ON the 20 th December, 2021, the OECD came out with its rules for the much touted Global Minimum tax. Having obtained the endorsement of 139 countries (through what means, allurement or threat, I do not know), the OECD has steamed ahead and has now come up with its model rules that will be dutifully followed by the members of the Inclusive Framework to ensure that very, very large multinationals pay at least 15% of tax on their income wherever they operate. This is being claimed as a big victory for the international tax order.

BEPS started as a response to tax minimisation by digital MNCS and the concept of a minimum tax was nowhere on the horizon. Everybody with any common sense knows that it is an American Project to see that its MNCs pay a minimum tax in the USA. The rules are so designed that it is the headquarters jurisdiction that gets the first right to reap the gains from the new system. The OECD, of course, reminds us that the two pillar solution was approved by 137 members of the Inclusive Framework (IF) and that the rules were developed by the members of the IF and adopted by consensus. The wording is such that it is not clear if the rules themselves were developed by the IF or if it was the OECD secretariat that has done the work since it has been put up for public discussion at this stage.

The OECD has issued multiple documents on the occasion - there are the model rules, there is a fact sheet, there is a summary for nit-wits like me - the Pillar two model rules in a nutshell - and there is an FAQ. The rules divided in ten chapters that run 45 pages followed by definitions of another 15 pages. The model rules are like a template that can (read should) be adopted by jurisdictions in their domestic legislation. So, now the OECD is also dictating the domestic legislations of non-member countries. So much for the much vaunted tax sovereignty of nations! The Indian budget will be presented on the 1 st of February. It is possible that some changes suggested by the OECD are incorporated in the Budget to fulfil the new-found zeal of the administration to toe the OECD line.

Having glanced through the jargon-filled rules, it is not clear to me for whom these are meant. If it is meant for the tax administrators, I must confess that much of it is beyond my comprehension. But be prepared for the Western penchant for abbreviations that will be thrown around by 'experts' - the top of which is the top-up tax, ETR, GloBE, IIR, UPTR, STTR and what have you.

The Pillar 2 proposals of the OECD are not compulsory for nations to follow. However, if countries do adopt , the same has to be in accordance with the what the OECD dictates. As I have said many times before, the two pillar solution proposed by the OECD is essentially a transatlantic patch up between the USA and the EU. The developing nations are just sacrificial lambs willingly serving the causes of the erstwhile colonial powers. Having whole-heartedly endorsed the OECD formula, the developing countries have to decide now whether to follow the OECD lead. There are very few, if any, of multinationals of the developing countries that will come within its purview in any case. In the case of India, there may be some large groups that will be in scope. However, it is doubtful if any of these companies park their intangibles in low-tax jurisdictions. That does not mean that the Indian companies are above board. Many of them are quite adept in playing the game and adroitly use tax havens both for evading and avoiding taxes as also for other nefarious objectives. But, it is unlikely that such companies will be within the scope. Of course, countries have the option of choosing a lower threshold also. But, unless it is a problem of large domestic groups hiding money offshore, there is no point in lowering the threshold. Besides, India is not a capital exporting country and it does not even have a CFC rule.

From a revenue gains perspective, the developing countries do not get any significant benefit from the optional provision and need not join in. So, the first dilemma for nations is to decide whether to join the OECD-led proposal for a minimum effective tax rate or not. The only aspect of the Pillar 2 proposal that could be of any revenue gain at all for the developing countries is the one that is known as the subject to tax rule or STTR. The present paper put up by the OECD does not discuss STTR at all and is slated for discussion in 2022 only. In fact, the very reason for the BEPS project, the tax challenges arising out of digitalisation of economies – the original BEPS Action Plan1 that got renamed as Pillar 1 proposal has also not been finalised and has been kicked down the road. So, what the OECD is doing is satisfying its core constituents- the USA and the EU and keep hanging the carrot of some itsy-bitsy tax gains for developing countries to be considered in future. In the meantime, these countries are being coaxed to join in other initiatives. The OECD very astutely got around getting its legitimacy by involving so many developing countries and now is dictating terms to them. It is a bit surprising how the negotiators from all these countries are unable to see through the clever game.

Nevertheless, let us try to decipher what the OECD has come up with. If you go by the summary everything looks very simple. There are just 5 steps involved to attain Nirvana. In step one, one needs to identify the MNC Groups that are within scope and the location of each constituent entity within the Group. The second step involves the determination of the income of each constituent entity; the third step is to determine the taxes attributable to the income of the constituent entity. The fourth steps is the calculation of the effective rate of all constituent entities located in the same jurisdiction and the determination of the top-up tax and finally, the fifth step is the imposition of top-up tax under the income inclusion rule and the undertaxed payment rule and voila, you are through. All of these will have to be done under the domestic tax laws of the countries and the OECD has very helpfully attached the readymade draft as well.

