OECD’s Pillar One and Pillar Two – impact and way forward

Rasmi Ranjan Das, Joint Secretary, Foreign Tax & Tax Research and Competent Authority for India talks about Pillar One and Pillar Two frameworks and developments made by the OECD.

EY: Multinational companies (MNCs) and stakeholders find Pillar One and Pillar Two Blueprints to be complex and have expressed concern in the public consultation process around double taxation arising from unilateral measures. In this context, what are your views on the overall framework of Pillar One and Pillar Two and the approach in which these issues will be discussed at the Organisation for Economic Co-operation and Development (OECD) level?

Rasmi Ranjan Das: Thank you and EY very much for giving me this opportunity to discuss the ongoing debate on Pillar One and Pillar two. I must clarify that the views expressed herein are my own and do not necessarily represent the views of the Government of India.

Now coming to your question, I have no hesitation in admitting that both blueprints on Pillar One and Pillar Two which seek to provide solutions to the challenges primarily posed by digitalization are not simple documents. However, I must say that any solution that is transformational may look, at least at the first instance, more complex than it is. As Albert Einstein once said, “if at first an idea is not absurd, then there is no hope for it.”

The fundamental problem that is sought to be addressed by the blueprints is that the existing international tax rules which were framed almost 100 years ago rely on a nexus rule based on physical presence and a profit allocation rule based on arm’s length principle. The all-pervasive digitalization of economy has created business models that can operate in a jurisdiction without physical presence. These models have scale without mass and heavily rely on intangible assets which have no observable location. These developments have rendered existing rules ineffective, if not completely obsolete. When you have such fundamental problems, the solution will always challenge the existing paradigm and cannot be an incremental one.

Even before Pillar One’s Unified Approach, the solutions that were initially proposed, i.e., marketing intangible approach, user participation approach, the significant economic presence approach; all rejected the separate entity approach and considered multinational enterprise (MNE) group as one. These solutions, in fact, attempt to align the taxation principles with the reality because an MNE group operates as one entity. But once we consider an MNE group as one taxable unit and seek to adhere to the fundamental principle of corporate taxation, that is, taxation of net income and elimination of double taxation, we are in unfamiliar territory. Therefore, at first instance, Pillar One looks complex. The same applies to Pillar Two as well. Having said that, without sacrificing the integrity of the rules, the Inclusive Framework is committed to making the rules as simple and predictable as possible. Particularly, India, along with other developing countries has always emphasized that the proposed solution to the digitalized economy must be simple so that it is easy to administer and easy to comply with.

This quest for simplicity and the desire to lower the compliance burden informs the design features of Pillar One. The simplicity  is sought to be achieved by refining the scope, laying down the positive list and negative list, having a revenue threshold based nexus, a profit allocation rule based on formulaic approach, reliance on consolidated financial results so that the MNE group does not have to rewrite its accounts, providing a segmentation  safe harbor, and considering a marketing and distribution safe harbor, to name a few. Equally important is the emphasis to provide a robust mechanism for dispute prevention and resolution mechanism. 

Similarly, under Pillar Two, simplification is attempted through consolidated financial accounts, effective tax rates based on Country by Country (CbC) reports, the safe harbor wherein the effective tax rate for one year will be accepted for subsequent multiple years without fresh calculation, a de-minimis profit threshold, concept of low risk jurisdictions, etc.

Still, given the overriding concern over the complexity of the proposal, as is evident from the public consultation inputs that have been received, the Inclusive Framework will be very mindful of those concerns and related suggestions. EY should also provide inputs on how the design can be simplified. We deeply value the inputs provided by EY in response to our request for comments as it is only through such collaborative approach that we can have a solution which shall be easy to administer and comply with.

EY: In the quest for simplicity, do you think the OECD will be more open to considering the United States’ option of safe harbor or is it completely out of the picture?

Rasmi Ranjan Das: Safe harbor is a United States’ proposal, but many of the Inclusive Framework members are not very sure how safe harbor will work. Safe harbor works when a country has taxing rights. For instance, we have taxing rights in transfer pricing and so we can have a safe harbor in transfer pricing.  But, when the country does not have a taxing right, how will safe harbor work? Let us say, we are looking at having taxing rights in respect of a company which operates remotely in my country, it has a certain revenue threshold and thus develops a taxable nexus as per the proposed solution. Unless we rewrite Article 5 or we have another article which over rides Article 5 of the double taxation avoidance agreement then safe harbor may not help. So, we need fundamental changes and those changes must be in the legal framework governing the international tax rules. Preferably, we should   have a multilateral instrument which will override the existing limitations or the existing definition of the nexus rules or profit allocation rules in Article 5 and Article 7 and, to some extent, may be Article 9.Therefore, I am not very sure, how the safe harbor  will work in the absence of legal changes in international tax rules. However, the discussion on safe harbor at the OECD is still on the table and the countries are engaged with USA to understand its position and concerns.

