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India’s Tax Regime after Pillar Two: Key Risks and Opportunities

Tax Incentives in India

India has a number of tax incentives that should be considered for Pillar Two purposes.
Expenditure based incentives such as the additional 30% deduction for new employees under Section 80JJAA of the Income Tax Act are particularly attractive in a post Pillar Two environment.
They are highly targeted and encourage direct investment.
Whilst they will reduce the GloBE effective tax rate (ETR) and potentially could give rise to top-up tax, the Section 80JJAA enhanced deduction also needs to be considered in terms of the substance-based income exclusion
Encouraging the employment of new employees increases the payroll carve out and reduces any potential top-up tax.
Such incentives are therefore attractive going forwards.
The same principles apply to a number of other tax incentives in the Indian Income Tax Act such as the 20% deduction for investments in newly established industrial undertakings or hotel business in deprived areas in Section 80 HHA. This would increase the tangible asset carve out component of the substance-based income exclusion.
The amount of the substance-based income exclusion feeds directly into the Pillar Two top-up tax calculation as it reduces excess profits which are then used to calculate the initial top-up tax based on the top-up tax percentage.
Even in a very low-taxed entity, this could eliminate any potential top-up tax if the profits were low but there was significant investment in tangible assets and payroll.
Even income-based incentives which are generally not as favourable under GloBE Rules are generally limited in scope in India.
Income-based incentives with a wide tax base bear the risk of substantially reducing the ETR.
For in-scope companies they would gain no benefit from this as they would suffer top-up tax in any case, and India would be administering a tax incentive that was ineffective and potentially lose tax revenue to a foreign jurisdiction (unless a qualifying domestic top-up tax (QDMTT) was enacted).
However, in India, income-based incentives typically have a relatively narrow scope.
The Patent Box under Section 115BBF of the Income Tax Act for instance applies a 10% tax rate to royalty income in respect of the exploitation of patents.
However, this is narrow in scope and given jurisdictional blending (see below) the impact on the jurisdictional ETR would be offset by any higher-taxed income of other group entities in India.