[By Khushbu Mathuria]
The author is a student of Rajiv Gandhi National University of Law, Patiala.
Introduction
With the incoming of the Trump administration, the US has withdrawn from the Global Tax Deal via a presidential memorandum issued on January 20, 2025. The memorandum states that the Global Tax deal (“The Deal”) signed in 2021 under the Biden administration has no force or effect in the US. It further stated that the US shall take “protective measures” against countries who are in non-compliance with any tax treaty with the US or in compliance with any extraterritorial tax rules that disproportionately affect American companies. As nations are adjusting to the sudden political shift, the future of the tax deal necessitates navigation of both domestic and international interest amidst the rising tensions and trade conflicts. The article delves into how this withdrawal not only disrupts the progress made so far but also prompts various countries to reconsider their commitment to the deal and to reinstate unilateral measures, in response to the perceived inequalities..
OECD’s Two-Pillar Approach to Global Tax
The Global Tax Deal is a multilateral agreement, signed by over 137 countries on October 8, 2021,to bring a global shift in the traditional approach of the taxation system and to further the aim of Base Erosion and Profit Shifting (“BEPS”) via a two-pillar approach. This two-pronged solution aimed to prevent a race to the bottom in corporate tax rates. However, despite this concerted attempt, after almost three years, the deal is thrown off course in the midst of a political maelstrom. The Deal has two Pillars:
The Pillar One undertakes reallocation of taxing rights for market jurisdiction over the excess profits underscored by Multinational Enterprises (“MNEs”) and large companies. The implementation of Pillar One involves the application of Amount A and Amount B. Amount A compliance involves a set of rules applicable to MNEs with a global revenue over USD 20 billion and total profits exceeding 10% of their global revenue subject to certain exclusions, reallocating 25% of the excess profit to market jurisdictions. Amount B on the other hand is a three-step analysis to price baseline marketing and distribution activities to further simplify the application of arm’s length principle via delivering a pricing matrix.
Pillar Two of the framework, introduces a framework for a global minimum tax of 15% for MNEs groups with the annual revenue higher than € 750 million. The underlying intent is to ensure that all streams of income within such MNE groups, regardless of the jurisdiction, either source or resident are taxed at the minimum rate of 15%. In this respect, OECD through the course of 2022 released draft provisions for the Pillar Two Global Base Erosion Rules (“GloBE Rules”), a commentary, and a set of illustrative examples to clarify the working of the rules.
The GloBE rules include the Income Inclusion Rule (“IIR”), which imposes a Qualified Domestic Minimum Top-up Tax on a main enterprise or the parent entity of an MNE group for income earned by its subsidiaries and Permanent Establishments (“PE”), that are taxed below a 15% minimum effective tax rate (“ETR”) in source jurisdictions. The taxing right under the IIR is offered first to the jurisdiction of the ultimate parent entity and, if unexercised by it, shifts to the jurisdiction of the next downstream entity. The Under-taxed profit rule complements the IIR by denying deductions or requiring adjustments if the top-up tax is not applied to low-taxed constituent entities. A de minimis threshold excludes jurisdictions with turnover below €10 million and profits below €1 million, and investment funds and Real Estate Investment Trusts are outside the scope of GloBE. These rules require integration into domestic tax systems for effective implementation.
The third rule, i.e., the Subject to Tax Rule (“STTR”) is a treaty-based provision that applies to related-party payments, such as interest and royalties, when they are not subject to a combined 9% ETR across both the resident and source jurisdictions. Unlike the GloBE rules, the STTR prioritizes the taxation rights of the market jurisdiction. Additionally, the IIR functions as a complimentary measure under Pillar Two enabling market jurisdictions to tax payments that might otherwise go untaxed in both the source and recipient jurisdictions.
Unilateral Measures, Trade Tensions and Global Hurdles in Implementation
The two-pillar framework was introduced as a multilateral solution for taxation of MNEs who derived profits in countries without having a PE. While the OECD was attempting to formulate a global solution, prior to 2021, when the global consensus was not in sight, countries had already started taking independent measures by implementing what we refer to as a Digital Service Tax (“DST”). Indian for Instance, implemented a 2% Equalization levy (“EL”) in 2020, on companies who had a significant economic presence. As a result of the DST and EL, which the US claimed, disproportionately targeted US based companies, the USTR initiated investigations under Section 301 of the Trade Act of 1974 and started imposing retaliatory tariffs on imports from Austria, France, Italy, Spain, Turkey, United Kingdom, and India.