EY: Pillar One Blueprint provides for various thresholds and classification of profits into routine and non-routine before arriving at the share of profits to market jurisdictions. In your view, are some of these proposals likely to be more beneficial or they are likely to create more issues than status quo? What are India's expectations from BEPS 2.0 and more specifically from Pillar One?

Rasmi Ranjan Das: Let me answer the second part of the question first. If the Inclusive Framework fails to agree on a consensus solution, the counterfactual is not encouraging, i.e., there may be unilateral tax measures and negative impact on global growth. So, what I want to emphasize is that, there is no possibility of “status quo” continuing. If we do not have a multilateral solution, we will have more of what people call as unilateral tax measure, I prefer to call them as national tax measures. As Lampedusa said in his work, The Leopard, “If we want things to stay as they are, everything will have to change.” So, things will change, and we have no option but to work towards a solution.

Now, coming to the first part of the question, I think providing thresholds does not complicate the issue but simplifies the issue. Thresholds restrict the number of companies which are required to comply. These are, revenue wise, big MNE group, who have the necessary capacity and resources to comply with the new rules. Similarly, various other thresholds like de-minimis profit threshold and even quantification of routine or non-routine profits which are based on formulaic apportionment, are only going to help in implementation of the law so that we are not talking of a qualitative analysis of the residual profit or the fact and circumstances of the case.

Regarding our expectations from BEPS 2.0, the Unified Approach as on date is not our preferred solution. It is, after all a compromise. We would have been happier if the G24 proposal, where India played a part in its formulation and in piloting it, which is based on significant economic presence and fractional apportionment, would have found a wider acceptance. Anyway, we stay engaged in this compromise solution of Unified Approach because it accepts that the two fundamental problems afflicting the international tax rules i.e., nexus and profit allocation need to be addressed. We hope that a consensus-based solution on the Unified Approach framework shall be fair, equitable, simple and administrable for the 137-member network of Inclusive Framework.

More specifically, we favor a taxable nexus based on a revenue threshold. We are not very excited about the plus factors because in our view it makes things complex. On profit allocation we want a high percentage share, preferably, an escalated approach where the share of profit to be given to the market jurisdiction goes up as the profit margin goes up. There is adequate academic research  to suggest that profits beyond a margin are more due to market failures and mostly  represent monopoly or near monopoly rents and not because of any intrinsic worth of the goods and services provided by a business. We also want a share in deemed routine return, in respect of the remote presence where there is no physical nexus.  Overall, we are interested to have a reallocation of taxing rights under Pillar One that brings meaningful and sustainable revenue for source and market countries. It must also address the concern that several companies perceived to be not paying their fair share of taxes in the source or market jurisdiction, shall pay their share of taxes. I must reemphasize that the aspects of quantum of revenue to be distributed and the new regime being perceived as fair and equitable by major stakeholders are very important. Otherwise, the new regime will not be stable in the medium term and we will soon be back to table discussing BEPS 3.0 and the national tax measures in some form or the other to capture that revenue perceived to belong to market jurisdictions will continue in the meantime. 

Thus, a suboptimal multilateral consensus solution, with both multilateral and individual country measures coexisting, will make things more chaotic.  So, we need to have a solution which is perceived as fair and equitable by at least majority of stakeholders.

EY:  Are the objectives sought to be achieved by OECD aligned with India's policy considerations? In terms of India's economic assessment, how beneficial is Pillar One from expected revenue target, compliance, certainty and administrative standpoint?

Rasmi Ranjan Das: I have already indicated how the new proposals are aligned with India’s policy considerations. This is the proposal which accepts that there is a problem with the existing nexus and the profit allocation rules. This is in accordance with India's position, which we have articulated for years, for instance in our reservation to the OECD model on Article 5 and 7. Further, the reason why it is aligned with our policy objective is that we strongly believe that markets do contribute to profit of an enterprise. And therefore, the jurisdictions that host markets do have a taxing right on part of those profits along with other jurisdictions that host production factors. In fact, as four economists wrote in their famous report in 1923, to the League of Nations, “The oranges upon the trees in California are not acquired wealth until they are picked, not even at that stage until they are packed, and not even at that stage until they are transported to the place where demand exists and until they are put where the consumer can use them. These stages, up to the point where wealth reached fruition, may be shared in by different territorial authorities.” 

