India perspective on Pillar Two of BEPS 2.0

The Blueprint

The Blueprint provides technical details on the design of the Pillar Two system of global minimum tax rules. The global anti-base erosion (GloBE) rules comprise of income inclusion rule (IIR) and the undertaxed payments rule (UTPR) acting as a backstop to the IIR. IIR triggers an inclusion at the level of the shareholder where the income of a controlled foreign entity is taxed at below the effective minimum tax rate. It is complemented by switch-over rules (SOR) which would permit a residence jurisdiction to switch from an exemption to a credit method where the profits attributable to a permanent establishment (PE) or derived from immovable property (which is attributable to a PE) are subject to an effective rate below the minimum rate. It is further supported by UTPR which acts a backstop to deal with circumstances where the IIR is unable, by itself, to bring low tax jurisdictions in line with the minimum rate.

Further, subject to tax rule (STTR) complements the GloBE rules by subjecting a payment to withholding or other taxes at source and adjusting eligibility for treaty. Unlike IIR or UTPR, the STTR is not concerned with effective tax rate (ETR); instead it looks to the nominal tax rate that applies to certain covered payments between connected persons.

In terms of the order of application, STTR takes on a primary role and is applied in priority to GloBE rules. Under GloBE rules, application of IIR will take precedence over the UTPR. UTPR will apply only in the absence of IIR and in relation to the intra-group payments to low tax jurisdictions. Thus, the top-up tax imposed under the STTR in the source jurisdiction is taken into account while determining the ETR for purposes of the IIR and the UTPR.

Notably, Pillar Two leaves jurisdictions free to determine their own tax system, including whether they have a corporate income tax (CIT) and where they set their tax rates, but also considers the right of other jurisdictions to apply the above rules as proposed where income is taxed at an effective rate below a minimum rate.

The determination of in-scope groups and entities is based largely on the definitions and mechanisms that are used in connection with country-by-country reporting (CbCR). MNEs with total consolidated group revenue below €750 million in the immediately preceding fiscal year generally are excluded from the GloBE rules.

India perspective

India has a worldwide system of taxation, under which persons resident in India [which includes foreign companies having place of effective management (POEM) in India] are subject to a comprehensive tax liability on their worldwide income, regardless of source of the income. India’s current rate of corporate income rate is 25% and 17% for new manufacturing companies. India has extensive taxing rights under the source rule in the form of withholding tax which target passive income streams as well as certain active business incomes, generally perceived as base eroding payments like royalty, fee for technical services (FTS), dividend and interest, irrespective of whether the same is undertaxed or not. In addition, the Indian income-tax law has transfer pricing and other anti-abuse provisions which are designed to counter cross-border shifting of profit. Overall, it can be said that even with the corporate tax rate reduction and phasing out of tax incentives, India is not indulging in “race to the bottom”. Given that the primary objective of Pillar Two is to target allocation of significant intangible and risk (and related returns) to group entities in low tax jurisdictions, the proposed rules for top-up tax/ minimum tax is a positive factor for countries like India which is largely a capital and technology importing country. 

Implications

Implementation of GloBE rules requires changes to the domestic tax legislation as well as the tax treaties which may be done through bilateral negotiations or amendment to MLI. Therefore, any imbalance or non-coordination with the existing domestic tax rules (particularly those relating to residency, POEM, withholding and credit of taxes) would lead to double taxation which is not the intended objective of the GloBE rules. Because dispute prevention provides far more certainty and cost efficiency to businesses and tax administrations than dispute resolution after the fact, the Blueprint requires mandatory dispute prevention mechanisms to be implemented. Businesses should have access to an effective mechanism to get an advance determination on all the determinations that will be required in applying the new rules. Hence, unless India can adopt an effective mechanism for preventing and resolving disputes under current tax rules – particularly those involving cross-border tax matters – implementing GloBE rules would be a challenge. Businesses also should evaluate the potential impact of these changes on their business models.