IN the beginning of 2019, the OECD had released a programme of work relating to taxation of digitalized economy that apparently rested on two pillars- pillar one was supposed to address the issue of allocation of taxing rights amongst countries in respect of the profits of multinationals arising out of cross-border transactions while pillar 2 was supposed to address the profit shifting issues that still remain to be resolved. Both of these were to be done by the so-called Inclusive Framework of more than 130 jurisdictions that are supposed to be working on an 'equal footing'. The list of jurisdictions keeps expanding. However, if one glances through the names of the countries/jurisdictions -almost 50 of them are known tax havens and many are UK satellites- number two country in the alphabetical list is Andorra, number 4 is Antigua and so on. Many of these jurisdictions are not even sovereign nations and, in fact, are contributors much of the problems relating to BEPS. Since most of them do not charge tax at least corporate tax, their interests are almost always aligned with the interests of the capital exporting countries and no one expects these jurisdictions to have expertise in the complex corporate tax structures. So, their inclusion in the framework seems deliberate and political.

Sensing that the discussions were stuck both as a result of the complexity of the issues formulated by the OECD Secretariat as also because of the differing interests of the negotiating parties, the Secretariat released a programme of work at the end of May 2019 detailing the proposals. We have previously seen the pillar one proposal.

The pillar 2 proposal was put in place by the OECD under pressure from the USA that had adopted a global minimum tax in its tax laws in respect of intangible heavy multinationals who would park their intangibles in tax havens and reap the benefit of such intangibles in the form of tax-free royalties and such incomes from not only the USA but also from other countries in the world. The USA considers these incomes stashed by its companies abroad as legitimately belonging to the USA but ignores the fact that these companies have been systematically stripping off income from other market jurisdictions. The Global intangible low-taxed income (GILTI) adopted by the USA in its tax reforms of 2017 is targeted towards the shareholders of controlled companies of US multinationals. The pillar2 proposal of the OECD is a modified version of the same and becomes Global Anti-Base Erosion (GLoBE) in the OECD version.

Although the proposal is essentially from the USA, the OECD Secretariat has put a nice veneer on it in the name of helping developing countries and it may be necessary to examine the justification in some details as given in the Programme of Work that was released in May, 2019 and it will be instructive to recapitulate the same.

OECD had already come up with 14 Action points under its BEPS project that was touted to have aligned taxation with value creation and closed gaps in the international tax architecture that allowed for double non-taxation. Nevertheless, certain members (read the USA) considered that these measures do not provide a comprehensive solution to the risk that arises from structures that shift profit to entities subject to no or very low taxation. These members were of the view that profit shifting is particularly acute in connection with profits relating to intangibles, prevalent in the digital economy, but also in a broader context; in, for instance, group entities that are financed with equity capital and generate profits, from intra-group financing or similar activities, that are subject to no or low taxes in the jurisdictions where those entities are established.

The essence of the Pillar 2 proposal is to have a global minimum tax on certain incomes of the multinationals. The minimum rate is to be decided by the Inclusive Framework but, according to some press reports, it seems to have already been decided by the Secretariat at 12.5% that is the corporate tax rate in Ireland. So, under the income inclusion rule, the income of a controlled entity of the MNC would be included for taxation if it were taxed at a rate below say 12.5%. Simultaneously, an under taxed payments rule would deny deduction for payment to a related party or allow levy of withholding tax by the source countries. A switch over rule is also proposed whereby treaties would be amended to allow the residence countries to adopt credit method instead of exemption method in respect of profits attributable to a PE or income derived from immovable properties, which are subject to tax at a rate below the minimum rate. It may be noted that some capital exporting countries give relief from double taxation by exempting the income of a company from its foreign PE in order to encourage their companies to invest abroad. Further a subject to tax rule would subject a payment (say for royalties) to withholding and adjust the eligibility of treaty benefits on items of income not subject to tax at a minimum rate.

The GLoBE proposal is based on the premise that in the absence of multilateral action, there is a risk of uncoordinated, unilateral action, (read digital service taxes being levied by countries like Italy, France etc.) both to attract more tax base and to protect existing tax base, with adverse consequences for all countries. There are many complicated elements of the proposal. For example, the determination of the tax base itself may be a problem- which financial accounts to follow, what accounting standards to follow, what happens to losses and blending of losses of various subsidiaries of the group. The programme of work also talked of carve outs, most importantly in the mining sector.

