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BEPS: Which Side Of The Table Are You On?

Published on Mon, Aug 05,2013 | 18:41, Updated at Mon, Aug 05 at 18:41Source : 

By: Daksha Baxi, Executive Director & Ritu Shaktawat, Senior Associate, Khaitan & Co

The G20 nations commissioned the OECD to study the issue of Base Erosion and Profit Shifting (BEPS), pursuant to which the OECD published their report on BEPS in February 2013. The OECD found that strategies followed by some multinationals allow them to pay as little as 5 percent in corporate taxes whereas smaller businesses pay up to 30 percent. Also, some small jurisdictions act as conduits and receive huge amounts of foreign direct investment compared to large industrialised countries and in turn invest large amounts in major developed and emerging economies. While these strategies are technically legal, they erode the tax base of many countries and threaten the stability of international tax system.  The OECD then announced to draw up an Action Plan to provide concrete timelines and methodologies for solutions to reinforce the integrity of the global tax system. Accordingly, on 20 July, the OECD has published its 15 point Action Plan in relation to BEPS.  The Action Plan thus marks a formal and broad based recognition of the immediate need to timely plug the gaps that are causing concerns for the economies world over in relation to fair taxation.

Among other things, the Action Plan proposes time bound actions to deal with the new business models, the spread of digital economy and the weaknesses of current rules of taxation which create opportunities for BEPS and double non taxation. MNEs (Multi-national Enterprises) through sophisticated tax planning are able to structure and split their activities across jurisdictions and benefit from the arbitrage resulting from the gaps in the interaction of respective domestic tax regimes. For example, where a particular type of expenditure under the tax law of one jurisdiction is deductible in the hands of the payer, corresponding income in the hands of the payee is not taxable under the tax law of another jurisdiction, resulting in double non taxation. Tax treaty abuse is another cause of concern for the governments to tackle. Definition of ‘permanent establishment’ which allows the source state to levy tax on business income is also being considered inadequate where businesses today do not need an establishment or a nexus with source states as envisaged under the current international rules, to be taxed therein for income generated through sales in that state. Intangible property development and exploitation is seen as another major area where transfer pricing rules need to play a vital role in being able to attribute income based on value creation. The OECD recognizes that some of the changes can be brought about through change in the commentaries but a number of them would require change in the text of the treaties. OECD recognizes that it would take years for the bilateral treaties to be renegotiated considering the bureaucratic process to incorporate such changes suggested by the OECD. They have therefore suggested a multilateral instrument to bring about these changes in existing tax treaties. Thus, the Action Plan seeks to kick start the process of consensus based updation of rules in the world’s major economies (OECD and G20) before the governments by unilateral measures develop competing standards which could lead to chaos and double taxation.    

As is very clear from the several high-pitched tax demands and transfer pricing adjustments made by the Indian tax authorities as well as the reservations submitted by them in relation to the various aspects of evolution of international taxation, India is at the centre stage of being emphatic about the BEPS issues faced by herself as well as the other developing and developed economies. Cases, where tax authorities allege ‘permanent establishment’ being created or change the nature of income to ‘royalty’ instead of business income or deny tax treaty benefits on the grounds of lack of ‘substance’ or treaty abuse (e.g. denial to give effect to India-Mauritius treaty) or make huge transfer pricing adjustment because of intangibles being created in India under a contractual arrangement, are not uncommon. The newer modes of doing business complicate things further. Applying the current tax rules – domestic as well as treaty and international tax rules – which do not currently cover such taxation, relief is generally granted to the taxpayer at the appellate levels. For example, the very recent disputes relating to taxation of income arising to eBay from sellers who list their products on eBay’s website and eBay facilitates e-commerce of such products providing a digital market place to the buyers and the sellers while not having any presence in India; and the ‘key words’ advertisement system of Google was characterized as royalty as well as technical service by the tax authorities but the tax tribunal granted relief on the basis that customers have no ‘right to use any equipment or circuit’ and there was no human element involved for it to be characterized as technical service.  

It is interesting to note that all of these issues, including addressing challenges of digital economy; more effective controlled foreign corporation rules; application of profit split method in relation to certain types of transactions; changes to definition of permanent establishments; requiring taxpayers to disclose aggressive tax planning arrangements; priority to transparency, substance and prevention of treaty abuse;  and revamping transfer pricing guidelines have been identified by the OECD’s group in BEPS Action Plan report.  This may be seen as vindication of the views of the Indian tax administration attempting to counter BEPS. The Action Plan report also sets out detailed time line within which they intend to bring about these changes to ensure that the new propositions are finalized by September 2015. Some of them are intended to be finalized as early as in September 2014. OECD having recognized the challenges in developing multilateral instrument has set a timeline of December 2015. The actual implementation by countries may take even longer. All the same, it appears that the move is in the direction of creating new interpretation and rules for international taxation where the current strategies pursued by the MNEs may not be successful in giving them the tax incidence as low as they have been used to so far.  As regards their dealings with India, in addition to the GAAR which are proposed to become effective for 1 April 2015, the MNEs may need to re-think their tax strategies even in terms of international tax standards. The world may be entering an era where MNEs would now need to ready themselves to think of much different tax rates and structures to meet their investors’ expectations for returns. The recent debate to shell out ‘moral’ taxes (Starbucks in the UK) is another area which MNEs need to factor in when their tax pay-outs in a jurisdiction do not match with the revenues generated from those jurisdictions. It would not be out of place to mention that in the absence of clear law requiring a taxpayer to pay what it is required to pay, how proper it is to expect payment of taxes on moral grounds when it is an established principle that fiscal laws are to be construed strictly. 

With all the reasoning that has been spelt out for the prevention of BEPS, one would have liked an attempt to answer some fundamental questions:  (i) What return do the taxpayers get from paying taxes? After all, payment of tax is sharing of revenue and therefore a sort of investment that a taxpayer makes with the government to whom taxes are paid.  (ii) What should the countries do to incentivise taxpayers to participate in the initiative of contributing to governments? (iii) Why would countries not eliminate differential tax rates and have territorial basis of taxation? That would eliminate the tax arbitrage and the need to shift profit elsewhere completely. May be these are utopian questions and since it is much more difficult to find satisfactory answers to them, perhaps what the OECD is looking at is the next best!

The ingenuity of the tax advisers will always find ways to reduce tax incidence, but in the short run, one would need to wait and assess as to what will be the 'permissible' limits of tax planning under the new rules contemplated to be framed and whether and to what extent they are subjective or objective and how such rules weigh on the threshold of certainty for taxpayers. The governments do have a highly complex balancing act at their hands.

The views expressed are personal.


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