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BEPS: Impact On India

Published on Fri, Oct 09,2015 | 22:32, Updated at Mon, Oct 12 at 23:01Source : CNBC-TV18 |   Watch Video :

It’s a 4 letter word that will transform global taxation. BEPS – Base Erosion and Profit Shifting refers to the complex structuring done by multinational businesses to artificially shift reduce profits to low tax countries and pay little or no corporate tax. The OECD estimates that 100 to 240 billion dollars in tax revenue is lost every year due to such tax avoidance. That’s 4-10% of global corporate income tax revenues. And so, in 2013 the OECD issued 15 BEPS action points and earlier this year, after several rounds of consultation, it issued final BEPS standards. So, what impact will the BEPS standards have on Indian companies and Indian multinationals? The Firm polled 12 top tax experts to find out…

Transparency is a key pillar
Mandatory Disclosure regime
Transfer Pricing Documentation
Country-By-Country Reporting

The top impact area for all 12 tax experts is disclosures. Transparency is one of the 3 pillars of the BEPS programme. OECD recommends that countries design a mandatory disclosure regime to obtain information on potentially abusive tax schemes and their users.  And there’s a new template for transfer pricing documentation and country by country reporting of revenues, profits and taxes paid.

Maulik Doshi, Partner, SKP

“Essentially the BEPS in its action plan 13 have kind of required a three tier documentation. So, they are going to revise the transfer pricing documentation guidelines to provide for a three tier documentation which includes preparation of a master file by the multinational enterprise, preparation of a local country filing in each of the countries where the MNC is operating and a country-by-country reporting.

It is more this country-by-country reporting that is causing a bit of concern for all multinational enterprises be it Indian or foreign. Essentially what it would require is it would require that key economic factors of every multinational enterprise be put up on a single piece of paper and that information, the country-by-country reporting, would be available to the tax authorities under the automatic exchange of information. So, essentially if a multinational is operating in India the tax authority at one go is able to see what kind of profits it derives in Singapore, whether the profit derivation in Singapore is linked to the value creation or is it just a shell entity and the profit is just lying as it is.

So, all these key economic factors like sales, the profit volumes, the number of employees, the key functions all that are getting captured under the country-by-country reporting and that is what is what is required under this action plan. So, that is one thing which multinationals, especially Indian multinationals would be kind of a little bit vary about.”

Aligning TP outcomes with value creation
Operational profits are allocated to economic activities that generate them
All 12 tax experts identified transfer pricing as the next big area of impact. OECD wants to align transfer pricing outcomes with value creation – so that operational profits are allocated to the economic activities which generate them. EY’S Vijay Iyer says “legal contracts may no longer be the sole basis for determining transfer prices”. TP Ostwal says “transfer pricing will get further complicated”.

Maulik Doshi, Partner, SKP

“BEPS action plan from 8-10 deals with aligning the transfer pricing outcomes with value creation and in which case they say that intangibles is a major force in terms of defining where the profitability would lie. While defining intangibles and while talking about intangibles Organisation for Economic Co-operation and Development (OECD) has played a lot of importance on some of the factors like marketing intangibles, the assembled work force, location savings and everything. So, all these concepts, the Indian tax administration were trying to put it across and making adjustments. So, you are seeing huge adjustments being made on marketing intangibles by the Indian tax authorities, location saving comes up in almost kind of each and every captive cases.

So, all these concepts were already used by the Indian tax administration. Now with OECD kind of putting its stamp of approval on some of these things and regarding them as one of the important competitive factor it would just kind of put more force with the Indian tax authorities in terms of using this.”

Rahul Mitra, Partner, KPMG

“I don't see any need for making any legislative amendment to these recommendations or guidelines because transfer pricing is not a matter of law that you need to amend and instil transfer pricing in the revenue administration of a country. It is to be understood, it is to be practiced. So, OECD as part of BEPS have given these guidelines. Now, these guidelines do not redefine transfer pricing. They actually instil the transfer pricing provisions or explain the transfer pricing provisions in a greater detail. So, one would need to adhere to these principles when a company administers its transfer pricing, when a company sets its pricing policy with its group companies and they way in which it will create a transfer pricing documentation, defences and also the manner in which the revenue administrators would also look into the transfer pricing matters in audits and appeals etc.”

