS 2.0, comprises two distinct components:
1. Pillar One: This segment focuses on the establishment of new nexus and profit allocation rules, aiming to allocate a more substantial portion of taxing authority regarding global business income to countries where market activities occur.
2. Pillar Two: This facet encompasses regulations for a new global minimum tax, which received approval in December 2021 from 141 jurisdictions actively participating in the BEPS 2.0 undertaking. The Pillar Two Model Rules delineate the implementation of a global minimum tax set at 15%, applicable to multinational enterprise (MNE) groups with a global turnover amounting to €750 million or exceeding said threshold.
The Inclusive Framework on Base Erosion Profit Shifting (BEPS) established by the Organisation for Economic Co-operation and Development (OECD) has undergone a continual evolution, aiming to forge an accord based on a two-pillar approach. This progression is designed to combat tax avoidance, foster the coherence of international tax regulations, and, fundamentally, cultivate a more transparent tax environment. Presently, BEPS 2.0 extends its purview to confront the complexities arising from the taxation of the digital economy. The erosion of domestic tax bases and profit shifting, commonly referred to as Base Erosion and Profit Shifting (BEPS), stems from the strategic exploitation of gaps and mismatches within the tax systems of various countries by multinational enterprises. This phenomenon impacts all nations, with developing countries experiencing a disproportionate burden due to their heightened dependence on corporate income tax.
Given the international nature of business operations, collaborative efforts among governments become imperative to effectively address BEPS and reinstate confidence in both domestic and international tax frameworks. The adverse effects of BEPS practices translate into a substantial financial toll, causing countries to incur annual revenue losses ranging from 100 to 240 billion USD. This financial impact equates to 4-10% of the global corporate income tax revenue, underscoring the urgency for coordinated action to mitigate the consequences of BEPS on a global scale.[1]
II. FRAMEWORK
Pillar One:
Pillar One, tailored for major multinational corporations, introduces a paradigm shift by reallocating specific segments of taxable income to market jurisdictions. Anticipated adjustments in the effective tax rate and cash tax obligations under Pillar One necessitate a meticulous examination of enduring consequences. The OECD’s intent to progressively broaden Pillar One’s scope to include more entities underscores the need for ongoing assessment. This pillar applies to approximately 100 of the largest Multinational Enterprises (MNEs) and aims to allocate a portion of their profits to countries where products are sold and services offered. Pillar One comprises these components:
1. Amount A:
- Definition: Represents a portion of residual profit allocated to market jurisdictions via a formulaic approach.
- Applicability: Relevant to all businesses under Pillar One.
2. Amount B (Fixed “Baseline” Return):
- Description: Involves a fixed return for marketing and distribution functions based on the arms’ length principle.
- Scope: Applicable to all businesses under Pillar One.
3. Tax Certainty:
- Nature: Encompasses effective dispute prevention and resolution mechanisms.
- Inclusion: Applicable to all businesses under Pillar One.
4. New Taxing Right:
- Concept: Signifies a share of residual profit allocated to market countries.
- Methodology: Utilizes a formulaic approach.
- Scope: Extends to all businesses under Pillar One.
The computation of Amount A involves three steps:
Step 1: Establish a profitability threshold based on a PBT to revenue ratio, identifying residual profit subject to reallocation (10% of revenues).
Step 2: Apply the reallocation percentage to determine the share of residual profits allocated to market jurisdictions (25% of residual profit).
Step 3: Utilize an allocation key based on locally sourced in-scope revenues to distribute Amount A among eligible market jurisdictions.
Amount A grants jurisdictional authority to impose taxes on a defined portion of residual profits generated by significant MNEs. The Multilateral Convention (MLC) empowers participants to exercise a domestic taxing right (Amount A) over specified residual profits, considering revenue, profitability criteria, and designated market nexus.
Amount B complements Amount A by simplifying transfer pricing rules for marketing and distribution functions, providing support to jurisdictions facing transfer pricing disputes linked to distribution activities. Transactions under Amount B use a pricing matrix unless internal comparable uncontrolled prices (CUPs) are available, with the matrix considering distributor attributes.
Pillar Two:
Pillar Two aims to ensure a suitable tax rate on income, employing intricate mechanisms for enforcement. Released on December 20, 2021, the OECD/G20 Inclusive Framework unveiled the Model Global Anti-Base Erosion (GloBE) rules (Model Rules) under Pillar Two, proposing a Global Minimum Tax at 15% for multinational enterprises with a turnover exceeding EUR750 million. The IF provided additional guidance throughout 2022 and 2023.
Insights on Pillar Two:
- The IF aims to legislate Pillar Two rules in 2023, effective in 2024, with a one-year deferral for the Undertaxed Payments Rule (UTPR).