So, countries where oranges are harvested, where they were packed and processed and where they were sold all should have taxing rights. The Unified Approach accepts those principles when it recognizes a taxable nexus based on remote sales and a profit distribution formula linked to sales in a jurisdiction. So yes, the Unified Approach is aligned with our policy objective and the direction is in line with our policy goal. Now the question is, it accepts the principle but how far does it go in giving those rights. This is something we will know only when we have the final solution.

Regarding economic assessment, it is always difficult to make a revenue forecast ex ante, particularly when we still have so many moving parts. We do not yet know the exact scope, nor the thresholds nor even the profit allocation percentage. Having said that, intuitively one can say that given the policy rationale and the direction of the proposal, there will be revenue gain for market jurisdictions like us. In addition, we are a fast-growing market and the ratio of sales in India to global sales for an MNE can only increase in coming years. That will be beneficial for us, as the distribution of profit is linked to sales in jurisdiction. But, beyond revenue, we must look at the broader picture, i.e., the benefit of having a modern international tax framework that provides certainty and predictability to all. This is most important to both tax administration and to the taxpayer. So, we hope that the solution will bring sustainable revenue, is fair and equitable and promotes innovation, investment and growth.

EY: Do you think India will continue with unilateral measures like the equalization levy If the expectations on share of market related returns under BEPS Pillar One are not met?

Rasmi Ranjan Das: That is a hypothetical question. For the time being, we in the Inclusive Framework are engaged in finding a consensus-based solution which on implementation should eliminate the rationale to have any national tax measures, whether it is equalization levy, digital service tax, or base erosion and anti-abuse tax or various other forms of national tax measures that have been taken including diverted profits tax, multinational anti avoidance law, etc. We hope that the solution will be such that it will eliminate the reasoning to have those measures.  Finally, however, it is the governments which will take the appropriate policy call in this regard, at the appropriate time, looking at the solution that we finally agree. Hence, at this stage, it is a hypothetical question.

EY: Any insights on the United States’ view on equalization levy?

Rasmi Ranjan Das:  The United States Trade Representative has a published report wherein they have given their   views on equalization levy. We are engaged with them in a discussion. We feel that the equalization levy is not targeted at any country or any business per say given our scope and our threshold and we also feel these are consistent with our international obligations.

EY: Do you believe the inclusion of consumer facing business as in scope for Pillar One would diverge from India's tax policy objective to address complexities notably arising out of digitalization?

Rasmi Ranjan Das: When the debate started, the focus was on those businesses, which due to digitalization can participate in the economic life of a country without an in-country physical presence. So, we had a remote nexus problem which needed to be addressed. And naturally, these businesses normally deal with digital goods or provide digital services. However, some countries felt that the scope should be much wider to cover certain other businesses which supply tangible products or provide on-ground services to consumers. It was felt that under the existing profit allocation system based on arm's length principle, a part of the residual profit which should be getting taxed in the market jurisdiction does not get captured in those jurisdictions. Therefore, there is a case to distribute such profits to those market jurisdictions. That is how the consumer business came as “in-scope”.

I agree that consumer facing business will add to the complexity of the proposal, but many countries feel that the policy goal should be to comprehensively address the problems in digitalization including the limitation of ALP.  This is in line with our own view. We have not accepted new Article 7 to 2010 OECD model and made known our   reservation. Most of the countries including many in the Inclusive Framework, do not accept that arm’s length principle always results in a fair and equitable distribution. That way the UA is also in line with our thinking about limitation of arm’s length principle and I do not see it as a departure from the policy objectives.

EY: One of the arguments in Pillar One is that they do not distinguish between digital companies and consumer facing businesses. Do you believe the Blueprints do bring equality considering that there are certain exclusions for consumer facing businesses that do not apply to a digital business? Is the parity really achieved?

