Column: Tackling profit-shifting
After years of failing efforts to spur the economy through spending and tax hikes, the developed countries tightened their belts against the perceived flaws in the international tax rules. These countries, which earlier supported globalisation, soon echoed the cries, of the developing countries, stemming from Base Erosion and Profit Shifting (BEPS) by multinational companies. BEPS is essentially tax avoidance through the shifting of a company’s activities to a low- or a no-tax jurisdiction. The Organisation for Economic Co-operation and Development (OECD), at the behest of the G20, unveiled a 15-point action plan, to combat BEPS, in July 2013.
Interestingly, India and other BRIC countries which are part of G20 are placed on an equal footing with the OECD-member nations for the BEPS project. Recently, the OECD released discussion drafts on some key aspects, including challenges in taxing the digital economy, prevention of treaty abuse and transfer pricing documentation.
Taxation of e-commerce: For e-commerce, tax authorities globally are grappling with the issue of the taxing rights of source country versus the resident country and the relevance of the Permanent Establishment (PE) definition where there is no physical presence of the entity.
The OECD’s discussion draft proposes to do away with the general exclusion of the preparatory and auxiliary activities from the definition of a fixed-place PE because many such activities constitute core activities in the digital world. A new nexus—economic presence PE—is proposed, which covers the significant digital presence of an enterprise engaged in fully dematerialised digital activity. Use of data from customers in another country or place of conclusion of contracts or consumption and payment for such digital products could be the new basis for taxation. This may be a paradigm-shift in the thinking about PE.
Concepts like a PE being created by the presence of a website or a server in another country or where conclusion of contracts is dependent on technology instead of a person are also proposed. India’s reservations against the OECD commentary and the approach of its judiciary is gaining wider acceptance.
Prevention of treaty abuse: The BEPS project addresses ‘treaty abuse’, for purposes of double non-taxation, by shell and conduit companies . The endeavour is to develop model treaty provisions and recommendations for anti-avoidance rules that can be incorporated in the domestic tax laws to restore source taxation in several situations. The discussion draft calls for three levels of checks—inclusion in the tax treaties
of a limitation of benefits (LOB) clause preventing companies from availing the benefits of tax treaties until they have fulfilled certain substance requirements, a ‘main purpose’ anti-abuse test which seeks to deny treaty benefits if one of the main purposes is to obtain tax benefits and domestic general anti-avoidance rules (GAAR).
The LOB clause may spell the death of many intermediate holding companies which lack substance and have been interposed only to avail tax benefits. Investments from countries like Mauritius, which ultimately results in double non-taxation of capital gains, is likely to be affected. The domestic GAAR rules of certain countries, including India, have a ‘dominant purpose’ test instead of a ‘main purpose’ test. While the inclusion of the LOB clause in the tax treaties may deliver greater certainty, the ‘main purpose’ anti-abuse rule is likely to impact international business. The portfolio investors, already vexed by Indian GAAR, will be dumbfounded if the ‘main purpose’ rule in the tax treaty isn’t tamed to mirror the Indian GAAR.
Transfer pricing (TP): The BEPS project also has many measures to battle TP issues, including the requirement of uniform TP documentation in order to enhance transparency of the tax administration. MNCs are required to provide information regarding global allocation of income, economic activity and taxes paid in the interest of transparency and substance. The OECD proposes hastening the implementation of these proposals , which will place a significant implementation and compliance burden on the taxpayers. Consultation with the stakeholders to gain consensus would aid MNCs on the radar of the Indian revenue.
Mutual agreement procedure (MAP): To bolster MAP, the OECD is seeking to provide more robust ways to resolve disputes. The challenge, however, remains whether the jurisdictions can be persuaded to follow them.
The final action plan of the BEPS project focuses on the development of a multilateral instrument which would override existing treaties or alter a number of them in one go, and would make it much easier for jurisdictions to implement the necessary changes. Though the idea of a multilateral instrument is novel, each country would have to undergo an adoption process which may not be straightforward, particularly if it affects the country’s sovereign right to tax.
The implementation of the action plan instigates significant changes to the OECD model convention, commentaries, tax treaties, domestic tax laws, etc. While the OECD addresses BEPS in an organised and systematic manner, it will be the
responsibility of individual nations to collaborate and agree upon the recommendations. The final action plans are expected to be rolled out by 2014/2015. Whatever may be the outcome, the BEPS project will undoubtedly have an amplified effect on the behaviour of the Indian tax authorities and may potentially be a game changer for cross-border trade. It is imperative that companies should analyse the potential impact of the BEPS project and ponder on the need for any potential re-alignment in their structures. The developments emerging at the
September 2014 G20 meeting in Australia should be closely monitored.