Digitisation of Economies — the changing tax order and the impact of two-pillar approach

Out of the 143 member states of the Inclusive Framework at present, 51 of the member states are classified as developing countries, i.e. non-G20, non-OECD and non-financial centres. As per OECD’s October 2021 report on “Developing Countries and the OECD/G20 Inclusive Framework on BEPS”, developing country participants in the Task Force on the Digital Economy went up from 34 percent of the total attendees in 2019 to 38 percent in 2020.

However, it was also reported that financial and human resource constraints faced by developing countries significantly affect their capacity to attend and actively engage in Inclusive Framework discussions.

Following the recommendations identified in the 2021 Report, the Inclusive Framework has made significant governance reforms to increase inclusivity. In March 2022, the Inclusive Framework announced the election of Marlene Nembhard-Parker of Jamaica as its inaugural co-chair to help amplify the voices of developing countries.

Developing countries have had a significant influence on the Two-Pillar agreement. Commitment to reduce the scope threshold of Amount A in 7 years from implementation, reduced nexus threshold of EUR 250,000 for low-GDP countries as compared to EUR 1 million for others are measures included to provide level-playing field for developing countries.

The Two-Pillar model rules are designed to ensure large multinational enterprises (MNEs) pay a minimum level of tax on the income arising in each jurisdiction where they operate. While, under Pillar One, taxing rights on more than USD 125 billion of profit are expected to be reallocated to market jurisdictions each year.

Amount B of Pillar One has been developed to provide a simplified, streamlined approach, with a particular focus on the needs of low capacity countries, to the application of transfer pricing rules to certain arrangements that are very often the subject of tax disputes. Under Pillar Two, the guaranteed availability of the Subject-to-tax rule (STTR) to developing nations has been ensured.

The 2022 Report (on Developing Countries) stated that developing countries will focus their engagement in ongoing negotiations to implement the Two-Pillar Solution in areas where they anticipate the best Domestic Resource Mobilisation return, such as Amount B and the STTR.

On Amount A, developing countries indicated that their highest priorities include understanding the estimated impact of the measures on their tax revenues.

Concerns of Developing Nations
Despite the accommodations made specifically for developing countries in the two-pillar solution there are certain issues to be considered before adopting the solution.

Certain member states of the Inclusive Framework anticipate that the adoption of Amount A would impact their tax revenue adversely. Some of these states have already adopted DST as suggested by BEPS Action Plan 1.

For example: Nigeria, which is one of the four states which have not agreed to the October 2021 Statement (other three being Pakistan, Kenya and Sri Lanka), introduced vide its Finance Act 2021, a 6 percent digital service tax on non-resident companies. The companies would fall-in scope if their gross turnover derived from Nigeria is more than N25 million (~USD 34,000) as compared to EUR 1 Mn proposed by Amount A.

Even in countries such as India, where the digital penetration is high, there are concerns about loss of tax-revenue due to discontinuity of DSTs, as equalisation levy applies on the gross consideration paid to MNEs without any threshold for scope, whereas only a part of residual profits from Amount A is allocated to India. This might be one of the reasons why India proposed for higher share of taxes in the recently concluded G20 Summit at New Delhi.

This being the case, underdeveloped countries in Africa, where digital penetration is much lower, may find Amount A to be less resourceful than DSTs.

Other African countries that have imposed some form of taxes on digital services provided by non-resident companies include Zimbabwe (5%), Tunisia (3%), and Tanzania (2%); Sierra Leone and Kenya have DST of 1.5 percent. The latest is Uganda, which proposed a DST of 5 percent to take effect in July 2023.

The likely impact of the GloBE rules and its impact on existing policies and tax incentives are being assessed by various developing countries in order to ensure that the implementation of the GloBE rules do not make them globally uncompetitive.

Developing countries which have corporate tax rates less than 15 percent to attract foreign direct investment may have to provide tax incentives to MNEs to remain globally competitive. MNEs which add significant value to developing countries may demand tax reforms from the government to nullify the impact of Globe Rules.

For example: Samsung, which produces 50 per cent of its smartphones in Vietnam and contributes to one fifth of the nation’s total exports, has requested for a multi-million dollar tax reform to compensate for the increased tax rates. Similar requests were made to the Vietnamese government by LG, Intel and Bosch. Consequently, Vietnam has proposed a bill for offering after-tax cash incentives or refundable tax credits to yield to the requests of these large corporations. Similarly, certain developing nations, predominantly from the global south, may have to yield to the requests of large MNEs to maintain their competitiveness. Therefore the design of tax incentives will require careful reassessment in a post-Pillar Two environment.

The increase in tax revenues owing to implementation of two-pillar approach may not add-up to a greater fiscal position for Global South due to the above-mentioned reasons.
Source: CNBCTV18