Will global minimum tax disrupt India’s tax regime?

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By S Anantha Padmanabhan

Towards a global minimum tax: On June 5, the G7 countries reached a historic agreement to support efforts to address the tax challenges arising from globalisation and digitalisation. Led by the G20/OECD Inclusive Framework, the countries mutually agreed, among other initiatives, on two revolutionary tax proposals that could have far-reaching implications for multinational companies. The proposals will be taken up for discussion in the G20 ministerial in Venice scheduled to be held in July.

The first proposal addresses the issue of reaching out an equitable solution on allocation of taxing rights where market countries are granted taxing rights of at least 20% of the profit, exceeding a 10% margin for the “largest and most profitable multinational enterprises”. The proposal further provides for coordination between the application of new international tax rules and the removal of all digital services taxes and other relevant similar measures, on all companies.

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The second proposal is a commitment to a global minimum tax of at least 15% on a country-by-country basis.

Why a global minimum tax rate

Many countries had raised concerns on the issue of profit shifting by multinationals who planned their corporate structures in such a way that their profits are parked in low-tax jurisdictions.

By setting up complex structures along with carrying out business through digital means, large multinationals were able to tap the global market, but ended up not paying taxes in market countries in the absence of their physical presence. Combined with the fact that these multinational companies are headquartered in low-tax jurisdictions, such arrangements resulted in the final profits having either negligible or zero tax.

Arising out of the Base Erosion and Profit Shifting (BEPS) Action Plan on Digital Economy, multiple countries including India, introduced the digital services tax or equalisation levy to counter such business practices. BEPS indicates tax avoidance methods used by MNCs to reduce their tax liability in host countries.

India introduced equalisation levy on online advertising revenue at the rate of 6% and followed that by expanding the scope of levy, at the rate of 2%, to cover foreign entities selling goods or services online. Separately, India also made amendments in its tax regulations by including the concept of Significant Economic Presence (SEP) under business connection. This primarily targets digital multinationals and the threshold for taxation is determined based on the user base (revenue / number of users). There are ambiguities in the meaning of certain terms used in the regulations as well as in their applications, in the absence of corresponding treaty amendment.

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How far India will be impacted by the G7 proposal for a global minimum tax? Let’s find out.

1. Profit allocation rules

The Pillar One proposal supersedes the OECD Pillar One blueprint. The new proposal prescribes reallocation of taxing rights in favour of market countries through the creation of a new taxing right.

A share of at least 20% of the group’s global residual profit, above a 10% profit level, will be reallocated to market countries using a formula approach. Clarity is awaited on how to determine “largest and most profitable business” as also the mechanism for calculating the allocable profit.

The proposal, if implemented, would mean that big tech companies such as Amazon, Google, Facebook and Apple which enjoy tax arbitrage will end up paying more taxes on their revenues in the market countries. Jurisdictions that were offering lower taxes or were considered tax havens, will cease to be attractive.

By aligning the taxing right with economic contribution, India will be at an advantage on having the right to tax such incomes of digital companies by invoking the digital nexus. However, one of the causes of concern is the removal of digital services tax and similar measures on implementation of the first proposal. For India, this would mean the revocation of equalisation levy which may be faced with a push back.

Further, one may have to evaluate whether the proposal for a global minimum tax will result in a tax gain or loss for countries who are collecting the levy on gross revenues. For e.g., India has 2% equalisation levy on gross revenue of online sale of goods or services. Whether the value will correspond to tax on 20% of global residual profits above 10% profit level, will have to be examined.

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2. Global Minimum Tax

The Pillar Two proposal comprises a set of tax rules designed to ensure that large multinationals pay a global minimum tax on all profits in all countries. The OECD Pillar Two blueprint proposed that multinational groups with consolidated revenues of EUR 750 million or more would be in scope.

Where the tax on profits is below an agreed minimum effective tax rate, the “income inclusion rule” would apply, wherein an additional top up tax is payable on cross border income. The undertaxed payment rule would apply as a secondary rule where the income inclusion rule has not been applied.

Possible impact on India

Currently, India’s effective tax rate is above the global minimum tax rate, which would not impact companies doing business in India. As a result, the proposal should not have any disruption and India may be an attractive investment jurisdiction.

This is a commendable step towards international tax reforms and moves towards bringing in parity in the global economy. Having said that, there are still a few aspects that need clarity such as to what constitutes largest and most profitable business, whether segmentation is required in cases where there is a mix of high profit making and low profit-making businesses, etc. On the revocation of digital tax or equalisation levy, it needs to be seen if India and other countries that have introduced digital levy will agree to its revocation.

Now the focus will be on the outcome of the G20 ministerial where the global minimum tax proposals will be discussed.

(S Anantha Padmanabhan is Partner with Deloitte Haskins & Sells LLP. Views expressed in this article are personal)