Besides, one question for which there is no satisfactory answer as yet is the relationship between the Pillar 1 proposals and those relating to Pillar 2. If pillar1 is to be on consensus basis for all countries, why Pillar 2 should not require consensus? Apart from the very technical nature of the proposals and the difficulty in understanding the various nuances and the interests that are represented at the OECD, the work is inherently political in nature. All taxes involve politics and such a ground-shaking proposal whereunder the century old rules for international taxation is being proposed to be changed- particularly the adoption of unitary approach at least partially in the international tax architecture, is bound to have political impact, - different interests are bound to clash and while discussions are still ongoing, one wonders whether, like the earlier OECD attempt relating to harmful tax practices, the present efforts will also flounder under political pressure. As for developing countries, quite apart from the complexities, there are also other concerns. In this connection, one particular paragraph from the programme of work relating to Pillar 2 relating to a global minimum tax proposal needs careful consideration.

"It posits that global action is needed to stop a harmful race to the bottom, which otherwise risks shifting taxes to fund public goods onto less mobile bases including labour and consumption, effectively undermining the tax sovereignty of nations and their elected legislators. It maintains that developing countries, in particular those with smaller markets may also lose in such a race. Over recent decades, tax incentives have become more widespread in developing countries as they seek to compete to attract and retain foreign direct investment. Some studies have found that, in developing countries, tax incentives may be redundant in attracting investment. Revenue forgone from tax incentives can also reduce opportunities for much-needed public spending on infrastructure, public services or social support, and may hamper developing country efforts to mobilise domestic resources. There is evidence that tax incentives are frequently provided in developing countries in circumstances where governments are confronted with pressures from businesses to grant them. Depending on its ultimate design, the GloBE proposal could effectively shield developing countries from the pressure to offer inefficient incentives and in doing so help them in better mobilising domestic resources by ensuring that they will be able to effectively tax returns on investment made in their countries. The proposal therefore seeks to advance a multilateral framework to achieve a balanced outcome which limits the distortive impact of direct taxes on investment and business location decisions. The proposal is also intended as a backstop to Pillar One for situations where the relevant profit is booked in a tax rate environment below the minimum rate." (Emphasis added)

There are implications for the global multinationals and the developed countries as we shall discuss later. But what is surprising that members of the inclusive framework actually endorsed such a view? For a country like India, the government is indeed trying to phase out incentives and it may indeed be beneficial for the government revenue as is apparent from the tax foregone statements currently found in our budget documents, From a revenue standpoint, tax incentives are indeed problematic. Nevertheless, there are many proponents of such incentives as well. Therefore, governments should have the sovereign power to decide whether to give incentives or not, depending on the particular economic situations. There may indeed be circumstances where tax incentives may be necessary. Setting tax rates, giving incentives are at the core of the sovereign functions of a government and one is really surprised that, apart from some civil society organisations, no one from the developing countries put up any meaningful resistance at the stage of the adoption of the programme of work by the G-20.

Powerful lobby groups successfully scuttled the OECD's Action Plan on digital economy with the clever argument that when the entire world economy was digitalized, any action against particular digital companies was not justifiable. However, consistent with that argument, it would be apparent that the scope of the anti-base erosion proposal could not be limited to highly digitalised businesses. The Pillar 2 proposal therefore proposed a systematic solution designed to ensure that all internationally operating businesses pay a minimum level of tax. In so doing, it helps to address the remaining BEPS challenges linked to the digitalising economy, where the relative importance of intangible assets as profit drivers makes highly digitalised business often ideally placed to avail themselves of profit shifting planning structures.

To put a gloss over the proposal it was framed in such a way that left countries to choose their own corporate tax rate and to decide whether to tax or not to tax but those countries that charged corporate tax would have the right to apply various counter measures in cases where income was to be taxed below a minimum rate.

