After years of freewheeling on light taxes, a global effort is closing in on big tech to extract a pound of flesh, writes Freny Patel
It’s been an open-ended abuse and one that irks most of us who dutifully pay our annual tax charges. Big tech companies, bloated with global profits, have been minting tax-free dollars for many years, eluding any obligations via loopholes due to their limited physical presence and lack of hard assets in the jurisdictions they suckle from.
According to a Fair Tax Foundation report from May 2021, the so-called “silicon six” – Facebook, Apple, Amazon, Netflix, Google and Microsoft – grossed more than USD6 trillion in revenue in the past decade (2011-2020). Combined, they have booked profits in excess of USD1.36 trillion.
But in terms of taxes, they have paid a mere 3.6% cash tax rate on revenue and 16.1% on booked profits. This is much lower than the revised US tax rate of 21% and nowhere close to India’s corporate tax rate imposed on foreign companies at above 42%.
Countries are vying with each other to ensure that adequate taxation of profits is paid in the right jurisdiction and that their economies don’t suffer just because there is no permanent establishment on the ground.
India alone loses in excess of USD10 billion in taxes annually thanks to “global tax abuse” by multinational corporations, the majority of which are headquartered in the US, according to UK-based research and advocacy group, the Tax Justice Network.
But governments around the world have had enough and are now looking to get their pound of flesh.
Pillar one, pillar two
On 1 July, significant progress was made when members of the OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting (BEPS) met, and 130 countries and jurisdictions agreed to a two-pillar proposal to address tax challenges arising from the digitalisation of the world economy.
At the end of October, the stage has been set to finalise the remaining elements of the framework in Rome, which will see the remainder of the 139 countries that have yet to give their assent to the changes haggle over a solution to reform international taxation rules.
Pillar one is about the reallocation of an additional share of profit from the home countries of multinational enterprises to market jurisdictions, while pillar two consists of the introduction of a global minimum corporate tax, subject to tax rules.
The US has played a “tremendously important role in promoting the negotiations that have led to this breakthrough,” says Pascal Saint-Amans, director of the OECD Centre for Tax Policy and Administration in Paris.
India is in favour of a consensus solution that is simple to implement and comply with, the government has said, adding: “The solution should result in allocation of meaningful and sustainable revenue to market jurisdictions, particularly for developing and emerging economies.”
China has also agreed to the international tax reform, but nine members of the inclusive framework – including a few low-tax EU member states, namely Ireland, Estonia and Hungary – have yet to accept the proposal.
The proposed global digital tax, presented to about 140 countries and regions, will be imposed on around 100 companies that have at least EUR20 billion (USD23.9 billion) in revenue, and a 10% profit margin.
“All countries will benefit from the recently reached multilateral agreement for bringing international taxation rules into the 21st century,” says Saint-Amans. The new agreement reinforces the international tax system and reduces the risk that countries will take unilateral measures that provoke trade tensions, he says.
“We have been facing a global challenge for some time – the international tax rules were no longer working,” says Saint-Amans. The proposal will allow countries to tax part of the profits that multinationals make in their markets, even when those multinationals have no physical presence.
All countries, including in Asia, stand to benefit if companies stop using aggressive tax optimisation strategies to move profits to low or no-tax jurisdictions, says Saint-Amans.
The right to tax
India took the lead last year and enacted an equalisation levy of 2% on all digital services offered in the country. The digitalisation of business models has pushed tax authorities and governments worldwide to revisit tax rules. This has given rise to a proliferation of unilateral digital service taxes as countries seek the right to tax the income earned by big tech in their domestic markets.
Akhilesh Ranjan, former joint secretary of the Central Board of Direct Taxes in Gurugram, says that the equalisation levy should be viewed as “an interim measure that was brought in by India in view of a lack of consensus on taxation of such income”. The levy serves the purpose of collecting tax from multinational companies that operate in India but do not pay any tax under the prevailing corporate tax rules due to the absence of a physical presence.
However, the levy is “on gross receipts, and directly results in double taxation that cannot be resolved under tax treaties”, says Ranjan, who is now an adviser with PricewaterhouseCoopers (PwC).
The global consensus being sought on pillar one of the OECD/G20 framework would allow taxation on a net income basis and the possibilities of double taxation would be minimised, Ranjan explains.