Countries to clearly states that they intend to avoid creating opportunities for non-taxation
Inclusion of Limitation-On-Benefits rule in Model Tax Convention
Inclusion of Principle Purpose Of Transactions Test

50% of the tax experts polled identified treaty abuse as the next big area of impact. The OECD has laid down new anti-abuse rules that address treaty shopping - Countries must make a clear statement that they intend to avoid creating opportunities for non-taxation or reduced taxation. The L-O-B or Limitation On Benefits Rule will be included in the OECD model tax convention as will be a more general anti-abuse rule based on The Principle Purpose Of Transactions.

Rohan Shah, Managing Partner, ELP

“The concerns of course have been double taxation and double non-taxation. That is where this sort of thing starts from and it is a valid concern on both counts. Now, as we sort of go forwards and what we effectively see here is again a move where much of it is around the concept of principal purpose test and most of us who have been looking at General Anti-Avoidance Rule (GAAR) long enough understand that the elements are not very dissimilar but when we talk the principal purpose test it is easy enough to sort of say that it is not solely a tax purpose but what then happens is that when you look at the rest of what the commercial rationale is and you might find that rationale but people are increasingly inclined to also say that relevant to this rationale was this particular territory or location the one which afforded you the best opportunities for that so called commercial rationale or in a manner has tax actually conditioned that at the end of the day. So, one completely agrees with the principal purpose test. There must be a global synergy on how it will be interpreted because if you have differential interpretations that would be quite disastrous.”

Minimum standards to strengthen effectiveness of Mutual Agreement Procedure
20 countries have agreed to provide for mandatory, binding MAP arbitration in treaties
-          USA, UK, Japan, Australia, France, Germany, Sweden, Canada…

Well 5 of 12 responses listed dispute resolution as a key impact area. OECD has set down minimum standards to strengthen the effectiveness & efficiency of the mutual agreement procedure.

Ketan Dalal, Partner, PWC India

“In practice the experience on mutual agreement procedures (MAP) is mixed. It takes quite a lot of time because two governments have to agree. Now what the BEPS report has done is to say we need to do something to do MAP much more effective in terms of process, in terms of timelines. So, in a sense that is good. So, it will provide possibly one more additional dispute resolution mechanism in terms of it being a little more meaningful.”

Menaka Doshi, CNBC-TV18

I’d like to point out here though - that 20 countries, including the UK, USA, Japan and Australia have agreed to provide for mandatory binding M-A-P arbitration in bi-lateral tax treaties as a mechanism to ensure that treaty related disputes are resolved within a specific timeframe. India has not signed up for this. Now for the next impact area on the list.

Changes to be made to PE definition in Article 5 of Model Tax Convention
To prevent artificial avoidance of PE status

The OECD also intends to make changes to the definition of PE in the model tax convention to prevent the artificial avoidance of Permanent Establishment status.

Rohan Shah, Managing Partner, ELP

“Firstly in terms of PE in India we have sort of explored and re-explored this issue judicially quite often and I do believe that our jurisprudence is a little more mature than anywhere else in the world. So, in a way we need to see whether our jurisprudence will get called into question and whether this will also override that but we have gone a pretty considerable distance in identifying what a PE will be.

So, from my perspective as I look at this the three or four questions which come up is one is definition of PE and effectively what are the criterion or ingredients. To me the other key issue will be profit attribution, how much will they actually attribute to the PE in the context of the incomes which are generated. I also suspect that this direction on PE is clearly more subjective and if at all one would have liked it far more objective.

My other sense is from an Indian perspective. Compliance and administrative burdens will rise but the ultimate truth of this is what impact will it have on treaties, how much will we take from this and weave into the treaties because that will then ultimately define:-

A: The relevance of this as a concept in India, and

B: The jurisprudence we already have do we sustain it or does that now need a relook and reinvention.”

