India And Puzzles Of International Tax: A Tale Of Trendsetter

Pillar One: Question of Permanent establishment

• Significant Economic presence (herein “SEP”)

Indian authorities shock the international taxation arena by expanding the nexus rule with the inclusion of Section 9 (Explanation 2A) of income tax Act 1960 based on BEPS project. When the Wei Cui talks about unilateral measures, it is to be noted that India is in forefront in this with provision of Equalization levy and SEP. The important aspect is that SEP is not applicable to Double Taxation Avoidance Agreement (herein “DTAA”) treaties, which require Permanent Establishment (herein “PE”), strictly in form of physical presence based on S. 90 of the Act where DTAAs are given primacy. India has created a threshold of Rs 2cr (20 million) and user threshold as much as 3 lacs with aim to include as many MNCs as possible and most probably this is going to conflict the Pillar one of OECD, which requires the threshold of Euro 20 billion and profitability above 10%. Certainly, India is not the case of “race to the bottom” but question is will this provision still be applicable when the profit sharing mechanism under OECD Pillar one will be implemented. Will the country already having unilateral measure will be made to give up provisions. Second issue is who is representing developing countries in instrument meant for countries like US and EU. India, who till now acted as leader and impacted its image with SEP. SEP provision gives no consideration to place of residency or business of MNC, whether MNC render services in India or agreement is signed in India. It is important to note that India has comprehensive and limited DTAA Treaties with all major economy and no DTAAs with under-developed and developing countries like Argentina, Afghanistan, Bhutan etc. This provision is majorly going to impact the underdeveloped countries. Hence, this is the reason why cooperation is needed. Even the India (considered as voice of global south) is peculiar on taxation and imposing additional taxes and provision, the voice of other countries who are made to face impartiality need OECD intervention in form of pillars.

Profit Attributable to SEP on Arm's length basis: Another concern is that the entire profit from SEP will be taxable. The major concern is Explanation 2A (b) where the income from advertising or data collecting or downloading software is taxed. This may create a situation where the authorities may insist on taxing indirect profits attributable to SEP in India even if done Arm's length basis. This falls contrary to establish judicial principle (DIT v. Morgan Stanley and Set satellites cases) where it was established that payment of price to PE on arm length basis by non-resident relieves entity from further tax.

• Equalization Levy and DSTs

Wei Cui arguments against cooperation based on US led Trade war is correct when it comes to India as well. OECD in urge to pacify US over Digital Service Taxs (herein “DSTs”) and tariffs has been creating hegemony of US in international taxation whether it is CFCs rules or Tariffs over DSTs or Equalization fees. The unilateral measure of US in form of CFC rules was never contest by parties benefitting from source based taxation with tariffs but DSTs are not only challenged but compromised by supranational organs in form of multilateral agreements. Two things with India's Equalization fees is to be noted that it was levy, not tax and secondly, it was applicable to all whether there are treaties or not. If we see from Indian perspectives, the judicial precedent is clear that tax is levied for common burden and levies for specific benefit based on “Quid pro quo”. It is true that based on population and internet inclusivity, India is a favorable market for MNCs. Domestic industries in India is made to charge platform fees in all digital transaction whether it is swiggy, zomato or rapido. It was never contested on ground on taxing digital economy. Therefore, equalization levies (often called “Google tax”) was meant to charge for services provided in India. Further, in S. 90 of Act and CIT v. Vishakhapatnam trust, court explicitly held that tax levied under finance Act is different from Income Tax Act. It applies uniformly overall and cannot be contested with DTAAs.

Pillar Two: Global minimum Tax

• Subject to Tax Rule (Herein “STTR”)

STTR was implemented with aim a to reduce “double non-taxation”. This is treaty based reform which aims to charge certain intra-companies payment mentioned in OECD as “Covered Payment” with minimum rate of 9%, if taxed below the rate it allows “Top up Tax”. The contention stands on two leg; firstly, uncertainties in covered payment and secondly, definition of services in “covered payment”. From Indian domestic law perspectives, the trouble is Section 194LC, which provide interest payment on home loans as 5% (surcharge and educational cess). From DTAAs perspectives, contention is royalties and technical services fees. Royalties rate and definition keep on vary. Covered payment under STTR include payments for rent or right to use industrial, commercial or scientific equipment and royalities. Court in case of Commissioner of Income Tax vs. M/s Gracemac Corporation, hold that licensing by Microsoft is not taxable as royalties, but it must be noted that licensing is the basic commercial exchange/service in company like Microsoft, which is included in “covered payment” of OECD. In another judgement Engineering Analysis Centre of Excellence Private Limited vs. Commissioner of Income Tax and Anr, demarcated four categories which can be termed royalties or not. This create confusion as to with this varied interpretation. Second is (which is also pointed out by Wei Cui) is what is technical services which is absent in treaties with Philippines or if defined, is below the rate (like in US and France). The example of GATS Mode 3to1 transition by Wei Cui is correct as there is vacuum as to digital service. What is technical services in business totally based on internet eg. Google. Whether the services like training engineers in Indian subsidiary provided by US based professional in data coding will be covered in GATS Mode 1 (based on internet) or 3 (based on services).

• Globe Rules

Although India Tax above the 15%, it can certainly affect India Gujarat International Finance Tech-City (GIFT) program established in 2015, where the government provided tax holiday and various other incentives which could bring the in sphere of top up tax. Although, provision of substance based Income Exclusion Rule provided exemption to capital extensive business (exemption based on tangible assets and payroll cost). The issue is important from perspectives of International Financial services center which occasionally have limited employees.

India is forefront runner in the Pillar two implementation. However, it cannot be denied that unilateral measures like SEP and EL are challenged in international area. The major concern is dispute resolution providing arbitration. Arbitration as dispute resolution mechanism can impact India as India considered this as sovereign function and neglects arbitration in such cases Further, the purpose of this instruments is questioned as all International cooperation are basically for benefits of developing or underdeveloped countries (eg. Paris Summit), but OECD pillars are for fulfillment of wishes of Developed countries (US and Europe). Hence, what developing countries gains from this is still limited and in some cases, devastating (tax haven mostly developing countries). US intervention on Equalization levy shows the imbalance in power sharing in model. It also impacts the incentives based program in India which is not only for MNCs but important for people where unemployment is rising (case with most of underdeveloped countries). Hence, before implementation, image cleaning where OECD provides equal status for developed and developing countries is needed because this impact the underdeveloped countries more.

The author is a post graduate in Law from National Law University Delhi (India). Views are personal.

References

Cui, Wei, New Puzzles in International Tax Agreements, 75(2) Tax Law Review 201-269 (October 12, 2021).

Chand, Vikram and Turina, Alessandro and Romanovska, Kinga, Tax Treaty Obstacles in Implementing the Pillar Two Global Minimum Tax Rules and a Possible Solution for Eliminating the various challenges (November 19, 2021).

Tandon, Suranjali; Rao, Chetan, Evaluating the impact of Pillars One and Two, Research Paper, No. 165, South Centre, Geneva (2022).

Noonan, Chris and Plekhanova, Victoria, Compliance Challenges of the BEPS Two-Pillar Solution, British Tax Review, Issue 5 (December 16, 2022).

Karanjot Singh Khurana, S Vasudevan, “Significant economic presence in Indian tax law: How significant will it be?” ITR online, (June 29, 2021).