“India’s concern now would be the amount of income that would be finally agreed to be allocated to market jurisdictions under pillar one,” he says. The co-ordination between the application of any new rules agreed on, and repealing the existing equalisation levy, may have its own dynamics, he adds.
Saint-Amans describes pillar one of the proposed framework as “the first fundamental reallocation of taxing rights in 100 years”, because it recognises the change in the economy and offers new taxing rights to countries worldwide.
The new minimum global corporate tax embedded in pillar two of the proposal will put a floor on tax competition, he says. “This global minimum tax will go a long way towards putting an end to The Ministry of Finance commented: “The principles underlying the solution vindicates India’s stand for a greater share of profits for the markets, consideration of demand side factors in profit allocation, the need to seriously address the issue of cross-border profit shifting and the need for subject-to-tax rules to stop treaty shopping.”
No easy consensus
A redistribution of taxing rights has significant implications on the revenue to the exchequer in many countries like India and the US. As such, it will not be easy to come to a consensus-based solution, especially as each country has its own objectives in mind.
Meyyappan Nagappan, leader in the international tax practice at Nishith Desai Associates in Mumbai, says if the deal is not made while there is the political will, companies will face high levels of complexity and compliance costs, especially if every country starts imposing an equalisation levy. “Indian companies with global consumer bases will not be spared … because [tax] thresholds will differ and scope will differ from country to country,” he says.
India needs taxes, but Nagappan questions, “at what cost?” The problem is that the revenue department sees taxes in isolation, he points out, while the idea behind international tax treaties is to encourage trade and cross-border transactions.
“The equalisation levy has not achieved its goal because foreign companies pass on the cost to the consumer when there is no alternative home-grown competitor,” says Nagappan. Confident that India will close the deal in terms as favourable as possible, he anticipates the “need to find a middle ground”.
With the G7 reaching an in-principal agreement in June this year for a 15% global effective tax and a profit allocation mechanism, unilateral levies such as India’s equalisation levy will have to be rolled back.
As per the proposed profit allocation mechanism, at least 20% of profits of a multinational company earned above the 10% margin will be reallocated away from the company’s country of domicile and taxed in the jurisdictions where they operate.
While the trade-off may or may not make sense for the government from purely a tax perspective, Nagappan points out the need to look at it from the angle of the next best alternative. “Otherwise, we are headed for trade wars and sanctions,” he says.
The Ministry of Finance has said it expected technical details of the proposal to be worked out in the coming months, with a consensus agreement by October.
“India has to accept the global consensus, or else countries can exert pressure and impose tariffs, making India’s exports expensive,” notes Dinesh Kanabar, the CEO at Dhruva Advisors in Mumbai, which specialises in the tax and regulatory space.
There are two conflicting issues that merit the need for a global consensus, says Kanabar – countries want a fair share of the tax levied, while companies want certainty. “Multinational companies want to ensure that there is no litigation globally and that their profits are not subjected to double taxation,” he adds.
The issue is whether it is possible to build a consensus with so many conflicting pulls and pressures, and Kanabar adds that the US and developed countries will want to ensure a minimum of tax goes outside their remits.
The proposal requires the support of the US to bear fruit. The Trump administration had favoured a safe harbour approach for pillar one and for pillar two pushed the idea of grandfathering, which is a policy or provision (usually contained in statute) under which an old rule continues to apply to some existing situations while a new rule will apply to future cases.
The Biden administration has decided to re-engage with the OECD with a view to reaching a global solution, says Nagappan.
“It is a great initiative that countries are coming together and pushing for a consensus in the taxation of the digital economy, however, we are some way off … it will take three to four years,” Kanabar predicts.
Multinationals look at the post-tax return before making an investment in countries and if they find 15% does not give them that return, they will not make investments in those jurisdictions, he says.
The issue of carve-outs is not really a fundamental problem, says Saint-Amans. However, shipping would be excluded from the global minimum tax under pillar two, as a pragmatic measure. This is because if ships were taxed, “ship owners may all register in just one country outside of the deal”.
A couple of other exceptions pertain to the reallocation of taxing rights to market jurisdictions under pillar one, says Saint-Amans, pointing to extractive industries and regulated financial services. “It is a fact that the profit from exploitation should belong to the lands where the resources are, so there is no reason to reallocate profits to market jurisdictions” when it comes to extractive industries, he explains.