Digital economy is increasingly becoming the economy itself
It has accelerated and changed the spread of global value chains in which MNEs integrate their worldwide operations

Menaka Doshi, CNBC-TV18

The changes to the definition of Permanent Establishment will also help meet the challenges arising from the digital economy. Interestingly, while OECD lists this as action point number 1, only 3 of 12 tax experts I spoke seem concerned about the digital economy, probably because it’s still at a nascent stage.

Now let’s talk about Mauritius! We already know that India and Mauritius are re-negotiating the double tax avoidance treaty. The BEPS programme makes that easier for India as it proposes anti-treaty abuse measures we spoke of earlier in the show. For instance the L-O-B and Principle Purpose Test. Also 90 countries are working on a multilateral instrument to amend all bi-lateral tax treaties and give effect to OECD’s BEPS standards. Does all this mean fewer investors will use Mauritius to route investments into India?

Grant Thornton’s Arun Chhabra says “post BEPS it likely that India will pursue renegotiation of the treaty and introduce a specific LOB or Principle Purpose Test. This will impact the attractiveness of Mauritius as a hold co jurisdiction”.

But BMR’S Shefali Goradia believes That “Unless India and Mauritius both sign multilateral instrument which incorporates standard anti-treaty abuse provisions, there should be no impact on this treaty. Yet she agrees that “In the long run, more companies will prefer to invest directly rather than through intermediate jurisdictions like Mauritius’.

V. Lakshmikumaran puts it differently though. He says “Mauritius in all likelihood will continue without much change.  BEPS is aiming to prevent un-intended treaty abuse. India Mauritius treaty is unlikely to get affected by BEPS, except that there may be introduced a clause relating to Limitation of Benefits”.

Maulik Doshi, Partner, SKP

“The India Mauritius treaty is already under renegotiation. A significant portion of the renegotiation has already taken place, it is just that it is not in the public domain. The OECD BEPS plan would kind of give more political advantage to India or more bargaining power to India to kind of negotiate with Mauritius and put the effective limitation of benefit clause, ensure that Mauritius does not kind of allow the treaty shopping to be done.

So, these recommendations are in line with what India wanted and that would help India to renegotiate the treaty more formally with Mauritius and we will see more and more disclosures to be made in respect of the investment holding companies etc. So, overall with these kind of steps being taken the use of Mauritius or any other special purpose vehicles as an investment holding company would reduce over a period of time.”

Rohan Shah, Managing Partner, ELP

“It would be jeopardise not to take account of all of this and if Mauritius and India really intend this to be significant the renegotiation must reflect at least all of the anxieties which are here and at least all of the principles which will gain currency over a period of time through what we have here.”

Menaka Doshi, CNBC-TV18

More disclosures, more substance, more anti-abuse measures in treaties and a new definition for PE. Add to that rules ensuring that hybrid instruments and entities, as well as dual resident entities, are not used to obtain unduly the benefits of tax treaties. Plus there are new CFC rules. OECD has also laid down a fixed ratio rule which limits an entity’s net deductions for interest to a percentage of its EBITDA. The list of BEPS related changes are many and that brings me to the impact of BEPS on commonly used corporate structures.

Dhruva Associates CEO Dinesh Kanabar says cross-border structures using lower tax jurisdictions are most vulnerable.

Dinesh Kanabar, CEO, Dhruva Advisors

“So, there is a limitation of benefit clause which has been suggested which is so extensive it is not perfunctory like the which you have between for example India and Singapore but is very extensive and if adopted in the tax treaty between India and Mauritius, Singapore, Cyprus or whatever else will mean that most companies investing through these jurisdictions if they really do not have substance will not qualify for the benefits of the treaty and therefore abuse of those treaties will now stop.”

Next on the impact list are structures involving third party debt or hybrids.

Dinesh Kanabar, CEO, Dhruva Advisors
“We have a very peculiar situation where a foreign company investing in India through a Compulsory Convertible Debenture (CCD) would regard it as equity for the purpose of Foreign Direction Investment (FDI). The Indian company which is issuing the debenture will regard it as a debt and there have been no thin capitalisation norms, the entire interest would be treated as a deduction. It is quite possible that in the country from which the investment is made such a CCD could actually be regarded as equity because it is compulsorily converted into equity, it is not a debt instrument really. Therefore one could really use such a hybrid instrument to ensure re-characterisation of income. So, therefore, for example if interest was paid that interest would be tax deductible in the hands of the Indian company but the recipient overseas could treat it as dividend because it is characterised as equity from the country in which the debentures have been subscribed to.

