By Naveen Aggarwal and Hariharan Gangadharan
The Organisation for Economic Co-operation and Development (OECD) nations and the other countries that are signatories to the G20 Inclusive Framework (IF) on Base Erosion and Profit Shifting (BEPS) worked overtime with an ambitious timeline for the implementation of the Pillar One of the two-pillar solution developed through multiple rounds of negotiation to address the tax challenges that have emerged over the past few years from the increasing digitalisation of the economy. The broad consensus was developed and announced in the statement released in October 2021, and it was reasonably expected that the necessary changes to domestic law and treaties would soon be drafted, enacted, and implemented in time for the new rules to come into force in 2023.
With respect to the new taxing right allowing market jurisdictions to tax a portion of the profits of the largest multinational groups, i.e., Amount A of Pillar One, the process for implementation entailed multiple steps. This included development and release of a multilateral convention, followed by its explanatory statement and the draft model rules for domestic legislation—all of this to get completed in early 2022. This was to be followed by the opening of the convention for signatures in a signing ceremony in mid-2022. This was to be finally succeeded by a process of ratification by countries, allowing it to enter into force and be given effect on the ground in 2023.
The development of standard remuneration for in-county “baseline” marketing and distribution activities, i.e. Amount B-related changes were scheduled to be released by end of this year. Over the past several months, we have seen several consultation documents released on Pillar One. These documents cover nexus and sourcing rules, tax-base determination, extractives as well as financial services exclusions and tax certainty.
However, as we near the half-way mark for the year, it appears that these challenging timelines for the development and signing of the multilateral convention by mid-2022 may not be met. The OECD secretary general, Mathias Cormann, recently suggested that the draft multilateral convention would be ready by the end of 2022 and that implementation of Pillar One could be deferred by a year, to 2024.
From an Indian perspective, this potential deferral could have an impact in three broad areas.
The implementation of the Pillar One is linked to the withdrawal of digital services taxes, such as India’s equalisation levy. When India gave its assent to the OECD framework, it was expected by most participants in the economy that the country would withdraw the equalisation levy from 2023 when the Pillar One proposals took effect. A potential delay in the implementation of the Pillar One could therefore prolong the applicability of equalisation levy by one more year. There are many areas of uncertainty around the scope of equalisation levy; for instance, the definition of ‘online sale of goods’ and ‘online provision of services’ is very broadly worded, which could be held to also cover transactions where the online element is merely tangential or incidental.
Also, the compliance mechanism for equalisation levy has not evolved fully. There is no refund mechanism where payments are subsequently taxed as royalty or fees for technical service, no appeal mechanism to resolve disputes, if any arise, on applicability of EL provisions, etc. An early withdrawal of equalisation levy would have helped to curtail avoidable litigation on this front. However, from Indian revenue’s perspective, the continuation of equalisation levy would, of course, ensure assured revenue for yet another year.
India and the US have agreed on implementing a transitional approach, under which India is required to give a credit for equalisation levy paid by an US multinational group during the period from April 1, 2022, to the date of the implementation of the Pillar One, or March 31, 2024 (whichever is earlier), against the Amount A tax liability of such groups. Any delay in the implementation beyond March 2024 may also have a bearing on the amount of credit that would be available to the US companies under this agreement.
Although OECD secretary general Cormann talked only of the Pillar One being deferred beyond the originally envisaged timeline, it will be interesting to see how this affects the implementation of the Pillar 2 proposals. Work on the Pillar 2 has proceeded more rapidly, and the model rules and a technical commentary on the GloBE Rules have already been released, and countries are now in a position to implement them by incorporating such model rules into their domestic tax laws.
Although Pillar One and Two are linked, in that they are part of a common solution, they can be implemented independently. Specifically, it will be important to watch out if India goes ahead with the implementation of the GloBE Rules this year so that Rules can come into force in 2023. If this is to happen, there is a lot to be done, both by the government (on making the necessary changes to the tax laws)and by those Indian groups to whom these rules will apply.
Finally, the ambitious timelines envisaged under the Pillar One and Pillar Two proposals did put a lot of pressure on multinational corporations who had to not only undertake detailed assessments of the potential impact of these changes on their tax profiles and structures, but also had to make significant changes to their internal reporting and financial systems to ensure that robust data needed for complying with these new changes was easily available. A potential delay could help companies plan and adapt to these new rules better.
Authors are Partners, Tax, KPMG in India. Views are personal.