Jayanti Dhingra
Abstract: This article argues on the subtle complexity arising between the Double Taxation Avoidance Agreement (DTAA) and the GloBE OECD Framework. Pillar Two rules might conflict with treaties, and this will be explained through two clauses that are mentioned in every DTAA – Business Profits clause and Non-Discrimination Clause. This becomes significant when taxes are imposed without even meeting the threshold of a Permanent Establishment (PE), violating the contractual obligations under a treaty and thus, creating uncertainty when both converge.
With the rise of globalisation, multinational companies have increasingly resorted to tax avoidance strategies, including shifting profits to low or no-tax jurisdictions. This has posed significant challenges to the tax bases of many countries, particularly developing economies. To address the problem of income being taxed in multiple jurisdictions with varying or differential levels, countries have developed mechanisms to ensure fairness and certainty in cross-border taxation, especially with respect to Multinational Enterprises (MNEs).
This article will present some potential conflicts or challenges that could arise from two such mechanisms that involve regulating the taxation of MNEs. One is Double Taxation Avoidance Agreement (DTAA) and the other is Pillar Two under the Organisation for Economic Co-operation and Development, OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting (BEPS). Section I explains the concepts of DTAA and GloBE OECD Framework, Section II directly dives into the conflict between DTAA and Pillar Two frameworks, Section III explains two such clauses which are mentioned in every DTAA – Business Profits clause and Non-Discrimination Clause, Section IV deals with current global trends which are shaping the complexities around Pillar Two frameworks, and Section V concludes with the piece.
Double Taxation Avoidance Agreement (DTAA)
A Double Taxation Avoidance Agreement (DTAA) is signed to ensure that countries do not tax the same income twice. For example, if India has entered into a DTAA with another country and a person is earning income in one country while a resident of another country, such a person would not be taxed twice on the same income. In fact, in Most Favoured Nation (MFN) treaties, DTAA forms one of the main components. An MFN clause ensures that if one country enters into a tax treaty with a third country offering more favourable terms, the same benefits are extended to the MFN partner country. Earlier, such benefits were considered to apply automatically. However, the Supreme Court’s ruling in Nestle SA v. Union of India clarified that MFN benefits can only be extended through a formal notification and mutual agreement between the contracting states.
GloBE OECD Framework
In response to the growing trend of multinational corporations exploiting tax competition, the BEPS Framework was introduced to avoid the ‘Race to the Bottom’ approach mostly adopted by countries to cut taxes to attract more foreign investment. This led to a significant reduction in taxes paid by the multinational corporations. The OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting (BEPS) refers to “tax planning strategies used by multinational enterprises that exploit gaps and mismatches in tax rules to avoid paying tax.” Recognising the limitations of the initial framework, the BEPS 2.0 project was introduced in 2021. It is centred around two key pillars – Pillar One and Pillar Two. Pillar One focuses on reallocating a portion of the residual profits of multinational enterprises to the jurisdictions where their customers or users are located, irrespective of physical presence. It applies to companies with global revenues exceeding €20 billion, and profitability of over 10% of revenues.
Pillar Two introduced the minimum global tax (GMT) for corporations to be set at 15%. The Rules put forward the “common approach” for a global minimum tax for corporations whose turnover exceeds EUR 750 million. “Common approach” means that its application is not dependent on mutual acceptance by both countries. Pillar Two would still be applicable even if one country has adopted the rules. Under Pillar Two, four main rules are framed – Income Inclusion Rule (IIR), Undertaxed Profits Rule (UTPR), Subject to Tax Rule (STTR), and Qualified Domestic Minimum Top-Up Tax (QDMTT). When a subsidiary is subject to an effective tax rate of less than 15%, IIR applies, and the country with jurisdiction over the ultimate parent entity can levy a top-up tax to reach the minimum threshold. If the IIR is not applied, such as when the parent jurisdiction does not implement the global minimum tax, other jurisdictions where a constituent entity of the group operates may apply the UTPR. This rule allows for tax adjustments to ensure the group pays its share of top-up taxes. STR is a treaty-based rule that allows the source country to impose taxes on intra-group payments that are taxed below 9% in the recipient country. QDMTT is a domestic imposed minimum tax imposed on MNE’s to retain the taxes collected instead of diverting it to foreign jurisdictions in the form of IIR or UTPR. This is an optional domestic rule, and it ensures that local profits of 15% stay within the source country only.