- The European Commission proposed a EU Directive assimilating Pillar Two rules into EU law, extending to wholly domestic groups in the EU.
- Model Rules lack a model Subject to Tax Rule (STTR), expected in 2023, with a multilateral instrument developed by mid-2023 for its incorporation.
- By end-2023, an implementation framework will streamline coordinated GloBE rules implementation.
- Pillar Two promises a transformative impact on the tax landscape.
III. BEPS AND INDIA
Current legal frameworks enable diverse countries to impose varying corporate tax rates on multinational companies (MNCs), prompting MNCs to strategically establish themselves in jurisdictions with lower tax rates to minimize tax liabilities. This often involves attributing a significant portion, if not all, of their profits to such jurisdictions, thereby reducing their overall effective tax rate—a practice commonly known as “profit shifting.” Consequently, this practice leads to “base erosion” in countries with higher corporate tax rates, contributing to substantial annual tax losses for India due to perceived “global tax abuse” by MNCs. The international spotlight on corporate tax avoidance emerged as large Multinational Enterprises (MNEs) generated revenue in foreign markets without a physical presence, creating challenges under prevailing international tax rules. Consequently, some countries, including several G20 members, responded by implementing “digital services taxes” on the revenue, rather than profit, of major technology firms to recoup lost tax revenue. However, both countries and MNCs find this approach inefficient.
Given India’s status as a capital-importing country, it holds a keen interest in the outcomes of BEPS 2.0. Experts universally agree that the initiative represents a significant stride toward establishing a more stable and equitable international tax system, particularly acknowledging the transformative nature of Pillar One in reallocating taxing rights. India’s proactive engagement in shaping international tax policies is underscored by its active participation in both BEPS 1.0 and 2.0. This reflects the country’s recognition that traditional tax reforms, rooted in century-old principles, are insufficient for addressing the complexities of the 21st-century economy, emphasizing the need for contemporary solutions.
In 2012, India initiated a significant transformation in digital taxation by redefining the term ‘royalty’ through amendments to domestic tax laws. As an active member of the Inclusive Framework (IF) implementing the Global Anti-Base Erosion (GloBE) Rules, India has faced increased scrutiny regarding the Permanent Establishment (PE) concept, traditionally the basis for taxing corporate profits. India’s tax authorities have broadened their perspective by recognizing virtual PEs, extending beyond conventional definitions. Pioneering the way, India enacted a 6% equalization levy targeting funds received for specific digital services provided within the country. Additionally, India has made substantial efforts to introduce the Significant Economic Presence (SEP) concept, expanding the ‘business connection’ interpretation under the Income-Tax Act, 1961. This expansion addresses complexities arising from the digital economy, ensuring appropriate taxation for enterprises with a substantial economic presence in India. India’s proactive approach underscores its commitment to adapting to the evolving international tax landscape and ensuring equitable contributions from digital businesses to the nation’s tax revenues.
IV. CONCLUSION
BEPS 2.0, delineated by its bifurcated framework, signifies a substantial paradigm shift within the realm of international taxation. Pillar One introduces an innovative paradigm of taxation based on market presence, while Pillar Two establishes a universally applicable minimum corporate tax rate. These initiatives are meticulously formulated to accommodate the dynamic nuances of the global economy, particularly in the era of digitalization. Despite the discernible strides in the formulation of BEPS 2.0, it persists as an intricate and evolving framework. Its repercussions for corporate entities are profound, necessitating a comprehensive evaluation of operational facets, tax responsibilities, and strategies for regulatory adherence. Given the substantial metamorphosis within the international tax domain, global enterprises must maintain a vigilant, well-informed, and adaptable stance.
The adoption of the dual-pillar resolution constitutes a seminal juncture, aspiring to reform entrenched tax statutes with wide-reaching implications for major corporate entities on a global scale. Entities domiciled in India with international footprints, as well as foreign entities with vested interests in India, are obliged to meticulously scrutinize the ramifications, cognizant of potential incremental tax liabilities and an augmented compliance onus. According to projections by the OECD, Pillar Two is anticipated to yield an additional annual tax revenue of US$150 billion, while Pillar One is envisaged to redistribute up to US$100 billion favourably towards market jurisdictions. This underscores the pervasive and profound impact of BEPS 2.0 on the international taxation landscape. In light of the dynamic evolution of the international tax milieu, a judicious approach involving continuous awareness and adept adaptation is imperative for enterprises engaged in global operations.
[1] Base erosion and profit shifting – OECD BEPS (2023) BEPS. Available at: https://www.oecd.org/tax/beps/ (Accessed: 19 December 2023).
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