International taxation: treaties, profit shifting and the global minimum tax

Detail

1. Basic principles: who gets to tax?

• Residence taxation: a country taxes the worldwide income of its own residents.

• Example: an Indian resident earns rent in Dubai. India can tax that rent.

• Source taxation: a country taxes income earned inside its territory, whoever earns it.

• Example: a US firm sells services in India. India can tax the profit earned in India.

• The conflict:

• The same income can be claimed by the residence country and by the source country.
• So the income gets taxed twice. This is double taxation.

• Double taxation discourages cross-border trade and investment.

• Permanent establishment (PE): a fixed place of business, such as an office, branch or factory, that lets the source country tax a foreign firm's business profits.

• No PE usually means the source country cannot tax those business profits.
• This is why digital firms with no office in India were hard to tax (see Section 5).

2. Double Taxation Avoidance Agreements (DTAAs)

• DTAA: a treaty between two countries so that the same income is not taxed twice. It also divides taxing rights between the two countries.
• Two methods of relief:
• Credit method: the home country taxes the income but gives a credit for the tax already paid abroad.

• Exemption method: the home country does not tax income that was already taxed abroad.

• Worked example: an Indian resident earns ₹100 abroad. The foreign tax is 20%. The Indian tax is 30%.

• Credit method: India's tax is ₹30. Subtract the ₹20 foreign tax credit, so ₹10 is paid in India. Total tax = ₹30, which is the higher of the two rates.
• Exemption method: India exempts the ₹100. Total tax = ₹20, which is the foreign rate only.
• Without a DTAA: ₹20 + ₹30 = ₹50. This is double taxation.

3. Treaty shopping and how India closed the loopholes

• Treaty shopping: sending investment through a treaty country only to get tax benefits, not for any real business reason.

• Typical route: a shell company in Mauritius or Singapore invests in India and claims the treaty's capital-gains exemption.

• India–Mauritius protocol (2016):

• Capital gains on shares acquired from April 2017 are taxed in India. This is source-based taxation.

• Result: the "Mauritius route" lost its main tax advantage.

• MLI (Multilateral Instrument): the OECD's multilateral treaty tool. It changes many bilateral DTAAs in one go, so each treaty does not have to be renegotiated separately.

• India ratified it in 2019.
• It added the Principal Purpose Test (PPT): treaty benefits are denied if getting them was one of the main purposes of the deal.

4. Transfer pricing, tax havens and information exchange

4a. Transfer pricing

• Transfer pricing: the prices charged in deals between related units of the same multinational, for example an Indian subsidiary paying its foreign parent for a brand licence.
• Arm's-length price (ALP): the price that unrelated parties would charge each other. Tax law requires ALP so that profits are not moved to low-tax places.
• Worked example:
• An Indian unit makes software at a cost of ₹100. It sells the software to its Singapore sister unit for ₹105, while an unrelated buyer would pay ₹150.
• Profit shown in India = ₹5. The ALP profit would be ₹50.
• So ₹45 of profit is shifted to Singapore, where tax is lower.

• The tax officer adjusts India's taxable profit up to ₹50.

• Legal base: Secs. 92–92F of the Income-tax Act (in force since 2001).

• Advance Pricing Agreement (APA) (from 2012): the firm and the tax department agree in advance on the pricing method for future years. This avoids long disputes.
• Unilateral APA: between the firm and the Indian tax department only.

• Bilateral APA (BAPA): also agreed with the tax authority of the other country. This protects against double taxation on both sides.

• Safe-harbour rules: fixed profit margins that the tax department accepts without scrutiny.

Year	APAs signed by CBDT
FY 2021-22	62 [10]
FY 2022-23	95 [9]
FY 2023-24	125 (a record at the time) [8]
FY 2024-25	174, including 65 BAPAs [7]
FY 2025-26	219 (highest ever), including 84 BAPAs [7]

• The total number of APAs since the start of the programme passed 1,000 (1,034) by FY 2025-26 [7].
• India signed its first bilateral APAs with France, Ireland, Indonesia and Sweden in FY 2025-26 [7].

4b. Tax havens and leaks

• Tax haven: a jurisdiction with very low or no taxes plus strict secrecy about who owns what.
• Leaks exposed people and firms using havens:
• Panama Papers (2016)
• Paradise Papers (2017)
• Pandora Papers (2021)

4c. Automatic exchange of information (AEOI)

• AEOI: countries regularly and automatically share financial-account data about each other's residents. No special request is needed each time.
• Common Reporting Standard (CRS): the OECD standard for AEOI. India's first exchange was in 2017.

• FATCA (the US Foreign Account Tax Compliance Act): India signed an agreement with the US in 2015.

