BEPS 2.0: How it Impacts MNCs

The new global tax framework will pose challenges for multinational companies, tax authorities and tax professionals

AAS WE WITNESS CHANGE IN ALL SPHERES OF THE ECONOMY, the world of taxes is not far behind. The changes particularly impacting multinational companies began when Lehman Brothers happened and countries started staring at falling tax revenues.

Two facts stood out. One, MNCs were able to park their profits in tax havens or low-tax jurisdictions; this was nothing new but started pinching in light of declining revenues. Second, with the dominance of the digital economy, old concepts of taxation like the existence of a permanent establishment (PE) to establish a taxable presence were no longer relevant. Also, unless global solutions were found to these issues, each country would evolve unilateral measures, which would result in chaos. The final thing was that some of the largest MNCs likely to be impacted by any change in the status quo were based in the US, and getting the authorities there on board was critical.

The OECD began work on developing a new order to address Base Erosion and Profit Shifting (BEPS) in 2013. After a series of pronouncements, we now have an Inclusive Framework to which 137 countries have signed up. This Two-Pillar approach (BEPS 2.0) is expected to be implemented in early 2023. Broadly, Pillar One provides that large companies (global revenues in excess of €20 billion), which have global operations and earn more than normal returns, would be taxable in the countries where they sell their products by attributing excess profits (beyond 10 per cent of revenues) to those operations, basis certain allocation parameters. This is expected to shift taxing rights on more than $125 billion from residence countries to source countries. Pillar Two provides that each member country will levy a minimum 15 per cent tax and should that not be the case, profits from low-taxed jurisdictions will be taxed in the home country (or otherwise) such that the MNCs end up paying a minimum 15 per cent tax on profits in each jurisdiction. This is expected to increase the taxation base by about $150 billion. These changes will have a major impact on the way MNCs have thus far operated or been taxed.

Pillar One addresses the demand of developing countries of taxing income in the country from where revenues are sourced whether or not there is a PE. It introduced the concept of Significant Economic Presence in its domestic laws, which applied to sales in India from non-tax-treaty countries. India also introduced Equalisation Levy to tax digital transactions. Once Pillar One comes into effect, these unilateral measures will need to be withdrawn. This has been committed to by India. But this still leaves a number of open questions: Pillar One applies to large MNCs. How will India tax the rest? Will it apply unilateral measures? Will it apply to others the same ratio as applicable to large MNCs? While each country wants to tax its share of the pie, the MNCs will want to ensure that they are not taxed on the same profit in different countries. How will this happen? What will this do to current supply chains? Will MNCs restructure themselves to

beat the revenue threshold? The answers will emerge in due course.

PILLAR TWO DEALS WITH PROFITS in low-tax jurisdictions. It will certainly impact structures involving location of IPs in countries like Ireland. It will call for closer scrutiny of entities operating in the UAE. It will call into question jurisdictions like the Netherlands. It will call into question holding company profits in low-tax jurisdictions. It will require Indian firms to relook at related-party transactions. Provisions that deal with how profits are derived from transactions in low-tax jurisdictions are fairly complex and are a subject in themselves. Broadly, the GloBE (Global Anti-Base Erosion Rules), as these provisions are called, have different facets. The first is the Income Inclusion Rule, which broadly envisages that income that is taxed at a lower rate in a jurisdiction will be taxed on the difference at the head office on a top-up basis; second, the Undertaxed Payments Rule, which seeks to deny deductions in respect of such income; third, the Subject to Tax Rule, which seeks to deny tax treaty benefits and imposes an additional withholding tax where a payment is subject to nil or nominal tax in the payee country; and fourth, the Switch-over Rule, which switches from exemption to credit method where there is a PE. The OECD has come up with detailed guidelines on the way forward. That said, the proof of the pudding is in the eating and the proof of the outcome of Pillar Two will be in its implementation.

The challenges the digital economy poses to the effectiveness of global tax architecture can only be suitably addressed through multilateral reform, and the Two-Pillar approach represents a step in the right direction. Both India-headquartered groups with international operations (India outbound) and foreign headquartered groups with Indian operations (India inbound) satisfying the threshold requirements would be required to assess the impact in terms of additional tax outflows and compliance burdens. This would need to be analysed keeping in mind the interplay of new taxation rules with existing treaties, domestic tax laws and transfer pricing regulations, application of carve-outs and carry-forward mechanisms and documentation.

Incremental tax burdens can affect the cash flow and overall profitability of businesses. An impact analysis of existing and alternate supply chains and business/ownership structures, along with realignment of technology to match documentation and compliance requirements, would be some of the important action points for businesses to consider. As and when implemented, this would mark a major strategic change in the international tax framework impacting both MNCs as also many low-tax jurisdictions.

All in all, as the Chinese curse goes, ‘MNCs will have interesting times’. The new global framework will pose some challenges for them, tax authorities and tax professionals. It will take some time before the provisions settle down and afford the certainty that MNCs will look for.

The challenges the digital economy poses to the effectiveness of global tax architecture can only be suitably addressed through multilateral reform, and the TwoPillar approach represents a step in the right direction