Therefore, through these rules, Pillar One and Pillar Two aim to ensure that multinational enterprises pay a fair share of tax in jurisdictions where economic value is created and to reduce the incentive for companies to engage in tax evasion activities.
Conflict between DTAA and Pillar Two frameworks
DTAA establishes clear rules for which taxes are to be imposed on each other and the rates for the same. However, it can create problems even if one country to the DTAA has adopted the Pillar Two framework, especially UTPR.
The problem arises with the imposition of UTPR. As India has not adopted the Pillar Two Framework, this would mean that Indian companies whose parent company is in India will not be subject to the top-up tax rule under IIR. However, if a parent company that falls under India’s jurisdiction has subsidiaries in a foreign country that has adopted Pillar Two, the foreign country can still tax the subsidiary under the UTPR. While UTPR was created as a “backstop” in case the 15% GMT is not collected under the IIR rule, it creates jurisdictional challenges as it follows the “common approach” and both countries need not have adopted Pillar Two. Hence, UTPR can create unique challenges for countries that have signed a DTAA between themselves, and if one of them has adopted Pillar Two. If an Indian multinational has subsidiaries in countries that have adopted Pillar Two (such as the UK, EU countries, Singapore, etc.), and the group’s effective tax rate in India is below 15%, those other countries can apply the UTPR. This means that the top-up tax that would have been collected by India under the IIR can instead be collected by other countries under the UTPR. This can occur even if the relevant income is earned and taxed in India, a country with which these jurisdictions may have a valid DTAA.
This raises significant concerns for the subsidiary company as it will have no direct relation to the profits of the parent company on which the tax is charged. Though UTPR is distributed in proportion to the asset value, it might be a small subsidiary company that is earning profits with modest margins, being subjected to the fiscal consequences of its parent company’s location in a non-participating jurisdiction.
In most DTAAs, such as those between India and the UK, India and France, there is a clause relating to Business Profits, which is modelled after Article 7 of the OECD Model Tax Convention. The core principle here is: “The profits of an enterprise of one of the Contracting States shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein…”
The concept of Permanent Establishment (PE) has been established to create a base threshold below which the company will not be taxed by a foreign jurisdiction where they have a presence. What counts is whether the presence of a company in a foreign jurisdiction is substantial enough for tax to be imposed on it. However, this means that not every subsidiary will be categorised as a PE and imposing taxes on such subsidiaries in pursuance of 15% GMT raises critical questions regarding which one should prevail – whether the treaty-based PE on the basis of DTAA, or 15% GMT, regardless of whether the threshold of a PE is met or not. If a local subsidiary is not a PE, then it raises a question on whether the original intent behind entering into a treaty (DTAA) is really that certain and predictable.
The OECD has stated in its Report on Pillar Two Blueprint that the imposition of Pillar Two top-up taxes is compatible with the provisions of the OECD Model Tax Conventions. The rationale is that the UTPR is a domestic tax on local group entities, not a tax on the profits of a foreign enterprise as per Article 7. However, this interpretation has raised concerns. DTAAs are binding international treaties. While the OECD asserts that no amendments to existing treaties are needed, it has not provided a clear mechanism for reconciling this position with the contractual nature of tax treaties, which are built on principles of mutual consent and legal certainty. The application of the UTPR in a treaty context, especially without mutual renegotiation of treaty terms, risks undermining the balance and predictability of the international tax regime, and especially when the DTAA do not have any clause relating to the imposition of Pillar Two taxes among contracting states.
