Search For Elusive Holy Grail Of Digital Taxation: Consensus

BEPS, Action Plan 1, Inclusive Framework, Pillar 1, Pillar 2 - these may sound like gibberish to most people outside the tax world. But, for the international taxation community, life has revolved around these words over the last few years. The latest additions to this list were made on Monday, and those were ‘Pillar 1 Blueprint' and ‘Pillar 2 Blueprint'.

International taxation refers to the field of taxation which deals with the applicability of tax laws of different countries to cross-border businesses or cross-border transactions. The international tax framework in place now was developed for a ‘brick and mortar' business environment. The basic constituent forming the foundation for this framework is the determination of tax liability based on physical ‘nexus', on so much of the profits as is ‘attributed' to such physical nexus. These have served well until now and countries were happy taxing only those businesses which had a physical presence of any sort.

With changing business models and the advent of digitalised businesses, enterprises are now able to carry on doing business—and at a large scale—without ever setting foot or establishing a presence in another country. Together with the challenges in the effectiveness of the current international tax rules in profit allocation, the new business models (doing away with the need for physical proximity to the markets) have also led to aggressive tax structures and profit shifting by multinational enterprises.

Need For Change And Consensus

Governments are under severe pressure to collect their ‘fair' share of taxes from multinational enterprises. There is renewed activism by civil societies against global digital giants not paying sufficient taxes in market jurisdiction where they operate. There is also a growing belief that these entities are exploiting the gaps in the current system including the existence of tax havens or low tax jurisdictions. All these have led to one clear conclusion that the preferred option would have to be something that is coordinated and agreed to by all countries.

Till that is arrived at, the pressure on governments for revenues has led to many countries implementing or announcing unilateral measures for taxing digitalised businesses. For any multinational enterprise, these unilateral measures would be very dangerous and expensive as it could lead to double or multiple taxation. France, Australia, the United Kingdom, India, Italy form part of a long list of countries which have or are in advanced stages of implementation of unilateral measures to tax digital businesses.

A change in tax law that is uniform and acceptable to all countries would be preferred by the taxpayers.

Unilateral measures can lead to tax laws becoming an issue for trade disputes.

We got an indication of that when the U.S. initiated investigations against France, India, and other countries for unilateral measures. The U.S. has even proposed retaliatory tariffs against French goods if France does not withdraw its proposal to tax American digital companies.

Work Done Thus Far By OECD

A few years ago, the OECD set up a dedicated project for relooking at the international taxation framework specifically the aspects relating to the allocation of taxing rights among many other things.

The members of the OECD-G20 Inclusive Framework on BEPS—the focus group set up for the purpose—has made gradual progress in discarding multiple options put forth by countries. There are currently have 130+ countries participating in the Base Erosion and Profit Shifting project.

After much deliberation and public consultation, the OECD group narrowed the option down to two broad solutions and did public consultations towards the end of last year. They also announced that they would continue meeting and work on reaching a consensus by the end of 2020.

The two board solutions have been termed Pillar 1 and Pillar 2.

• Pillar 1: Re-allocation of taxing rights
  Offers to revolutionise the way global profits are allocated between countries. The proposal is to allocate global profits based on the location of customers, even if products or services are offered remotely.

• Pillar 2: Global anti-base erosion mechanism
  Proposes an effective minimum corporate tax rate that every multinational has to pay, regardless of where they operate from. This would lead to countries being able to collect taxes up to the minimum rate so agreed from the corporate if they are at using tax havens to keep their total tax low.

This would be a disincentive for ‘profit shifting'.

The OECD says the two pillars could, together, end up raising an additional $100 billion in corporate taxes.

The inclusive framework was expected to finalise the recommendations on these two Pillars basis a consensus and move towards implementation by end of 2020.

Recent Developments

On Monday, the OCED has released two blueprints—each running into a few hundred pages—providing an update of the work done so far. Despite the effort over the last year, the progress in terms of building consensus is meagre.

There is no agreement or plan on the minimum rate of tax to be proposed under Pillar 2. There is no consensus on the manner in which profits are to be allocated under Pillar 1.

This would mean that the unilateral measures would continue.

The fact that the U.S. walked away from these efforts and is not inclined to implement the current proposals makes arriving at a consensus in the near future extremely difficult if not impossible.

What Does It Mean For India?

India is among those countries which have implemented unilateral measures to tax the digitalised economy. We recently introduced an Equalisation Levy on non-resident e-commerce operators selling goods or services or facilitating the sale of goods or services if they do not have a taxable presence in India.

India has also introduced the concept of ‘significant economic presence' - under which a non-resident with a prescribed number of users or prescribed amount of business would be considered to have a taxable presence in India even if it had no physical presence.

Earlier this year, the SEP provisions were deferred to April 1, 2021, on account of OECD's ongoing work and efforts to reach a global consensus.

These provisions will now come into play from April 1, 2021, without further deferral. It is unlikely that by then the OECD's work would have concluded in a consensus outcome.

In short, we can expect India's unilateral measures to stay.

The Equalisation Levy introduced has various issues that require more clarity. Since it is unlikely to be a temporary tax, the CBDT must consider engaging with taxpayers and clarifying some of these.

As regards the implementation of SEP provisions, the thresholds have yet to be prescribed. The CBDT had invited public comments but had stalled work in light of the OECD project. It may be an opportune time to revive those.

Conclusion

Global consensus on taxing digitalised companies appears to be a distant dream now.

Even if an agreement or consensus is reached, its implementation would be a bigger task.

• Multilateral instruments would have to be finalised.
• Minimum rates have to be agreed upon.
• Most countries will have to amend their domestic tax laws to enable implementation.

In the meantime, the search for the holy grail of consensus will continue in an imperfect world with unilateral tax measures.

Ajay Rotti is Partner at Dhruva Advisors LLP.

The views expressed here are those of the author and do not necessarily represent the views of BloombergQuint or its editorial team.