By Sudhir Kapadia & Matthew Mealey
In October 2020, the OECD released a series of documents titled ‘Addressing the Tax Challenges of the Digitalisation of the Economy’, concerning its Base Erosion and Profit Shifting (BEPS) 2.0 project. These included the Pillar Two Blueprint proposing global minimum tax rules to ensure that global income of MNCs is subject to agreed minimum tax rate (MTR). The blueprint was meant to provide “strong basis” for future agreement; however, it was rendered rather academic, given the complexity of proposals that are subject of intensive negotiations in Inclusive Framework (IF) of 139 jurisdictions.
Recently, MTR proposals accelerated following clear intent signalled by the new US administration to engage in multilateral tax policy efforts, including BEPS 2.0. This led to the communiqué at the June G7 summit, its subsequent affirmation by the IF, and, recently, the G20 economies agreeing to more stable and fairer international tax architecture. A high-level consensus appears to have been reached by the IF for MTR of “at least” 15%. Furthermore, the implementation timeline has moved forward to 2022 for US-headquartered MNCs and 2023 for others.
The aim is to reduce tax competition by ensuring profits of MNC groups are subjected to minimum tax irrespective of their domicile or markets of operation. While each country will still set its own tax rate, this proposal enables corresponding countries to levy additional taxes if an MNC’s tax-liability falls below the prescribed threshold on country-by-country basis.
The proposals will impact digital as well as non-digital businesses. Further, MTR is not a measure that targets only artificial or harmful tax incentives, but rather reduces economic impact of all lower corporate tax rates and incentives.
While G20 and IF’s confirmation mark important steps in advancing the work, efforts are focused now subsequent negotiations between 139 countries to finalise the finer aspects of the proposals and implementation plan (expected as early as October-2021).
An effective MTR will lead to increased tax costs for MNC groups that currently utilise tax incentives in different countries. Reduced efficacy of tax incentives may stimulate or reinforce the relocation of mobile business activity away from lower tax locations.
The large developed countries in G7 are likely to benefit from MTR either through higher tax collections or reduced impact of tax competition or both. Various large developing countries in the G20 (e.g. China, South Africa, Mexico) have corporate tax rates higher than MTR, and may also be expected to support these proposals.
Countries that grant incentives under the MTR will need to decide whether to increase their own tax rate to the new minimum. This may increase their own tax yield but decrease their relative competitiveness. If the efficacy of tax rate competition falls, countries may also want to reinforce alternative economic policies and increase competitiveness in other areas to compensate for this.
From the Indian perspective, the recently-announced concessional tax rate of 17% (for new manufacturing companies) would likely not be adversely affected by the MTR. Indeed, incentives at or about the level of the MTR become relatively more competitive when the value of more generous incentives is reduced. To this extent, India was expected to support an MTR of at least 15%.
Though India is working towards the sunset of many incentives, quite a few well-targeted income and investment-linked incentives continue to exist. It seems important for G20/IF to consider whether a carve-out should be provided for policy-driven incentives to balance tax and economic considerations, especially in developing countries/countries with low resources.
Also relevant for India is the Pillar One proposal of allocating MNCs’ global profits to market jurisdictions providing active customer participation, even in absence of any physical presence in such jurisdictions. G20/IF has accepted that 10% of MNE’s global profits shall be deemed to be routine profits and 20-30% of balance profits will be allocated to market jurisdictions. India may seek a higher allocation given the huge customer base it offers to MNCs. Further, India may advocate against US’ proposal to apply Pillar One to top-100 MNCs as against top 300 MNCs originally proposed by the OECD. Also, it will be interesting to see the impact on India’s equalisation levy, especially since the US has demanded abolition of digital services tax and its equivalents.
Kapadia is EY India tax leader and Mealey is senior partner, EY Global. Views are personal