But wait a minute. How does one determine which company or group is in scope? The received wisdom is that an MNC group having annual revenue of 750 million Euros will be in scope. But that is now changed . To be in scope, the annual revenue of the group entities should be 750 million euros in at least two of the four fiscal years immediately preceding the tested fiscal year. And if the fiscal year is for a period other than 12 months,( as used to happen earlier in India before the concept of previous year was changed uniformly to the financial year) the threshold of 750 million would have to be proportionately adjusted. And what happens if there is a corporate restructuring like merger or demerger happens on a particular year. Don't worry, there is whole chapter (6) devoted to that aspect.

All along, the OECD had been preaching the single entity concept that each subsidiary or permanent establishment is a separate entity dealing at arm's length with each other. Now a group concept though well known in the accounting context is being introduced albeit for a limited purpose. So, it becomes necessary to know which entities form part of the MNE group. According to the draft rules, the group means a collection of entities that are related through ownership or control such that the assets, liabilities, income, expenses and cash flows of these entities are included in the consolidated financial statements of the ultimate parent entity , unless these are excluded on grounds of materiality or on the ground that the entity is held for sale (1.2.2) The group concept will also include permanent establishments. Interestingly, in the definition section, there is a meaning given to the term 'permanent establishment' as follows:

(a) a place of business (including a deemed place of business) situated in a jurisdiction and treated as a permanent establishment in accordance with an applicable Tax Treaty in force provided that such jurisdiction taxes the income attributable to it in accordance with a provision similar to Article 7 of the OECD Model Tax Convention on Income and on Capital;

(b) if there is no applicable Tax Treaty in force, a place of business (including a deemed place of business) in respect of which a jurisdiction taxes under its domestic law the income attributable to such place of business on a net basis similar to the manner in which it taxes its own tax residents;

(c) if a jurisdiction has no corporate income tax system, a place of business(including adeemed place of business) situated in that jurisdiction that would be treated as a permanent establishment in accordance with the OECD Model Tax Convention on Income and on Capital provided that such jurisdiction would have had the right to tax the income attributable to it in accordance with Article 7 of that model ; or

(d) a place of business (or a deemed place of business) that is not already described in paragraphs (a) to (c) through which operations are conducted outside the jurisdiction where the Entity is located provided that such jurisdiction exempts the income attributable to such operations

The definition of PE is thus different from the OECD Model and fixed place of business is replaced by place of business including a deemed place of business. Unfortunately, 'deemed place of business' is not further defined.

So, in a common man's language a subsidiary and a PE is part of an MNC group. But, there are various exclusions. All Governmental entities, international organisations, non-profit organisations, pension funds, investment funds being the ultimate parent entity and a new addition- a real estate development vehicle that is the ultimate parent entity, are excluded. However, for the purpose of determination of the group in scope, these are not excluded from the revenue threshold. There are other complications here that we skip for the purpose of this discussion.

Governmental Entity has been defined as an Entity that meets all of the following criteria set out in paragraphs (a) to (d) below:

(a)  it is part of or wholly-owned by a government (including any political subdivision or local authority thereof);

(b)  it has the principal purpose of:

(i)  fulfilling a government function; or

(ii)  managing or investing that government's or jurisdiction's assets through the making and holding of investments, asset management, and related investment activities for the government's or jurisdiction's assets; and does not carry on a trade or business ;

(c) it is accountable to the government on its overall performance, and provides annual information reporting to the government; and

(d) its assets vest in such government upon dissolution and to the extent it distributes net earnings, such net earnings are distributed solely to such government with no portion of its net earnings inuring to the benefit of any private person.

Besides, under certain conditions, if another entity is owned or controlled by these excluded entities to the extent of 95% or 85% of their value, then that entity is also an excluded entity. 'Value' is not defined.

Then follows the equally confusing charging provisions. What one can make out is that it is the ultimate parent entity of an MNE Group, that owns (directly or indirectly) an ownership interest in a low- taxed constituent entity at any time during the Fiscal Year shall pay a tax in an amount equal to its Allocable Shar e of the Top-Up Tax of that low-taxed constituent entity for the fiscal year. This is the famous income inclusion rule.(IIR)

The GLoBE income of each constituent entity is to be determined in accordance with the financial accounting net income or loss taken into account for preparing the consolidated financial statement of the ultimate parent entity. Some items like dividends and gains from shares, net tax expenses, gains on revaluation, if any, prior period errors and due to changes in accounting principles are to be excluded. Interesting to note is that there is a provision for policy disallowed expenses and the example given is that of illegal payments ( bribes). There are complex provisions relating to adjustment of expenses relating to stock options. If transactions between group entities were not recorded at arm's length, necessary adjustments will have to be made. The GLoBE income or loss determined is allocated between a PE and the main entity in line with the local tax rules (whatever that means).

Having determined the income of the constituent entity, the total taxes paid have to be determined as laid down in chapter 4. In the OECD lingo, this is 'covered taxes' and the 'adjusted covered taxes'. Covered taxes will basically mean taxes on income or related taxes. There is an elaborate definition of the same in Article 4.2. The adjusted covered taxes will be current tax expense accrued in the financial accounts with some adjustments to take into account deferred taxes as well.

