In today's Expert Column, we share an insightful article that examines the impact and future implications of the OECD/G20 BEPS Pillar Two framework for India authored by Mr. Pramod Achuthan (Partner, Ernst & Young LLP) and Ms. Nidhi Lalwani (Industrial Trainee, Ernst & Young LLP). The authors begin by questioning whether international income tax rules, developed in a "brick-and-mortar" era, remain effective in today's global economy. They provide a fascinating historical context where countries competed by lowering taxes to attract wealth, leading to profit shifting on paper without any actual productive activity moving locations. The authors highlight that a key strategy for governments to make it more difficult for corporations to move money and economic activity across borders to minimize their tax bills has been to establish a mutually agreed-upon global minimum tax rate.

The authors explain the Pillar Two architecture with clear numerical examples and discuss the impact of the GloBE rules on India in comparison to the current scenario. The authors also analyze the broader impact of the GloBE rules on multinationals, arguing that a global minimum tax will ultimately serve the long-term interests of even the most profit-hungry and aggressive multinationals. However, the authors caution that "...while the GloBE rules serve as a potent tool against base erosion and profit shifting, it's crucial that their implementation does not impede the growth of emerging economies".

"BEPS Pillar Two Framework: What’s the future for India?"

Ending the ‘Race to the Bottom’

The critical question today before the global economic landscape is whether the international income tax rules, developed in a ‘brick-and-mortar’ era more than a century ago retain their efficacy in the modern global economy.

The global landscape of international corporate taxation is undergoing significant transformations as jurisdictions grapple with the difficulty of defining and apportioning corporate income for the purposes of tax. Prior to this, it was seen as acceptable and even smart economic policy to charge little to no tax on society’s wealthiest individuals and corporations. Countries even competed with one another so that if one nation raised taxes to tackle inequality’s corrosive effects on economic growth and democracy, its neighbour would respond by cutting taxes. This engendered a shift of profits on paper from the first to the second country, even if no actual productive activity shifted its location. In current international tax system, corporate taxes is levied in the country where the businesses has its production factors i.e tangibles, intangibles, people, capital.

Disrupting this extractive pattern required Governments to make it harder for corporations to move money and economic activity across borders for the purpose of minimizing their tax bills. The key was setting a mutually agreed Global Minimum Tax Rate (GMTR), inaugurating a new form of globalization to ensure minimum taxation while avoiding double taxation or taxation where there is no economic profit, ensure transparency and a level playing field, minimise administrative and compliance cost, cope with different tax system and different operating models by jurisdictions and business.

Framework of Redefined taxation

In October 2021, 137 OECD/G20 countries and jurisdictions, out of the 140 members of the OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting (BEPS) agreed to join the official statement of the Two-Pillar Solution. The reform is based on a two-pillar structure as follows:

Pillar One of the evolving international tax system aims to reallocate a portion of the profits of the largest multinational corporations to the jurisdiction they operate in and related to application of the arm’s length basis to incountry baseline marketing and distribution activity.

Pillar Two introduces rules to curtail base erosion and profit shifting, guaranteeing that the large multinational enterprise groups are subject to GMTR of 15%.

Given the aforementioned updates, this article aims to identify and capture overview of Pillar Two rules including GLobe rules wider reach on MNEs.’

Pillar Two Architecture 

Based on the mechanics, Pillar Two can be broadly categorised into two buckets:

1. Subject to Tax Rule (STTR)

• STTR is a tax based rule, to provide for taxation in source/payer jurisdiction.
• It imposes a top-up withholding tax for certain payments made to connected persons (having direct or indirect ownership of more than 50% or de facto control relationship) if the recipient entity is not adequately taxed on such payments in the home jurisdiction;
• It is applicable only on covered payments which constitute interest, royalties, payments made in consideration for the use of, or the right to use, distribution rights in respect of a product of service, insurance or reinsurance premium, guarantee, brokerage or financing fee, use of movable property, intermediary services.
• Primary objective of STTR is to achieve a minimum level of taxation [different from GMTR used for GloBE rules] through Top-up tax (i.e. as much levy so as to bring the tax rate to minimum rate). It only applies where the income is subject to a tax rate in the Country of residence below 9%.
• Any taxes paid under STTR are considered to be Covered Taxes for determination of Effective Tax Rate (ETR) for the GloBE rules.