• Why it matters: money hidden abroad becomes visible to the Indian tax department, so hiding income in havens gets harder.

5. Retrospective taxation: the tax-certainty lesson

• Retrospective taxation: taxing past transactions under a law that was changed later.
• The Vodafone story, step by step:
• Vodafone bought a foreign company that indirectly owned Indian assets. India said capital-gains tax was due.
• 2012: Vodafone won in the Supreme Court, because the deal happened outside India.
• Finance Act 2012: Parliament retrospectively amended the law so that indirect transfers of Indian assets became taxable, going back to past years.
• 2020: India lost the Vodafone and Cairn arbitrations under investment treaties.

• Taxation Laws (Amendment) Act 2021: the government withdrew the demands and refunded the amounts collected.

• Lesson: sudden changes to tax law damage investor confidence. Tax certainty is itself a way to attract investment.

6. BEPS and taxing the digital economy

6a. BEPS

• Base Erosion and Profit Shifting (BEPS): tax planning that uses gaps and mismatches between countries' tax rules to move profits to low- or no-tax places.
• "Base erosion" means the taxable profit reported in a country shrinks.

• "Profit shifting" means that profit is booked somewhere else, often in a haven.

• OECD/G20 BEPS project: ran 2013–2015 and produced 15 actions.

• Action 1: the digital economy, where firms earn from users in a country without having a PE there.

6b. India's equalisation levy (EL)

• Equalisation levy: India's own levy on payments to non-resident digital firms. It is charged on the gross amount paid, not on profit, and sits outside the Income-tax Act [4].
• 6% on online advertising: introduced by the Finance Act 2016 [4].

• 2% on e-commerce operators: added by the Finance Act 2020, covering supplies made on or after 1 April 2020 [4].

• Worked example: an Indian firm pays ₹1 crore to a foreign platform for online ads. EL = 6% × ₹1 crore = ₹6 lakh, deducted by the Indian payer.

• Abolition:
• The 2% levy covered only supplies before 1 August 2024 [4].
• The EL provisions are not applicable from 1 April 2025 [4].
• Background: the US opened Section 301 trade investigations (Section 301 is the US law that allows trade retaliation against "unfair" foreign practices). India issued a formal response to the US Section 301 report on the equalisation levy [5].

6c. Significant Economic Presence (SEP)

• SEP: a non-resident is treated as having a taxable presence in India because of its digital transactions or users, even with no office. It extends the PE idea to the digital economy.
• Introduced by the Finance Act 2018.

• Thresholds from 2021: ₹2 crore of payments or 3 lakh users in India.

• Limit: where a DTAA applies, the treaty's older PE definition usually overrides SEP. So SEP mainly bites on firms from non-treaty countries.

7. The Two-Pillar Solution (October 2021, about 136+ jurisdictions)

	Pillar One	Pillar Two (Global minimum tax)
Aim	Give market countries (where the users are) a share of taxing rights	A floor on corporate tax
Scope	MNEs with over €20 billion revenue and over 10% profit margin	Groups with €750 million+ revenue
Rule	Amount A: 25% of residual profit (profit above a 10% margin) is reallocated	15% minimum effective tax rate in each country
Tools	Multilateral convention	GloBE rules: IIR, UTPR, QDMTT; treaty-based STTR
Status	Convention stalled	Many countries have put it into law

• The Inclusive Framework now has 147 countries and jurisdictions working on the global minimum tax [2]. (NCERT: about 136+ at the October 2021 deal.)

7a. Pillar One: worked example

• An MNE has €100 billion revenue and €20 billion profit, so its margin is 20%.
• Routine profit (10% margin) = €10 billion.
• Residual profit = €20 billion − €10 billion = €10 billion.
• Amount A = 25% × €10 billion = €2.5 billion. This is shared among the market countries in proportion to their sales.

7b. Pillar Two: the tools

• Effective tax rate (ETR) = covered taxes paid in a country ÷ profit earned in that country.
• Top-up tax = (15% − ETR) × excess profit, where excess profit is profit minus a carve-out for real activity (payroll and tangible assets).
• Worked example: a subsidiary earns €100 million in a haven and pays €5 million tax, so ETR = 5%.
• Top-up rate = 15% − 5% = 10%.

• Ignoring the carve-out, top-up tax = 10% × €100 million = €10 million.

• Who collects the top-up tax, in order of priority:

• QDMTT (Qualified Domestic Minimum Top-up Tax): the low-tax country itself collects the top-up first, so the revenue stays at home.
• IIR (Income Inclusion Rule): otherwise the parent company's country collects it.
• UTPR (Undertaxed Profits Rule): a backstop. Other countries where the group operates collect it if the parent country does not apply the IIR.
• STTR (Subject-to-Tax Rule): a treaty-based rule. It lets source countries, mostly developing ones, tax certain related-party payments such as interest and royalties that are lightly taxed abroad.