However, in 2021 pursuant to the ongoing discussions of the OECD framework, the US under the Biden Administration suspended such proceedings for 180 days. Subsequently, in October 2021, 136 IF members reached an agreement on the two-pillar approach and issued a joint statement under which Austria, France, Italy, Spain, the United Kingdom and the US compromised to take back DSTs and other relevant unilateral measures. Pursuant to the Joint statement, Ministry of Finance, India issued a Statement (“MoF Statement”) that excess EL paid by MNEs will be available as a credit for set off against their corporate liability determined under Pillar One. This transitional approach came in the backdrop of dropping off of retaliatory measures by the US. Following this, in 2024, India completely did away with the 2% EL. As a consensus, most countries with DSTs agreed to a moratorium pursuant to the negotiations of Pillar One.
Despite their efforts, the OECD’s Pillar One framework faces criticism from experts and organisations like the African Tax Administrative Forum for its complexity, particularly in revenue sourcing, requiring further clarity and capacity building. Disagreements over DST withdrawal and withholding tax treatment still remain a contentious issue. While there was some progress, the US withdrawal and retaliation has brought this to a chokehold and these concerns have further compounded with the already existing drawbacks of Pillar One, discouraging countries from moving forward with its implementation and making them reconsider their commitment to the GloBE framework.
From a regulatory point of view, as a result of the withdrawal and the stagnated drafting, countries have already started proposing economic measures to protect their revenues. France for instance, in order to revive their budget deficit, has already suggested an amendment increasing the DST rate from 3% to 5%, which is to be reviewed by the full assembly later this year. In addition, disappointed by the sluggish state of OECD discussions, Italy has approved the withdrawal of one of the two thresholds for its 3% DST, bringing more MNEs under its ambit. Given this trend of reinstating and exacerbating unilateral domestic measures coupled with the threat of retaliatory trade tariff from the US, we have come full circle and are back where we began, raising the true possibility of a trade war.
With respect to Pillar Two, many European countries are actively implementing. Countries such as France, Germany, Ireland, Italy, Spain and the United Kingdom already have enacted the legislations and the final law is in force. The Asia-pacific has exhibited different levels of commitment and progress towards the implementation. Australia, Japan, Malaysia and Vietnam have the final law in force. Hong Kong SAR has published the draft laws for IIR and QDMTT to be in effect from January 1, 2025. Since a significant lot has already put the framework into effect, US’s withdrawal has resulted in a patchy approach to the global tax reform.
India’s Tax Strategy: Navigating Uncertainty in the Digital Tax Landscape
Amid rising trade tensions with the US and to align with the global tax reforms, India abolished the 2% equalization levy for overseas entities. This move was also aimed at addressing various domestic concerns, such as promoting Foreign investments, boosting investor confidence and ensuring a more favorable business environment. As far as the Indian scenario is concerned, while the 2% equalization levy was scrapped off in 2024 for overseas entities,.
It is to be kept in mind that scrapping the EL does not mark the end of digital taxes. While the proposal to abolish the DST has been introduced via amendments to the Finance Bill, 2025, the fact remains that entities which have a PE in India and are deriving profits from online advertising services, are still liable to pay tax at the rate of 6%. In addition, entities which have a significant economic presence continue to be taxed under the domestic tax framework.
At present, the elephant in the room is whether India in compliance with the trend, will reinstate EL as a measure to protect the revenue it is losing. As far as Pillar Two is concerned, a number of market jurisdictions already have their ETR for corporate entities above the 15% limit, as also in the case of India. In such a scenario, the impact is expected to be revenue neutral and the primary benefit would flow from STTR which is a matter of bilateral negotiation between countries. This puts India in a difficult spot as India’s potential move on the EL could intersect with these international tax negotiations at a geo-political level.
Way forward: Aligning Global Reforms and Domestic Interests
The withdrawal of US marks a significant turning point in international taxation, with far-reaching implications both globally and individually. While the deal aimed to create a more equitable and unified global framework, the disruption caused by political action has threatened to undermine the collective effort.
For India, the challenge lies in balancing its domestic interests with political commitments. On the bright side, by keeping a wait and watch approach for Pillar Two, India has played its cards right. While countries who are moving towards implementing Pillar Two will be facing significant hurdles, India can take its time to carefully plan out its next move and devise a suitable policy keeping its sovereign interest in mind. The next 60-90 days will be significant for the US as well, as they will be decisive of how they handle the intricacies of the global defiance with the GILTI framework in place.
India’s decision would depend on assessing whether the implementation would yield potential revenue that outweighs the significant changes needed to the existing tax infrastructure and compliance mechanisms. Since the authorities have issued no comments, India is likely to postpone any further actions related to implementing the GloBE provisions until the uncertainty is resolved and there are clear indications of substantial benefits.