Illustration 1:

Facts:

• A Co in Country A holds 100% shares in I Co incorporated in India. I Co pays royalty to A Co.
• Suppose domestic law of Country A levies tax on royalty income at 20%. However, under a special tax rate regime, it exempts 80% of the income from the scope of the levy of tax.
• Country A–India tax treaty provides for source taxation of 0%.
• Domestic laws of India levies source taxation of 15%.

Current Scenario:

• Royalty income is chargeable at 4% [(100-80%) of 20%] in Country A in hands of A Co and India levies no tax on such royalty income as per Country A – India tax treaty.
• Net tax liability = 4% in Country A

Impact of STTR:

• Adjusted Nominal Tax Rate in Country A = (100%-80%) of 20% = 4%.
• Top up tax = 9% - Adjusted Nominal Tax Rate of 4%

      = 9% - 4%

      = 5%

Thus, STTR enables India to levy Top up tax of 5%.

• Resultant Net Tax Liability

Country A – 4%

India – 5% (under STTR)

2. GLoBE Rules:

Applicability - Consolidated group revenue as per consolidated financial statements of ultimate parent entity > EUR 750 million in immediately preceding fiscal year.

Computation of Effective Tax Rate –

GloBE Rules consider jurisdictional blending instead of worldwide blending:

Computation of top-up tax

The top-up tax for a jurisdiction is the difference between 15% and the ETR in that jurisdiction, multiplied by the excess profit in that jurisdiction.

The top-up tax is proposed to be levied in one of the following ways:

1. Qualified Domestic Minimum Top-Up Tax (QDMTT) - A QDMTT is defined as a domestic minimum tax that applies to local constituent entities of in-scope Multi National Enterprises (MNEs) and is implemented and administered in a way which is consistent with the GloBE rules.

2. Income Inclusion Rule (IIR) - IIR operates as a top-up to the existing tax liability to allow tax collection equivalent to GMTR to ensure MNE group is subject to MTR wherever the Ultimate Parent Entity (UPE) is located, without giving risk of double or over taxation.

3. Switch Over Rule (SOR) – SOR applies as a complementary rule for effective application of IIR to PE profits by allowing switch from an exemption method to credit method.

4. Undertaxed Payments Rule (UTPR) – UTPR acts as backstop to IIR as it allocates top-up tax of low tax jurisdiction of an MNE group not covered by IIR, so as to bring overall tax rate of low tax jurisdiction to the GMTR. UTPR facilitates recovery of top-up taxes from group entities which are situated in High Tax Jurisdiction, making base-eroding deductible payments to group entities in Low Tax Jurisdiction.

Illustration 2:       

                             

Facts:

• A Co, an MNE, headquartered in Country A and operates in several other countries through subsidiaries, including in India.
• A Co's subsidiary in India, I Co, makes a profit of 1,000 Million but pays only 50 Million of income tax there because of incentives, or due to a low tax rate. This works to an ETR of only 5%, which is lower than the 15% GMTR under the GloBE rules.

Current Scenario:

• The profit earned by I Co is chargeable to tax at 5% in India.
• Net tax liability = 5% in India

Impact of GloBE Rules:

• In first place, India can itself levy a top-up tax of 100 Million, thereby increasing the ETR to 15 per cent; which is commonly known as the QDMTT.
• If India does not levy QDMTT, then Country A (as the country where the ultimate parent of the group is headquartered) can levy 100 Million top-up tax on the parent entity of the group under the Income Inclusion Rule or the IIR; OR
• If neither Country A nor India levies a top-up tax, any other country in which A Co group operates (Country B or C) can collect the 100 Million top-up tax, commonly known as Under Taxed Payments Rule or the UTPR.