A typical clause in DTAAs, modelled after Article 24 of the OECD Model Tax Convention, provides: “Nationals of one of the Contracting States shall not be subjected in the other Contracting State to any taxation or any requirement connected therewith, which is other or more burdensome than the taxation and connected requirements to which nationals of the other Contracting State in the same circumstances are or may be subjected.”
This is the non-discrimination clause, and it prohibits a country from taxing nationals or residents of a foreign country more burdensomely than its own in similar circumstances. The OECD Pillar Two Blueprint also has an answer to this. It states that the provisions of IIR or UTPR are top-up taxes applied at the group level, and they are not dependent on the residence of any taxpayer. According to the OECD, this framework ensures horizontal equity; all large MNE groups, irrespective of where they are headquartered, will bear the same minimum 15% effective tax burden globally.
The non-discrimination clause can be looked at from two points of view. From a policy point of view, it would seem that the broader policy argument behind IIR and UTPR is to ensure equal treatment at the group level for all entities. Thus, the net effect would be to compel the company to comply with the minimum 15% tax threshold. However, from a contractual treaty point of view, it would seem that the UTPR is highly discriminatory, because if a comparison is drawn between the foreign entity and the domestic entity, the former has to pay more tax than the latter. Hence, the foreign subsidiary appears to bear a heavier tax burden solely due to the location of its parent entity. It will now need to be seen how countries and their respective courts maintain the equilibrium between the two. There is ambiguity in various areas regarding which rule should prevail over the other. As DTAAs are based on mutual consent and specific terms and conditions laid down, it becomes necessary to explore whether 15% GMT should be able to bypass treaty obligations when no such clause exists in the original DTAA signed between countries. This can create legal uncertainty, increase disputes, and undermine the predictability that DTAAs are meant to provide. This also creates a disconnect, as the MNE subsidiary is not being taxed for its own operations but for operations done by other companies in another jurisdiction. The subsidiary did not earn the income but is being taxed for it.
On January 22, 2025, a Presidential Memorandum was issued stating that “Global Tax Deal have no force or effect within the United States”. The United States pulled out of the OECD global tax deal, which can have a global impact on the consensus that was reached among 140 countries to impose 15% global minimum tax on MNEs. Some days later, the House Ways and Means Committee Chair Jason Smith introduced a bill named the Defending American Jobs and Investment Act (H.R. 591) in a press release, stating that “the bill would impose reciprocal taxes applicable to any foreign country that decides to target Americans with unfair taxes under the OECD’s global minimum tax.”
This means that US multinationals would gain a competitive advantage over non-US groups, as they would not be subject to top-up taxes in other countries, potentially increasing the chances of discrimination being caused to other MNE’s and their respective jurisdictions. The U.S. withdrawal is likely to tilt the playing field in favour of American MNEs, who will no longer face top-up taxes under IIR or UTPR. As a result, non-U.S. MNEs may find themselves at a competitive disadvantage, raising fresh concerns over the erosion of the broader goal of international tax fairness.
India has adopted a “wait and watch” approach towards implementing the Pillar Two framework, especially in the light of Donald Trump’s election back to the Presidential Office. Moreover, the GloBE rules also have a negative impact on developing countries if they have not adopted the IIR or the UTPR, as they would divert the profits of Indian companies to other countries (especially developed countries that have adopted the Pillar Two rules). Moreover, the Global OECD tax deal has already been disadvantageous to developing countries, as they offer more tax incentives to attract foreign direct investment to their own countries.
It will need to be seen what stance developing countries, especially India, take in light of multiple tax challenges that are coming up. Adopting Pillar Two without the necessary adjustments in DTAAs inevitably leads to more confusion and more leeway given to countries under the IIR and UTPR regimes to impose taxes on any group entity, even though the profits might be due to a company from a different jurisdiction. This would also subject them to extraterritorial taxation without any nexus with the main operations conducted.