Rasmi Ranjan Das: Most of the documents brought out by the Inclusive Framework highlighted two problems. First, there is a possibility for a business to be involved in the economic life of a country without having a physical presence, i.e., there is a nexus issue. Second, on which all the Inclusive Framework members equally agree is that the arm’s length principle is good, when used to allocate profit or to find out the transaction value in respect of routine transactions i.e., for which comparables are available. But it fails to allocate appropriately the profit, which is the residual profit as they call it, the profit beyond what is allocated for routine functions. These are the two fundamental things on which Inclusive Framework members agree. The second part which says that residual profit cannot be allocated properly under the arm’s length principle is being addressed in respect of consumer facing goods where, even though they already have a physical presence, some additional profit will flow to  the market, because it is believed that under the arm’s length principle, the allocation of profit to the market jurisdiction is less than equitable

The businesses which have been taken out of consumer facing even though apparently they look as consumer facing are those, for instance banking industry, where there is an understanding or acknowledgement that  all the residual profit gets generated and captured because of the regulatory framework that govern banking industry, in the country in which they undertake the business. Hence there is no need for allocating any residual profits, because all the profits that get generated gets captured in those market jurisdictions. However, I accept your point that there may be a case to include all businesses and it may not be fair to target a limited number of consumer-facing businesses. But since this is a 137-member group, it is a compromise solution where most countries agree that digitalized businesses and consumer facing businesses should be covered. Beyond that, for business to business (B2B) model under CFB and other businesses, which are not covered in the scope, there is no agreement yet.

EY - Tax certainty is an essential element of Pillar One and this Blueprint has taken an approach which is based on the number of steps whether it is dispute prevention and the existing Mutual Agreement Procedure (MAP) to new and innovative mandatory binding dispute resolution mechanisms. OECD peer review reports on India MAP process, have acknowledged that the experiences of the peers in handling and resolving MAP cases with India have been generally positive. In this backdrop, is India adequately equipped with controversy management options for dealing with future controversy that may arise on these counts?

Rasmi Ranjan Das - Dispute prevention and dispute resolution in any case is a priority goal for the Indian tax administration. India's efforts in resolution under MAP have received international appreciation. India, along with Japan, has been awarded the first prize in 2020 by the OECD MAP Forum for resolution of transfer pricing MAP cases.

We need to look at dispute prevention and resolution regarding Amount A differently because it is a multilateral profit distribution mechanism, based on an MNE group as a taxable unit and therefore the bilateral MAP process will not work there. It is by nature multilateral, and therefore we require a multilateral dispute settlement system. The Blueprint provides the basic architecture for such a multilateral mechanism - an early certainty process, followed by a review panel and determination panel. I personally feel that the most important thing is to design the rules and to provide early certainty. In the first year, there may be issues about whether some businesses are in scope and how they are computing their consolidated profit or what will be their revenue sourcing rules. But, once that is agreed upon and looked into by the lead tax administration, in the following years it would be much easier to decide on these issues. If we have simplified rules, a review panel and a determination panel, we should be able to resolve t controversies that may arise because of the implementation of Amount A. So, I am hopeful that the system that we are trying to design will answer all questions that may arise in the spectrum of Amount A under Pillar One.

EY – India has had some concerns on certain dispute resolution mechanisms like arbitration. How do you foresee an innovative mandatory binding dispute resolution mechanism?

Rasmi Ranjan Das - India has an in-principle opposition to arbitration as a mechanism to resolve tax disputes. It is based on the principle that taxation is a sovereign function and tax disputes can only be resolved either by statutorily empowered tax officials or by a competent tribunal and court. Now the new innovative binding dispute resolution mechanism under Amount A does not embrace arbitration. It is built around a panel of tax officials and hence is not something which is against our policy position.

EY – India has not implemented controlled foreign corporation (CFC) rules in the past or due to various tax policy considerations. Do you believe similar considerations could have an impact while introducing income inclusion rule (IIR) as per Pillar Two? What are your thoughts on the interplay between the IIR and India’s existing place of effective management rule (POEM)?

Rasmi Ranjan Das - The first part of your question is hypothetical. Introduction of a tax measure is a sovereign policy choice of the government and such decisions are made after a careful consideration of all aspects of the matter. Pillar Two is not going to be a minimum standard i.e., every country is not obliged to impose IIR. It is a policy choice made available to all jurisdictions so that by virtue of an agreement on Pillar Two (as and when reached), any country that wishes to have an IIR can have it in the manner agreed, without any constraints. Therefore, at this stage, what India, or for that matter any country will do is a hypothetical question. Further, the primary purpose of Pillar Two is not to garner revenue, but to ensure that the large profit making MNEs pay certain amount of minimum tax. I would like to believe that once Pillar Two is agreed, tax rates in most low or no tax jurisdictions will come up to at least the minimum rate level. If that happens, imposition of an IIR type of tax may not be very relevant.