Profits are tied to marketplaces where financial services operate due to existing regulations, he says, however, “while these two sectors are not included in pillar one, they will still be under the rules of pillar two, which means that there will be a minimum tax for them both”.
The road ahead
A few details remain to be negotiated, such as the new reallocation of taxing rights over the so-called “winners of globalisation”, which effectively are the largest multinationals, says Saint-Amans.
But these details will be finalised in October 2021, complete with an implementation plan to develop model legislation, guidance and a multilateral treaty. Says Saint-Amans: “The idea is for that work to be completed in 2022, with implementation in 2023. This is an ambitious schedule, but it is crucial that we complete this work as soon as possible.”
The groundwork for BEPS 2.0
The June G7 meeting paved the way for G20 leaders to endorse the base erosion and profit shifting (BEPS) framework under two pillars. Pillar one focused on the redistribution of tax revenue and pillar two on setting a minimum global corporate tax. The G20 proposal was rubber-stamped by 130 nations and jurisdictions. The deal is expected to be finalised at the G20 leaders’ summit in Rome in October.
Akhilesh Ranjan is adviser, tax policy, at PwC. As the former joint secretary (foreign tax), he led India’s initiative in the BEPS project, a multilateral OECD convention to prevent multinational companies from exploiting gaps in tax rules. He speaks to Freny Patel about the G7 proposal.
How effective is the G7 proposal for countries like India that already impose an equalisation levy?
The G7 finance ministers have agreed on new taxing rights that would allow market countries like India to tax a portion of the profits of large multinational companies derived from those markets (i.e. where sales arise – pillar one). They have also agreed to enact laws that would ensure that all multinational enterprises (MNEs) pay a global minimum tax at the rate of at least 15% (pillar two).
The G7 agreement does not bind other countries although, as the largest world economies, any actions taken often have significant effects on global issues. The decision taken by the G20, being the mandated group, is more likely to have an impact on the movement of the OECD project and possible influence on a consensus of the inclusive framework of 139 countries. While the G7 proposal shows clear momentum, there are numerous political and technical elements of disagreement among countries that will have to be bridged for real consensus to emerge.
Is the proposal an opportunity for the US at the expense of developing nations?
The G7 proposal has two components. First, on the OECD Inclusive Framework’s Taxation of the Digitalising Economy project, it could be viewed as an early test of whether the new US position would provide momentum to finding a common base for agreement on the inclusive framework. Second, the global minimum tax. The recommendations driven by the US on a global minimum tax of 15% do appear to help the US to retain its competitive edge, even with the proposed increase in its domestic corporate tax rates. However, one cannot say whether these are at the expense of developing nations. The US might earn additional revenue as a consequence of the proposal, but developing nations are unlikely to lose revenue on this count.
How effective would a global consensus be in plugging the current legal loopholes?
There are several concerns that were voiced by countries on the current international tax rules, even after the reforms were ushered in by the BEPS project. The existing concepts of permanent establishment and fixed place of business favour residence-based taxation. Countries now have an understanding that a market can add value and contribute to profits.
A global consensus on allocation of new taxing rights to market jurisdictions, by introduction of a new set of tax rules without reference to physical presence (pillar one), would contribute to reducing the imbalance between residence-based and source-based taxation. An agreement under pillar two on a minimum global tax for MNEs would go a long way towards making redundant the current strategy of parking profits in low-tax and no-tax jurisdictions.
What impact will a consensus have on tax treaties?
Once a consensus is achieved, the changes on account of pillar one and two proposals will require steps for the introduction of a multilateral instrument in order to include these changes in the existing bilateral tax treaties. The multilateral instrument will have to be signed and ratified by countries, and will also require changes to the domestic laws of the respective countries. Considering this, the implementation of the new rules is likely to take a couple of years, and is likely to create additional complexities for taxpayers, as countries are unlikely to implement the agreed rules in the same way, and with the same effective dates.
How do you view article 12B of the UN model, since it is said to be a positive step for developing nations? What problems do you foresee in terms of its implementation or enforcement?
Article 12B does appeal to developing countries due to its simplicity and ease of administration. It is also important as it gives expression to the voice of many developing countries, which now feel that they have a role in shaping global tax policy. Having said that, it must be noted that the implementation and enforcement of the article requires changes to tax treaties. If a global consensus is reached on pillar one, and once India and other developing countries sign on to pillar one, it may not be open for them to try to renegotiate their treaties to include article 12B.