The conflict between UTPR and DTAA non-discrimination and business profits clauses, which are among the many elements of a DTAA, shows the tension between international tax treaty law and global minimum tax norms. While the OECD seeks to justify the UTPR on grounds of policy measures and achieving parity, these arguments do not always square with the contractual and consensual nature of treaties like the DTAA. This becomes particularly disadvantageous for countries like India. In cases where MNCs are operating in countries that have adopted UTPR, those jurisdictions can impose additional tax where the group’s income is taxed below the GMT, irrespective of where that income arises. As a result, even if a significant portion of the MNC’s economic activity is located in India, other jurisdictions may collect the top-up tax, thereby reducing India’s potential share of tax revenue.
Even if India wants to continue its approach of “wait and watch”, it is advisable to introduce Qualified Domestic Minimum Top-up Tax (QDMTT) to protect its tax revenues and prevent such taxes from going to foreign jurisdictions through IIR or UTPR. This is because when QDMTT is imposed on a particular MNE, it is not subject to either IIR or UTPR, since QDMTT takes precedence when collecting top-up taxes. This could help countries like India retain taxes earned as a source country, preventing other countries (especially developed ones) from enriching themselves through profits earned by operations conducted in India.
Furthermore, under DTAAs, companies can avoid paying double taxes (paying tax in both the foreign and home country) through the application of Section 90 and Section 91 of the Income Tax Act, 1961. India allows a foreign tax credit (FTC) for foreign income taxes paid by resident companies, either under a DTAA (Section 90) or unilaterally if no DTAA exists (Section 91). For a tax to be eligible for FTC, it must be a tax on income, and it must be in the nature of an income tax, surcharge, or cess. FTC is not available for interest, penalties, or other types of levies. If the UTPR charge in the foreign country is characterized as an income tax and not a penalty, interest, or other non-income levy, it could potentially qualify for FTC under Indian rules, and hence, companies could avoid paying double taxes. However, Indian tax law does not specifically address the treatment of UTPR or other Pillar Two top-up taxes for FTC purposes yet. This could prove disadvantageous to companies operating in India. In India, the corporate tax is imposed on the whole income and consolidated under the Indian tax law. This means that the MNEs would have to pay double taxes – first, to a foreign country under UTPR, and then in India, as per the corporate tax rules. If India does not treat these UTPR payments as “income taxes” eligible for credit under the Income Tax Act, the Indian parent cannot offset the foreign tax paid against its Indian tax liability. Therefore, if UTPR-imposed taxes abroad are not considered creditable taxes under the Income Tax Act, there could be double taxation and more difficulties for companies that are already strategizing their plans and policies because of different rules adopted by different jurisdictions under the Pillar Two framework.
Furthermore, in order to align DTAA with the Global OECD framework, there is an urgent need to strengthen Mutual Agreement Procedure (MAP) clauses in DTAAs to explicitly cover Pillar Two related disputes. Current MAP clauses are not adequate to cover the new types of disputes that could arise from potential conflicts between DTAA and Pillar Two top-up taxes rules. MAP is the primary mechanism to resolve disputes arising out of the DTAA between countries. Including cross-jurisdictional considerations in taxation among different countries could potentially give some predictability to otherwise inconsistent application of these rules. This solution could be adopted as an interim solution until a more concrete approach is adopted.
Conclusion
Various legal complications can arise between DTAAs and the OECD Pillar Two framework. This article focused only on the broad challenges that countries like India, especially Indian companies, could face, while taking the example of Business Profits and the Non-Discrimination clause in the DTAA. For these reasons, countries should tread with caution as the operation of rules like UTPR could have an impact on the fiscal economy of countries that risk losing potential tax revenue. It is high time that a concrete solution is laid out, particularly in light of the US pulling out of the Global Tax Deal, which could affect the global international tax regime. This can lead to varying interpretations and applications of the rule, which could present complex legal challenges for MNEs operating across multiple jurisdictions.
Jayanti Dhingra is a fourth year law student at O.P. Jindal Global University. She is passionate about corporate governance and international law.
Categories: Legislation and Government Policy