By Sudhir Kapadia and Matthew Mealey
In October 2020, the OECD released a series of papers titled “Addressing the Tax Challenges of the Digitization of the Economy”, regarding its Base Erosion and Profit Shifting (BEPS) 2.0 project. These include the Pillar Two Blueprint offering global minimum tax rules to ensure that global multinational income is subject to the agreed minimum tax rate (MTR). The plan was supposed to provide a “solid basis” for a future agreement; however, it was made rather academic, given the complexity of the proposals which are the subject of intense negotiations within the Inclusive Framework (IC) of 139 jurisdictions.
Recently, MTR’s proposals have gained momentum following the clear intention signaled by the new US administration to engage in multilateral tax policy efforts, including BEPS 2.0. This led to the June G7 summit communiqué, its subsequent affirmation by the IF, and recently the G20 economies agreed to a more stable and fairer international tax architecture. A high level consensus seems to have been reached by the IF for an MTR of “at least” 15%. In addition, the implementation timeline has increased to 2022 for multinationals headquartered in the United States and to 2023 for others.
The objective is to reduce tax competition by ensuring that the profits of multinational groups are subject to minimum tax regardless of their domicile or their operating markets. Although each country always sets its own tax rate, this proposal allows corresponding countries to levy additional taxes if a multinational’s tax liability falls below the prescribed threshold country by country.
The proposals will have an impact on digital and non-digital businesses. Furthermore, fixed rate tariffs are not a measure that only targets artificial or harmful tax incentives, but rather reduces the economic impact of all lower corporate tax rates and incentives.
While the confirmation of the G20 and the IF mark important milestones in the progress of the work, efforts are now focused on subsequent negotiations between 139 countries to finalize the finer aspects of the proposals and the implementation plan (expected from October-2021).
An effective MTR will lead to increased tax costs for multinational groups that are currently using tax incentives in different countries. The reduced effectiveness of tax incentives can stimulate or reinforce the relocation of mobile business activity away from low-tax areas.
The large developed countries of the G7 are likely to benefit from the TM either through higher tax collections or a 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 the average tax rate and one can also expect that they support these proposals.
Countries that provide incentives under the TM will have to decide whether they wish to increase their own tax rate to the new minimum. This may increase their own tax return but decrease their relative competitiveness. If the effectiveness of tax rate competition decreases, countries may also want to strengthen alternative economic policies and increase competitiveness in other areas to compensate for this.
From an Indian perspective, the recently announced preferential tax rate of 17% (for new manufacturing companies) would likely not be affected by the MTR. Indeed, incentives at or near the level of the MTR become relatively more competitive when the value of the more generous incentives is reduced. To this extent, India was to support an MTR of at least 15%.
Although India is poised to remove many incentives, a number of well-targeted incentives related to income and investment continue to exist. It seems important that the G20 / IF consider whether an exception should be made for political incentives in order to balance fiscal and economic considerations, especially in developing / low-resource countries.
Also relevant for India is the first pillar proposal to allocate the global profits of multinationals to market jurisdictions offering active client participation, even in the absence of any physical presence in those jurisdictions. The G20 / IF has agreed that 10% of global multinational profits be considered routine profits and that 20-30% of the remaining profits be allocated to market jurisdictions. India might ask for a higher allocation given the huge client base it offers to multinationals. In addition, India could oppose the US proposal to apply the first pillar to the top 100 multinationals compared to the top 300 multinationals originally proposed by the OECD. Also, it will be interesting to see the impact on India’s equalization levy, especially as the United States has called for the abolition of the digital services tax and its equivalents.
Kapadia is EY’s tax manager in India and Mealey is the senior partner, EY Global. Views are personal