BEPS 2.0 – Two Pillar Inclusive Framework
Nations across the globe worked on the inclusive framework. On 12 October 2020, OECD issued a blueprint on the two-pillar approach to address the current gaps. In July 2021 approximately 130 nations signified their consent to the approach. Though a lot of work is still pending on how these pillars can be made operational, this article explains the two-pillar inclusive framework approach and its far-reaching consequences for developing nations.
Historical Context & The Two-Pillar Mandate
The current international tax framework is built over rules conceptualised nearly a hundred years ago.1 The business models have evolved over time, and with the advent of internet and consequent digitalisation, avenues have opened up for large Multi-National Enterprises (MNEs) to devise innovative structures for minimising tax liabilities.
Today all functions—from starting a business to selling products/services and repatriating sales proceeds—are digitally managed without any need for physical presence. In 2015, the OECD issued its first set of Base Erosion and Profit Shifting (BEPS) reports, notably Action Plan 1: “Addressing the Tax Challenges of the Digital Economy”. On 12 October 2020, OECD released the two-pillar blueprint, and by July 2021, approximately 130 countries joined the consensus to ensure fair taxing rights.
Pillar One: Re-allocation of Taxing Rights
Applies to roughly the top 100 biggest and most profitable MNEs (revenue > €20bn, PBT > 10%). It re-allocates a share of their non-routine profits to market jurisdictions where goods/services are consumed, replacing traditional physical PE requirements with an economic nexus.
Pillar Two: Global Minimum Tax (15% GMT)
Creates a level playing field by establishing a Global Minimum Tax rate of 15% for MNE groups with annual revenues of at least €750 million. Operates via the Income Inclusion Rule (IIR), Untaxed Payments Rule (UTPR), and Subject to Tax Rule (STTR).
Pillar One Architecture: Amount A & Amount B Mechanics
Pillar One addresses the tax challenges arising from extremely large business groups capable of creating complex multinational structures to avoid or defer taxes under traditional source/residence rules. It introduces two foundational concepts:
Fundamental Principles Underpinning Pillar One:
- Group-Level Taxable Profits: Taxable profits are determined at a consolidated MNE group level rather than separate entity-by-entity accounting, eliminating internal transfer pricing distortions.
- Source State Taxing Rights Without PE: Direct allocation of taxing rights to market states irrespective of physical PE.
- End-Customer Nexus: Sourcing is tied to the location of the end-consumer rather than the payer entity.
- Formulaic Apportionment: Amount A uses formulaic profit-splitting, while other income relies on traditional Transfer Pricing (TP).
- Inbuilt Dispute Prevention: Mandatory binding dispute resolution mechanism (with limited opt-out flexibility for developing countries strictly on TP and PE matters).
Determination of Amount A: Five-Step Allocation Framework
The 5-Step Process to Determine Amount A:
- Determine the size of the business based on the revenue threshold.
- Apply nexus and revenue sourcing rules to identify eligible market countries.
- Determine the consolidated adjusted Profit Before Tax (PBT).
- Allocate Amount A profits to eligible market jurisdictions via formula.
- Eliminate double taxation across participating states.
Activity Test
Business must fall under Automated Digital Services (ADS) (online ads, social media, search engines, OTT content) or Customer Facing Business (CFB). Extractive industries and regulated financial services are excluded.
Dual Threshold Test
MNE must satisfy: (i) Gross revenues > €20 billion (to be reduced to €10bn after 7 years around 2030), AND (ii) Profitability > 10% (PBT/Revenue) in at least 2 of 4 prior periods and on average across the 4 periods.
Quantitative Nexus Thresholds:
- Jurisdictions with GDP > €40 billion: Revenue from jurisdiction must exceed €1 million per annum.
- Jurisdictions with GDP ≤ €40 billion: Revenue from jurisdiction must exceed €250,000 per annum.
Amount B Benchmarking & Mandatory Dispute Resolution
Amount B: Baseline Marketing & Distribution Activities (BMDA)
Amount B seeks to standardize and simplify transfer pricing rules for routine distribution entities. Key features:
- Methodology: The Transactional Net Margin Method (TNMM) is designated as the most appropriate TP method, using net profit indicators like Return on Sales adjusted for geography and industry.
- Preservation of Existing Rulings: Amount B does not override prior Advance Pricing Agreements (APAs) or MAP settlements.
- Unresolved Consensus: No consensus yet exists regarding sales agents or commissionaires whose functional profiles differ from baseline marketing and distribution.
- Capacity Building: Substantially aids developing economies by reducing complex transfer pricing audits and litigation.
Mandatory Dispute Prevention and Resolution Mechanism:
Pillar One mandates an early certainty framework. The lead tax administration (ultimate parent jurisdiction) forms a Review Panel of 6 to 8 interested tax administrations. If consensus fails, a second Determination Panel is constituted, whose decision is binding on all participating states.
Critical Strategic Considerations & Reservations for India
1. Forfeiture of Equalisation Levy (₹ 4,000 Crores):
India currently collects approximately ₹ 4,000 crores annually from its unilateral 2% Equalisation Levy on e-commerce operators. Under the multilateral convention, all unilateral digital taxes must be withdrawn, while revenue accruals under Pillar One remain uncertain and subject to volatility.
2. The Amazon Paradox & 10% Profit Margin Filter:
The 10% global profit threshold is unreasonably high. For example, Amazon—with a market capitalization of $1.7 trillion—failed to meet the 10% profitability test for FY 2021 on a consolidated basis (retail low-margin drag), completely escaping Amount A despite reaping enormous profits from its Indian user base. In years where it exceeds 10% (e.g. 19.6% PBT), only 2.4% of total revenue is pooled across all global market states.
3. Dissent of Developing Countries:
Developing economies including Nigeria, Kenya, Pakistan, and Sri Lanka withdrew from the Inclusive Framework citing inequitable profit distribution that disproportionately favours residence states over consumption nations.
4. 7-Year Review Period Is Unreasonably Protracted:
Waiting 7 years (until 2030) to lower the revenue threshold from €20bn to €10bn is far too distant. Emerging economies like India must negotiate to reduce this review window to 3 years to prevent base erosion.
5. Consolidated Accounting Dilution Risk:
Because Amount A is based on global consolidated financial statements, losses suffered by an MNE in unsuccessful business ventures or unprofitable foreign markets dilute global PBT, reducing India’s tax share even when Indian operations are highly profitable.
Next Steps, Tentative Timelines & Conclusion
Conclusion: While the initiative of bringing certainty to tax challenges in the digital economy is a commendable move, the complexities involved and the determination and allocation of profits to member jurisdictions appear questionable. Given that unilateral measures like Equalisation Levy must be surrendered, it is only fair that India and fellow developing nations ensure robust safeguards so that there is no net loss to the national exchequer.