Global tax restructuring a recognition that the existing system is weak – The Economic Times

lipped from: https://economictimes.indiatimes.com/opinion/et-commentary/view-global-tax-restructuring-a-recognition-that-the-existing-system-is-weak/articleshow/87027399.cmsSynopsis

Britain introduced the ‘Google tax’, India introduced the ‘equalisation levy’, and a host of other countries took different unilateral measures. Given that many impacted companies were American MNCs, the US Trade Representative (USTR) retaliated with trade measures.

Dinesh Kanabar

Dinesh Kanabar

CEO, Dhruva AdvisorsAjay Rotti

Ajay Rotti

The writer is partner Dhruva AdvisorThe OECD now formally recognises that the existing global tax system suffers from two fundamental infirmities. One, with trade becoming borderless and not limited by physical boundaries, the digital world does not require existence of a fixed place of business, or permanent establishment (PE). Two, profits arose not merely from research, manufacture and production, but also from access to markets.

This twin recognition marks a radical departure from the existing thought process on how MNCs should be taxed. In 2013, the OECD began a review process that resulted in recommendations of 15 action items. While finalising on what needed to be done on these items, countries started to take unilateral measures to address the gaps in the global tax system.

Britain introduced the ‘Google tax’, India introduced the ‘equalisation levy’, and a host of other countries took different unilateral measures. Given that many impacted companies were American MNCs, the US Trade Representative (USTR) retaliated with trade measures.

It was, therefore, only in the fitness of things that the OECD came up with its ‘Two-Pillar’ approach to address the two above-mentioned infirmities. The framework was approved in principle a couple of months back, and has now been formalised with 136 of the world’s largest economies agreeing to be a part of the ‘Inclusive Framework’ and implement the Two-Pillar approach.

Simply stated, Pillar 1 provides that large MNCs – having a turnover of more than Rs 20 billion, or about $23.2 billion, and a profitability of over 10% – would allocate 25% of their excess profits to the market jurisdiction where they sell their products, irrespective of their physical presence. The monetary threshold would be reviewed and reduced after seven years.

While the number of MNCs impacted today is few, Pillar 1 marks acceptance of a radical proposition – attribution of profits to markets jurisdiction. India as a developing country has been a consistent advocate of this view, and sees this as a welcome development. As a quid pro quo, countries have agreed to not impose unilateral measures, and to reverse the existing unilateral measures by December 2022.

As to how will such a withdrawal take place, and whether the withdrawal will only be in respect of those MNCs covered by Pillar 1, remains to be seen. The identification of unilateral measures and the methodology of rollback remains an important open issue.

Pillar 2 provides that all countries will impose a minimum tax of 15% on corporates. This is an important step towards eliminating tax havens and addressing the issue of harmful tax competition. While countries may still not impose a 15% tax, Pillar 2 provides that where profits are earned in jurisdictions where the tax rate is less than 15%, the home jurisdiction can tax those profits by way of income-inclusion rule.

Other alternative approaches have also been prescribed, as a result of which countries that do not impose a 15% tax will end up ceding the tax to home/other jurisdiction without benefiting the taxpayer. Similarly, to avoid double non-taxation, it is proposed that where profits are not subjected to tax in the other treaty country, the source country will have a reversionary right to tax such profits.

The agreement reached on the Two Pillars marks a giant step forward in international taxation. That said, there are still several open issues, including the manner of resolution of global disputes relating to attribution of profits to market jurisdiction, the manner and shape in which unilateral measures will be withdrawn, etc.

The next one year will see intense negotiations on the evolution of a multilateral instrument, which will be the basis for implementation of the Two-Pillar approach. The ultimate success of the new provisions will lie in the execution of the proposals, and their adherence in spirit by the 136 countries.

(The writers are partners, Dhruva Advisors)

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