7c. US exit and the "Side-by-Side" package

• US stance: the US withdrew in January 2025. The G7 reached a "side-by-side" understanding in June 2025 to keep US-headquartered groups out of some Pillar Two rules (scaffold).
• Inclusive Framework package (agreed January 2026): it has three parts [2][3]:
• Material simplifications of the rules.
• Closer alignment of substance-based tax incentives (incentives linked to real investment and jobs) with qualified refundable tax credits.

• A Side-by-Side (SbS) system.

• How the SbS system works [3]:

• It has two safe harbours for MNE groups headquartered in jurisdictions recognised as having an eligible tax regime. This is the route that covers US groups.
• These groups are exempt from the IIR and UTPR in other jurisdictions.

• A separate UPE safe harbour (UPE means ultimate parent entity) exempts only the parent's home country from the UTPR.

• Meaning: the 15% floor survives. However, groups based in countries with an "eligible" home regime are largely left to their home country's rules.

7d. India's position

• India backed the Two-Pillar deal.
• India gave up the equalisation levy (from 1 April 2025) [4].
• India also offers IFSC (International Financial Services Centre, e.g. GIFT City) and data-centre tax holidays. These must fit with a 15% floor, otherwise other countries could collect top-up tax on the profits India leaves untaxed (verify current).

8. The UN track

• Why a UN track? Developing countries want a forum that is more inclusive than the OECD, where rich countries largely set the agenda.
• Terms of Reference (ToR): an ad hoc intergovernmental committee adopted the draft ToR on 16 August 2024. The UN General Assembly then adopted them [6].
• Negotiating committee: a Member State-led intergovernmental negotiating committee (INC) meets in 2025, 2026 and 2027, with at least three sessions per year [6].

• Bureau: a Chair, 18 Vice-Chairs and a Rapporteur, chosen on the basis of equitable geographical representation [6].

• Structure: a framework convention plus protocols, which are separate legally binding instruments that implement or elaborate the convention [6].

Prelims Hooks

• PPT (Principal Purpose Test) came to India's DTAAs through the MLI, which India ratified in 2019. It denies treaty benefits if getting them was one of the main purposes of the deal.
• India–Mauritius protocol (2016): capital gains on shares acquired from 1 April 2017 are taxable in India (source-based).
• Transfer pricing is in Secs. 92–92F (since 2001). APAs started in 2012. CBDT signed a record 219 APAs in FY 2025-26, and the total passed 1,034 [7].
• Equalisation levy: 6% on online ads (Finance Act 2016) and 2% on e-commerce (Finance Act 2020). The 2% ended 1 August 2024 and the whole levy ended 1 April 2025 [4]. Trap: the levy sat outside the Income-tax Act.
• SEP (Finance Act 2018): thresholds of ₹2 crore of payments or 3 lakh users.
• Pillar Two: 15% minimum ETR for groups with €750 million+ revenue. Collection priority: QDMTT → IIR → UTPR. The STTR is treaty-based.
• Pillar One Amount A: 25% of profit above a 10% margin, for MNEs with over €20 billion revenue.
• Side-by-Side package (January 2026): exempts groups headquartered in "eligible regime" jurisdictions from the IIR and UTPR [2][3].
• CRS is an OECD standard (India's first exchange in 2017). FATCA is a US law (India–US agreement in 2015). Trap: don't swap them.
• UN tax convention: ToR adopted 16 August 2024. The INC meets in 2025–2027 [6].

Mains Points

• Tax sovereignty vs. global coordination: India gave up its unilateral equalisation levy in exchange for a multilateral deal.
• Pillar One, which would give market countries like India taxing rights, has stalled.
• The Side-by-Side package has diluted Pillar Two for US groups.

• So India's gains are uncertain. This strengthens the case for the UN track and for keeping SEP.

• Tax certainty as an investment policy: Vodafone and Cairn show that retrospective tax causes arbitration losses and harms India's image.

• The 2021 Act repaired trust.

• The record APA numbers (219 in FY 2025-26) show that India is moving from disputes to dispute prevention [7].

• Incentives vs. the 15% floor: IFSC and data-centre tax holidays may lose value under Pillar Two, because another country can collect the top-up tax.

• India can adopt a QDMTT to keep that revenue at home.

• It can also redesign incentives as substance-based ones or as qualified refundable tax credits, in line with the 2026 package [2].

• Transparency against black money: DTAA amendments (Mauritius, MLI-PPT), CRS/FATCA data sharing and leak-based probes together make it harder to hide money abroad. This links to GS-III themes of money laundering and black money.