Thus, effectively, A Co group would end up discharging 15% global minimum tax in each  jurisdiction under GloBE Rules.

Beyond the taxes: GloBE Rules' wider reach on Multinationals ^[1]

The OECD business sector, contributing $44 trillion in gross value added, is incredibly diverse. A focused study of 5,000 major corporations shows these firms generate $40 trillion in revenue and contribute $17 trillion in gross value added.

Long term interests:

• For the past four decades, globalization has provided a fertile field for certain innovative corporations to avoid paying their fair share of taxes. However, the growing inequality leads to a weakening consumer base that ultimately erodes companies’ profits.
• A global minimum tax will serve the long-term interests of even the most profit-hungry, aggressive multinationals—even if they don’t realize it.

New Financial Statement Disclosures:

• MNEs will be required to disclose jurisdictions with potential exposure to top-up taxes in their financial statements, adding complexity to the existing financial close process.
• Group-level filing requires adaptations to financial close and consolidation processes, along with change management efforts.

Need for restructuring:

• IIR in present form is likely to negate any domestic tax incentives/benefits given to CEs to achieve minimum taxation such as tax holidays, investment linked incentives. MNE groups will be discouraged to invest in developing economies due to additional tax impact.
• Thus, enacting top-up taxes might demand major alterations to global structures, value networks, and activity locations to mitigate material impacts.

Added Compliance costs:

• Minimum tax may increase the MNEs’ compliance burden such as filing of income tax returns in another jurisdiction as well as the authorities’ administrative cost. Introducing a new regime almost inevitably adds another layer of complexity to the already highly complex framework of international taxation.
• The minimum tax requires generating, communicating and verifying large quantities of tax relevant information (e.g., on effective tax rates in a given jurisdiction) as well as additional safeguards to prevent its circumvention.

Revamping finance to align with tax:

• Existing ERP systems may lack the robustness to support BEPS Pillar Two complexities. Collaboration between historically siloed tax and finance departments becomes crucial, requiring open communication, shared data, and integrated systems.

Data requirements:

• Calculations under BEPS Pillar Two involve pulling data from over 250 new sources per entity across multiple countries, posing a substantial challenge for corporations with diverse regional systems.

Conclusion

When companies make their profits at the expense of ordinary citizens and use their money to ensure that they don’t pay their fair share of taxes, it adds to the public’s ire and threatens the stability of economic and political systems.

Many no/ low tax countries are developing countries that often implement favourable tax regimes such as tax holidays (by using temporary reductions or eliminations of taxes) to attract and stimulate investment in the national economy.  A Global Minimum Tax stifles such other forms of tax competition that enhance welfare.

For the developing economies, whether the additional tax revenues outweigh the development of the economy through the inflow of foreign capital and investments is an unanswered question. Thus, while the GloBE Rules serve as a potent tool against base erosion and profit shifting, it's crucial that their implementation does not impede the growth of emerging economies.

Having said that, Global tax policy will likely always remain an unfinished job. No tax regime is perfect, even in one jurisdiction, much less two hundred. And the competing interests of different jurisdictions and MNEs make it unlikely that any regime will last permanently. Nonetheless, international regulators should lean towards deliberate, mutually beneficial and thoughtfully planned reforms.

Moreover, after U.S. President Donald Trump, on January 20, 2025, issued a Presidential memorandum stating that the ‘Global Tax Deal has no force or effect within the United States,’ effectively challenging the progress made so far by the OECD to levy a minimum 15% tax on the profits of multinational corporations, it will be interesting to evaluate the impact of such withdrawal by the U.S. before India decides to join the OECD’s global tax deal. It is worthwhile to mention that no changes have yet been made so far as Indian tax law is concerned.

Views expressed above are personal.

We acknowledge CA Shraddha Mandlecha’s contribution in writing this article.