On interaction between IIR and PoEM, IIR helps to tax profits of the subsidiary at the parent level. And, rules like POEM are designed to decide the residence of a company. As they operate on completely different levels, I do not see any conflict between the two.

EY - Which element of Pillar Two Blueprint do you think will have a greater relevance for India and why?

Rasmi Ranjan Das – In Pillar Two, as India has always said and which has been echoed by most developing countries, including by G24 of which we are a part, the “subject to tax rule” (STTR) is of critical importance to fight base erosion. The STTR is based on the rationale that a source jurisdiction that has ceded taxing rights in a tax treaty should be able to apply a top up tax, where the income in the hands of the resident is not taxed or taxed at below the minimum rate by the treaty partner. In a sense, it complements the IIR and undertaxed payments rule and is in line with overall policy of Pillar Two. So, yes, more than IIR, we are interested in STTR from a developing country perspective. Where base eroding payments if not taxed at the level of other treaty partner will be taxed by the source country in exercise of its secondary taxing rights and that is important for us.

EY – If the consensus is not achieved, do you expect India to explore the United Nations (UN) proposal of Article 12B or similar extended sourcing rights?

Rasmi Ranjan Das - Let me start by saying that India is a G20 country and it is a G20 mandate to achieve consensus by mid-2021. We are committed to try for that consensus. I am hopeful that we will have some consensus, because so much has been invested by countries over the last three years and the counter-factual of not reaching a solution is not pretty.

On the UN proposed Article 12B, I feel that the problem that we are dealing with is multilateral which   requires a multilateral solution. It is very difficult to implement a multilateral solution through bilateral negotiation of tax treaties as United Nations or for that matter OECD models are meant for. Therefore, multilateral inter-governmental forum like Inclusive Framework is the best place where this can be done.

The other part is, Article 12B appears to be simple and it is simple if you implement it on a gross basis. Some businesses in fact say that they may prefer a small gross basis taxation rather than what they perceive to be extremely complex Pillar One.12B will be helpful if we have such a tax. But once you move to a net-basis taxation  which  majority of the businesses and countries want,  12B has to address all the related problems like group financials, segmentation of in scope business, interaction of consolidated  financial accounts with taxable profits, elimination of double taxation, dispute prevention and resolution  which the Inclusive Framework is currently grappling with. Having said that the UN proposal is now effectively part of the UN model and hence it has got a huge persuasive value for all countries. Whatever be the solution, it will be inevitably compared with the UN proposal and Inclusive Framework solution will be sustainable if it is perceived to be better and more comprehensive solution by most of the countries and stakeholders as compared to UN proposal of Article 12B. So, I see the value in UN proposal of Article 12B as setting a benchmark and providing guidance to countries on how the solution can possibly look like.

EY - How is India gearing up for this change? And in case the BEPS 2.0 proposals get implemented on an as is basis, what are the organizational changes you anticipate including the structural changes, administrative team, strengthening the team and the skills, etc.

Rasmi Ranjan Das - The good thing is that India is part of the rule making process, so we know and will know the nuts and bolts of the solution well in advance. There will be no surprises or lack of clarity for the Indian tax administration. I, therefore, see no problem in implementing the new rules as and when they are finalized. The exact administrative response in terms of structural changes or capacity building will depend on the finer details of the solution which are yet to be agreed upon.

EY - Any final thoughts for our readers on this subject?

Rasmi Ranjan Das - We live in momentous times so far as international taxation is concerned. Pillar One and Pillar Two, whatever be their final shape, are likely to govern the policy space for at least next couple of decades. It is therefore necessary that all stakeholders, including governments, businesses, academia, civil society and professionals should participate and provide their inputs. In that context, the role of professional bodies like yours (EY) is quite important in shaping these discussions. So, I urge all your readers to stay engaged in this discussion and provide us and the Inclusive Framework, with their inputs and suggestions.  We must also note that change is inevitable in international tax rules. It cannot simply be wished away. Therefore, we should prepare ourselves for those changes and look at our processes closely so that when changes do come, we are not found wanting to cope with it. So, to all of us, stay informed.

(This interview with R R Das is basis our interaction with him in February 2021.)