Taxing Digital Economy

Taxing Digital Economy

Subject: Economy

Section: Fiscal Policy

Why in the news?

Over the past four years, 137 countries have engaged intensively with the OECD to find a solution to the tax challenges arising from digitalisation.

Issue?

Inter jurisdiction operation-The unique features of the digital economy—firms can operate seamlessly across borders and users and their data contribute to their profits—made it harder to tax such an economy.

The Global Minimum Tax?

The Organization for Economic Co-operation and Development (OECD) finalized a landmark agreement to subject multinational enterprises (MNEs) to a minimum 15% tax from 2023.

• The global minimum tax rate would apply to overseas profits of multinational firms with 750 million euros ($868 million) in sales globally. Governments could still set whatever local corporate tax rate they want, but if companies pay lower rates in a particular country, their home governments could “top up” their taxes to the 15% minimum, eliminating the advantage of shifting profits.
• A second track of the overhaul would allow countries where revenues are earned to tax 25% of the largest multinationals’ so-called excess profit – defined as profit in excess of 10% of revenue.

Following years of intensive negotiations to bring the international tax system into the 21st century, 136 jurisdictions (out of the 140 members of the OECD/G20 Inclusive Framework on BEPS) joined the Statement on the Two-Pillar Solution to Address the Tax Challenges Arising from the Digitalisation of the Economy:

• Pillar One- taxing rights on more than USD 125 billion of profit are expected to be reallocated to market jurisdictions each year. Developing country revenue gains are expected to be greater than those in more advanced economies, as a proportion of existing revenues.
• Pillar Two- introduces a global minimum corporate tax rate set at 15%.  The new minimum tax rate will apply to companies with revenue above EUR 750 million and is estimated to generate around USD 150 billion in additional global tax revenues annually. Further benefits will also arise from the stabilisation of the international tax system and the increased tax certainty for taxpayers and tax administrations.

Recent development :

The Pillar Two model rules provide governments a precise template for taking forwards the two-pillar solution to address the tax challenges arising from digitalisation and globalization of the economy agreed in October 2021 by 137 countries and jurisdictions under the OECD/G20 Inclusive Framework on BEPS.

The rules create a “top-up tax” to be applied on profits in any jurisdiction whenever the effective tax rate, determined on a jurisdictional basis, is below the minimum 15% rate.

The new Pillar Two model rules will assist countries to bring the GloBE rules into domestic legislation in 2022. They provide for a coordinated system of interlocking rules that:

• define the MNEs within the scope of the minimum tax;
• set out a mechanism for calculating an MNE’s effective tax rate on a jurisdictional basis, and for determining the amount of top-up tax payable under the rules; and
• impose the top-up tax on a member of the MNE group in accordance with an agreed rule order.

The Pillar Two model rules also address the treatment of acquisitions and disposals of group members and include specific rules to deal with particular holding structures and tax neutrality regimes. Finally, the rules address administrative aspects, including information filing requirements, and provide for transitional rules for MNEs that become subject to the global minimum tax.

Impact?

The OECD, which has steered the negotiations, estimates the minimum tax will generate $150 billion in additional global tax revenues annually.

Taxing rights on more than $125 billion of profit will be additionally shifted to the countries where they are earned from the low tax countries where they are currently booked.