What BEPS is doing is to provide really that such re-characterisation ought not to be accepted, it provides for two separate measures; one is it provides for a limitation on the quantum of interest that one can reduce from the profits of an enterprise and therefore thin capitalisation to an extent is put a ceiling to and thereafter it says that if an instrument is characterised differently in two countries there can be two implications, one implication could be in the type of structure in which I mentioned to you, India could deny dedication for interest. In the alternative if India does grant deduction for interest then the income would be characterised as taxable in the country in which it is received notwithstanding the fact that the amount is characterised as equity. So, there is a primary and secondary adjustment which is proposed which will sort of ensure that you are not carrying out an arbitrage of this nature.”

Structures that involve ownership of intangibles will also have to adapt to the post-BEPS world.

Dinesh Kanabar, CEO, Dhruva Advisors

“There are two parts to the whole discussion. At this point of time intangibles are regarded as base, in the country in which they are legally owned subject obviously to meeting some of the substance requirement. What BEPS action plan is recommending is that it is irrelevant where the legal ownership rests. An intangible is required to be taxed in the jurisdiction where it is created.

So, if for example, we have got an example of an Indian pharmaceutical company, IT company which was developing a product and that product was done so to say, on an outsourced basis in India but the legal ownership was situated overseas in a low tax jurisdiction that it was possible to argue at this point of time that the ownership was there, the income was there, all that India as a developer is entitled to is merely the cost of development and an appropriate mark up but not really the profits arising from exploitation of the IP.

We are now moving to a regime to say where is the value created and which is the country which really bears the economic risk with regard to the creation and that is the country where such profits would be liable to tax. Therefore structures which are used to move IPR out into a lot cost jurisdiction may meet a very rigorous condition of substance and may actually fail.”

Menaka Doshi, CNBC-TV18

Net, net, will BEPS result in a higher effective tax rate for Indian Companies, especially Indian multinationals? The poll verdict is mixed.


KPMG’s Rohan Phatarphekar says yes “Possible as the Income attribution to India operations may increase”.

Ameet Patel disagrees. He says “The aim of the BEPS project is to avoid double non taxation as well as double taxation. Therefore, although this will increase the compliance burden on Indian companies, in the long run it will reduce the tax rates at which companies are being taxed in India.”

V. lakshmikumaran says “tax rates may increase but at the same time the Indian government has promised to reduce rates as well.”

Menaka Doshi, CNBC-TV18

While Finance Minister Arun Jaitley has welcomed OECD’S efforts and emphasised the need for genuine and equitable multilateralism how and when India aligns itself to the BEPS standards will the determine the changes we’ve discussed today and hence the ultimate impact on companies.

Finance Minister Arun Jaitley Press Note
‘…welcomed the efforts of OECD in areas of BEPS project and automatic exchange of information which have important implications for Commonwealth countries…Arun Jaitley  noted that India has been the beneficiary of these systems by getting vital information on tax evasion and emphasized the need for genuine and equitable multilateralism in deciding global norms and standards on taxation’.

Rohan Shah, Managing Partner, ELP

“How much do we really decide to take on and what form do we take it on. The second is we have often seen that there are global laws but India tends to give some of these issues a very municipal and very local interpretation. If that is what India is still going to do then there will be a concern because every time our administrators have had latitude the results have not been spectacular for the entirety of business community. So, that will be one of the concerns and lastly my concern is how is this going to impact other taxes because for example intangibles we are already seeing that it has almost a co-equivalent impact in both transfer pricing and customs valuation.

So, as we move forward in terms of direct taxes in that realm how will this impact indirect taxes will also to me be a concern because many of these issues directly will have the propensity to shoot up the burden of indirect taxes.

Menaka Doshi, CNBC-TV18

There’s also the issue of different speeds of adoption by countries across the world. The move to eliminate double non-taxation shouldn’t result in double taxation.

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