Analysing the Contours of UN Tax Solution

Taxation of the digitalized economy has been at the forefront of the global taxation discourse. The statement of OECD where 131 countries including India have agreed to support the global framework which outlines a two-pillar solution is a sign that countries are willing to come on the same page and accelerate the reformation of international tax rules. As per the statement, countries have agreed to finalise the framework by October 2021. Similarly, the recently held G20 meeting also advocated for the OECD framework and signed off on global minimum corporate tax. Recent developments validate the stand India and other developing economies have been advocating i.e. increase in allocation of taxation rights to market countries pursuant to increasing digitisation and globalisation.

While the governments have been extensively engaged with the OECD, in April, 2021, the United Nations Committee of Experts on International Cooperation in tax matters approved and added Art 12B to the UN Model Tax Convention in order to provide a solution to the growing taxation issues of the digitalised economy. This provision seeks to tax “automated digital services” specificities of which to be decided through bilateral agreements and amendment to existing tax treaties. The approach of the UN expert committee differs significantly from ongoing deliberations at the OECD and G20 level, which takes into account multilateralism and covers a broader range of businesses.

Prima facie, the solution focuses on bilateral negotiations and is easily understandable, however, there is a need for careful analysis of the provision to evaluate the underlying challenges from a technical and implementational standpoint. Article 12B intends to create new taxing rights for source countries by providing an alternative of gross basis or net basis method of taxation (with certain riders).

A gross-based tax does not account for significant expenditure incurred by an MNE which often leads to excessive taxation and may be suitable for single-source incomes like dividend/interest rather than digital services which involve significant investments. On the other hand, the net-based taxation suggested by the solution may result in administrative difficulties and disproportionate compliance burden for the entities. There is a need for a calculated approach for determining the basis for the allocation of taxes to source countries.

Further, the solution only covers Automated Digital Services and does not apply to the wider set of business models which benefit on account of increasing digitalization and globalisation. As a result, certain business models, though liable to pay taxes, may not come under the scope of this provision’s applicability.

Taxation reforms must offer a structure based on the robust principles of neutrality, certainty, flexibility, and simplicity and withstand the test of time. It is for this reason OECD Pillar one Framework covers large MNEs with certain exclusions. Another aspect that needs examination is that the UN Solution gives the countries a chance to impose a unilateral levy to cover the business model outside the scope of art. 12B in which case, there are bound to be overlaps and uncertainty leading to tax disputes.

Towards this, a white paper authored by The Dialogue and Economic Laws Practice sheds light on the challenges presented by this framework in detail. The paper evaluates Art 12B on the touchstone of technicality and policy standpoint in order to check whether it could survive the growing complexities of the international tax system. Careful scrutiny of the provision suggests that it is better to have a multilateral approach where all the countries are on the same page, irrespective of whether they are developed or developing.

UN tax solution requires bilateral negotiation between countries to agree on parameters such as tax rates, attribution percentage, and scope of qualified profit, resulting in uncertainty and non-uniform tax rates across the globe. Adopting a bilateral procedure would increase the chances of power imbalance, hardships and time consumption, affecting the businesses and the source country. Also “automated digital services” have several aspects, with each of these aspects based or operated in multiple jurisdictions and not just the two nations that are entering into a bilateral arrangement.

The increasing digitalisation in every sector and rapid globalisation where every country’s MNEs may be affected requires that this problem is solved through multilateralism where governments reach a consensus. Keeping in mind the significant efforts made by G20, EU has also put on hold their digital tax framework in order to achieve a global consensus. One may envisage a situation wherein the OECD framework will become a regime adopted by most of the nations, within which few nations may create exceptions through bilateral arrangements through Article 12B route.

The global tax agreement supported by India and other countries is a good step forward towards a multilateral solution and is likely to boost India’s trade negotiations. This is an opportune time for developing countries including India to reap the benefits of the global push and work towards reaching a multilateral solution. Going forward in any other direction may significantly put unnecessary pressure on the international taxation system and might result in increased disputes, trade wars, and deter economic growth.

Disclaimer: The views expressed in this article are those of the author and do not necessarily reflect the views of ET Edge Insights, its management, or its members

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