A decade of dramatic developments in Indian and international taxation

Last decade has seen frenzied activity in the world of Indian taxation. Supreme Court’s celebrated verdict in the case of Vodafone came in 2012, only to be countered by the contentious retrospective amendment by Parliament, followed by battles invoking non-tax legal instruments such as Bilateral Investment Protection Agreement, to finally culminate recently in a rare retreat by the Government in the face of adverse international arbitral award. Advanced Pricing Agreements, Safe harbor, Thin capitalization provisions were all introduced in transfer pricing only in the last 10 years. Black Money law offered a window to errant taxpayers to atone for the past tax evasion. One of the stated objectives of controversial demonetisation of 2016 was to clean the tax closet of skeletons. Year 2017 saw one of the most sweeping changes in the form of GST, which took protracted negotiations with a score and a half states, constitutional amendments and remarkable political will to come through. Concepts such as General Anti Avoidance Rule, Place of Effective Management were codified and the tax treaties with Mauritius-Singapore-Cyprus saw their treaty shopping utility being consigned to history. Although the much-expected Direct Taxes Code never saw light of the day, the tax authorities managed to log into the online world and went faceless for assessments as well as appeals. Quite an astonishing set of changes in a span of just 10 years!

International tax scene

While all this was happening in India, international tax scene was no less dramatic. Globalisation of the last few decades, accompanied by communication revolution saw exponential rise in digital ways of doing everything, including business. While digitalization of economy brought great convenience to consumers and immense wealth to companies and their shareholders, it also facilitated a great deal of tax avoidance. The antiquated framework of the international tax rules was not upgraded enough to respond to the complexities and opportunities of the new online world. When questioned by the US senate members about his company’s tax planning strategies which seemed a bit underhand to tax authorities, Tim Cook, the head of Apple, unapologetically proclaimed that his company was playing by the existing tax rules. Too bad, if those rules left the tax authorities feeling deprived. This was unacceptable and governments had to act. They also needed to augment revenues to address fiscal pressures in the aftermath of global financial crisis. In 2013, G20 – a group of 20 nations that make most of the biggest economies of the world – decided that tackling tax avoidance should be a priority. By 2015, the Base Erosion and Profit Shifting Package of 15 actions was adopted by G20, Action 1 dealing with the digitalization of the economy.

Key problems

Digitalisation cum globalization has mainly created two problems for the century-old tax system based on source-residence based taxation rights. First: Existing system provides that the profits of a foreign company can only be taxed in another country where the foreign company has a physical presence, commonly known in tax jargon as permanent establishment. In the digitalised world, it has become possible to conduct business in any country without much substantial presence on the ground. The biggest example of this would be companies like Google which can sell their services directly anywhere in the world to anyone who has an internet connection. So how can a country bring a Google into its tax net when the Company has little physical presence on ground yet millions of users? In other words, whether the source of today’s multinational enterprise’s (MNE’s) income lies more inside a country where its customers are or where it conceptualises and creates services for those customers? Second: Compared to physical assets like plant and machinery and inventory, it is easy to move around intangibles like brands, copyrights, patents across countries. Just like water finding its way to low-lying area, such new age assets find home in low-tax countries and companies can shift those easily. Further, it is difficult to pin down the ownership, control and management of an MNE to a particular country. In this age of jet travel, video conferences and multi-national staff, it is not unthinkable for an Isreali registered company listing on a US stock exchange, holding its intangible assets in Switzerland, while making most of its money from customers in Asian countries. Which country should then have residence-based right to tax profits of such an MNE? Some countries have taken advantage of this confusion, offering irresistible tax regimes to MNEs, weaning them away from their home countries as well as market jurisdictions. For instance, US-origin technology giants have used Ireland as a base for their non-US business from countries like India. Effectively, Ireland encroached upon the revenues that would have ordinarily belonged to either India or the US or both.

OECD estimates that the above problems cause countries to lose between US$100-240 billion annually in tax revenue, which is equivalent to 4-10% of global corporate income-tax revenues.