After completing this exercise, one has to then determine the effective tax rate paid in a particular jurisdiction by the MNC group. So, for this purpose, the adjusted covered taxes determined for each of the entities in a jurisdiction will be aggregated and then divided by the net GLoBe income of all such entities in that jurisdiction. Thus if there are two entities of the MNC group in a particular jurisdiction, one is in a loss another is in a profit, the figure to be taken will be after adjustment of the loss against the profit of the other.

There is also the provision for a substance based exclusion (which is a complex calculation representing an excluded routine return on tangible assets and payroll) from the net GLoBE income. This is important for entities availing any tax incentives. Essentially, this will reduce the GLoBE income by the sum of the payroll carve out and the tangible asset carve out for each entity in a particular jurisdiction excluding investment entities. The payroll carve out is normally equal to 5% of its eligible payroll costs of eligible employees and the tangible asset carve out is 5% of the carrying value of eligible tangible assets located in such jurisdiction. Of course, there are many riders included in rule 5. But, these rates change in case of a transition period of ten years on a sliding scale, starting from calendar year 2023starting with 10% for payroll and then reducing each year by 0.2%. Similarly, for assets, the rates start with 8% in 2023 and then keep sliding by 0.2% each year.

Ultimately, the jurisdictional excess profit which equals the jurisdictional GLoBE income reduced by substance based exclusion will be multiplied by the difference between 15% and the jurisdictional ETR, giving us the jurisdictional top up tax. This will then be further reduced by any qualified domestic minimum top up tax, if any. (The Indian MAT?) The top up tax of a constituent entity will then be determined by applying the formula – Jurisdictional top-up tax multiplied by (GLoBE income of the constituent entity/aggregate GLoBE income of all constituent entities).

That is not all. There will be De Minimis exclusion for jurisdictions where the MNE has either an average GLoBE revenue of less than 10 million Euro or an average GLoBE income or loss of less than 1 million Euro computed on a three-year average basis. There will be further safe harbours apparently to limit compliance burden!

If your head is still not reeling, then read on. The ultimate parent entity of the group is responsible for calculating the top up tax for all the low-taxed constituent entities. There are separate rules for all kinds of scenarios including partially owned Parent entities. If the top up tax is not charged through the income inclusion rule or the income inclusion rule does not fully cover the same, then the under-taxed payment rule (UTPR) will kick in as a back-stop. Article 2.4 deals with the mechanism for the same and I reproduce the same.

"2.4.1 Constituent Entities of an MNE Group located in [insert name of implementing-Jurisdiction] shall be denied a deduction (or required to make an equivalent adjustment under domestic law) in an amount resulting in those Constituent Entities having an additional cash tax expense equal to the UTPR Top-up Tax Amount for the Fiscal Year allocated to that jurisdiction.

2,4.2 The adjustment mentioned in Article 2.4.1 shall apply to the extent possible with respect to the taxable year in which the Fiscal Year ends. If this adjustment is insufficient to produce an additional cash tax expense for this taxable year equal to the UTPR Top-up Tax Amount allocated to [insert name of implementing-Jurisdiction] for the Fiscal Year, the difference shall be carried forward to the extent necessary to the succeeding Fiscal Years and be subject to the adjustment mentioned in Article 2.4.1 to the extent possible for each taxable year.

2.4.3 Article 2.4.1 shall not apply to a Constituent Entity that is an Investment Entity."

Pure gobbledygook! That is not all. The OECD promises to provide us a Commentary on the various provisions in the near future. And then hopefully, the Indian tax administration will happily apply the same. Having taken credit for the current OECD work, it will be difficult to then take a different line. One has to still wait and see what actually transpires. But, let us end with describing how the OECD itself views the gains to the developing countries.

FAQ 2. What are the benefits of the global minimum tax rules for Inclusive Framework members and what will be the impact on developing countries?

"With a minimum effective tax rate of 15%, the GloBE rules are expected to generate around USD 150 billion in additional global tax revenues per year. This includes not only the revenues expected from the application of the rules themselves, but also additional corporate income tax revenues expected from the resulting reduction in profit shifting activity as a consequence of introducing the rules. A jurisdictional effective tax rate of 15% is a big step up from the historically often very low rates on foreign source income of MNEs.

The GloBE rules acknowledge the calls from developing countries for more transparent, mechanical, predictable rules to level the playing field and reduce the incentive for MNEs to shift profits out of developing countries. The GloBE rules are expected to reduce pressure on governments to offer wasteful tax incentives and tax holidays, while still providing a carve-out for certain income that arises from real substance. In addition to this, developing countries are expected to be able to further protect their tax base through the application of a treaty based Subject to Tax Rule (STTR) which will allow countries to retain their taxing right, which they may have otherwise ceded under a tax treaty, on certain payments made to related parties abroad which often pose BEPS risks, such as interest and royalties ."