Now, the entire proposal seems to come unstuck- not from any opposition from the developing countries that have plenty to oppose but from the most important country- the USA. The US involvement with the BEPS project has been peculiar. It was the driving force behind scuttling many of the proposals and its representatives at the OECD working groups and the TFDE cajoled and coerced others to either to change path or follow its preferred course. Most of the representations and public consultation documents also came form the numerous US interest groups. But many observers felt that the US will not agree to anything that is against its domestic legislation. Thus, has now come true with the US Treasury Secretary writing a letter to the OECD Secretary General on the 3rd of December, 2019 as follows:

" Dear …

The United States supports the discussion at the OECD to address the issues faced by the international tax system.

We believe that it is very important that these talks reach agreement in order to prevent the proliferation of unilateral measures, like digital service taxes, which threaten the longstanding multilateral consensus on international taxation. The United States firmly opposes digital service taxes because they have a discriminatory impact on US-based businesses and are not consistent with the architecture of current international tax rules, which seek to tax net income rather than gross revenues.

For any new multilateral agreement to become effective, it will need to be implemented through amendments to tax treaties and/ or through domestic legislation, which in turn will require broad support. Based on extensive consultations with taxpayers, we have concluded that there is broad support for greater tax certainty and administrability. However, we have serious concerns regarding potential mandatory departures from arm's length transfer-pricing and taxable nexus standard s- longstanding pillars of the international tax system upon which U.S. taxpayers rely. Nevertheless, we believe that taxpayer concerns could be addressed and the goals of Pillar 1 could be substantially achieved by making Pillar 1 a safe-harbor regime. The Unites States also supports a GILTI-like Pillar 2 solution. We look forward to working with the OECD along these lines, building on the wok already done.

We urge all countries to suspend digital services tax initiatives, in order to allow the OECD to successfully reach a multilateral agreement.(…)" ( Emphasis added)

The US is wrong. There is no international tax system and there is no consensus on current allocation of taxing rules and also for the use of the arm's length standard. The USA itself and its allies mostly adopted and developed these. Developing countries had no role in their developments and have been consistently opposing these long before the BEPS project started. It is also ironic that the USA is now so vehemently opposing the digital service tax. In the initial deliberations, on Action 1, it was the US representatives that reportedly suggested a small excise tax on gross revenues, which later got translated into equalisation levy. The Pillar 2 proposals again apparently started from the US delegates.

Therefore, the rather unusually swift reaction from the OECD perhaps reflects the frustration with the vacillating US stands. The US Secretary General wrote back to the US Treasury Secretary on the next day, December 4, 2019 itself.

"Dear …

Thank you for your letter of 3 December and in particular your strong support for the OECD discussions and a multilateral agreement on digital taxation. We fully share your sense that the international tax system is under intense strain and that a global solution is needed to stop a proliferation of unilateral measures and to help us return to a stable international tax system that avoids double taxation and taxes net rather than gross income.

Let me also thank you personally for your involvement over the last 2 years in moving us forward in this process. To a large degree, it was the US tax reform that set the framework conditions within which we have advanced. It was also your personal involvement as well as that of your delegates that steered the international community away from seeking a narrow digital solution and introduced innovative proposals into the discussions. And it was also your personal interventions at G20 meetings that moved the discussions to a broader scope using a more formulaic approach and a new nexus concept that moved us beyond the tax rules as they currently stand.

We have already held two public consultations attended by stakeholders from around the world and like you, while noting broad support for existing rules, clearly identified the need for greater tax certainty and administrability. This is why the OECD proposal on a "Unified Approach" contains a very strong tax certainty dimension. Without it, there would be no conditions for achieving a consensus.

Throughout the extensive consultation process, however, we had so far not come across the notion that Pillar 1 could be a safe-harbour regime. We raise this concern, as it may impact the ability of the 135 countries that are now participating in this process, to move forward within the tight deadlines we established collectively in the Inclusive Forum. (…)"

So, the OECD has finally called the bluff of the USA. The Secretary General has invited the Treasury Secretary to visit France before Christmas for discussion. It is unlikely that the USA will oblige and we will be stuck with the extant transfer pricing rules and the distribution of the tax pie of the multinationals bringing to nought years of efforts. At the same time, it is unlikely that the tax systems of other countries will be back to the pre-BEPS position.