Solution proposed

136 out of 140 member jurisdictions of the OECD/G20 Inclusive Framework on BEPS, representing more than 94% of global GDP, reached a political agreement recently on the Two-Pillar Solution to Address the Tax Challenges Arising from the Digitalisation of the Economy as well as a Detailed Implementation Plan. Tables below summarise the key aspects of the Two-Pillar Solution:

Pillar 1: Market jurisdictions get more taxing rights		Impact in India
Objective	More allocation of taxing right to market jurisdictions, i.e., countries where goods or services are used or consumed	No more requirement of permanent establishment in India to capture business profits of foreign companies
Taxpayers covered	MNEs (other than those engaged in extractives and regulated Financial Services) with ·         Global turnover >20 billion euros ·         Profitability >10%	About 100 biggest and most profitable MNEs get covered by this threshold rule
Countries covered	Those from which the above MNEs derive at least 1 million (250,000 in case of small countries with GDP<40 billion) euros in revenue	If Indian revenue of any of the above 100 MNEs is <1 million euros, India will miss out on any allocation in respect of that MNE
Reallocated tax base	25% of profit in excess of 10% of revenue, using revenue based allocation key	E.g. While Alphabet, parent of Google will get covered, Amazon, because of its <10% profit margin, may escape the net
Computation of tax base	Using financial accounting income, with a small number of adjustments; Losses allowed to be carried forward	No need to prepare separate tax accounts only for this purpose
Dispute resolution	Mandatory and binding mechanism to be set up and followed by countries to ensure tax certainty to the above MNEs	Provides tax certainty to MNEs, though their tax compliance and cost may increase
Administration	Streamlined tax compliance through a single entity
Obligation of market jurisdictions	Remove all unilaterally imposed digital services taxes for all companies and commit to not introduce new	Equalisation levies imposed under Section 165 (@6% on online advertisement etc.) and under Section 165A (@2% on ecommerce supply and services) of the Finance Act, 2016 will have to be abolished by India for all companies, not just the MNEs covered by Pillar 1.
Method of implementation	Through a Multilateral Convention (MLC)
Timeline for implementation	Text of the MLC and its Explanatory Statements to be finalised and signed in 2022; Entry into force and effect in 2023	FY 2023-24 may be the first year to compute MNE’s tax dues in India under Pillar 1.

 

Pillar 2: Limiting tax competition among countries		Impact in India
Objective	Providing a minimum tax on corporate profits, putting a floor on tax competition among countries	Indian parent gets to tax income of its foreign subsidiary if it has been subjected to lower than minimum tax in the other country; When India is a source  jurisdiction, it gets to impose limited source taxation on certain related party payments of interest, royalties etc. subject to tax below a minimum rate in the payee jurisdiction
Taxpayers covered	MNEs (other than Government entities, international organisations, non-profits, pension funds, investment funds that are Ultimate Parent Entities) with consolidated group revenue of at least 750 million euros (other than international shipping income)	Indian MNEs having global group revenue of INR 6500 cr will get covered
Countries covered	Low tax jurisdictions (i.e., where the effective tax rate of the MNE’s constituent entity, calculated with reference to financial accounting income is less than 15%)	E.g. Indian MNE’s subsidiary in Mauritius, where its Effective tax rate is lower than 10%
Countries excluded	Jurisdictions where the MNE has revenues of less than 10 million euros and profits of less than 1 million euros	E.g. Indian MNE’s subsidiary in Dubai where the revenues and profits are below these thresholds
Computation of tax base	Using financial accounting income, with a small number of adjustments; Losses allowed to be carried forward	No need to prepare separate tax accounts only for this purpose
Method of implementation	·         Two interlocking rules (Income Inclusion Rule or IIR and Undertaxed Payments Tax or UTPR, collectively called Global anti Base erosion Rules or GloBE Rules) to be adopted by members countries in their respective domestic law ·         A treaty based rule called Subject To Tax Rule or STTR to be inserted in bilateral treaties through a multilateral instrument (MLI)	IIR is similar to Controlled Foreign Company (CFC) rules in some countries. India had once considered adopting CFC rules, but didn’t.   Now, India will include the IIR and UTPR in its domestic tax law based on a model text developed by the OECD-G20   India will become signatory to the MLI
Timeline for implementation	·         Model GloBE rules to be developed by November 2021 ·         MLI to be developed by mid-2022	FY 2023-24 may be the first year to compute MNE’s tax dues in India under Pillar 2.