India Tax in a post-Base Erosion and Profit Shifting world
The Base Erosion and Profit Shifting (BEPS) project, a joint initiative between G20 countries and the OECD, works towards the development of a coherent global taxation system which addresses BEPS concerns. The main purpose of such initiative is to address the gaps in the current international tax rules relating to arrangements that achieve no or low taxation by shifting profits away from the jurisdictions where the activities creating profits takes place.
The OECD has released its final reports for the 15 Actions on 05 October 2015. India has actively participated and contributed in this process. The Government of India, in its response to the UN questionnaire on country experience regarding BEPS issues, had identified the following as common practices of BEPS in India: i) Shifting of profits by aggressive transfer pricing by way of payments to foreign affiliated companies ii) Non Taxation of digital economy in country of source iii) Treaty Shopping and iv) Artificial avoidance of PE status. The OECD reports largely address these practices through the following actions.
Action 8-10 & 13: The reports looks to tackle the aggressive transfer pricing methods adopted by taxpayers by transferring risks among, or allocating excessive capital to group members. The amended guidance on applying the arm’s length principle notably provides guidance on: i) the identification of the actual transaction, ii) what is meant by control of a risk, and iii) circumstances in which the actual transaction undertaken may be disregarded for transfer pricing purposes. Additionally, with the introduction of Master File and Country by Country report, Indian Tax Authorities now would have a larger pool of Information at hand, to help them in addressing BEPS concerns.
Action 1: While accepting that the digital economy is largely evolving into the economy itself, the OECD report has acknowledged that working on rules designed exclusively for the digital economy may be detrimental. However, towards addressing the concerns of the developing countries, modifications have been proposed to the definition of a Permanent Establishment and its list of exemptions, which may lead to formation of PE and taxation of allocable profits in the source countries.
Action 6: The BEPS report on Action 6 seems to reciprocate the thoughts of the Government of India with regard to addressing treaty shopping. The report proposes a “minimum standard” commitment from the Countries, with a goal to address “Treaty shopping” and other conduit arrangements aimed towards the abuse of treaty provisions. This commitment requires all countries to introduce an express statement in its treaties and adopt a variation of either or both, a LOB Rule (objective rules allowing benefits of a treaty to only qualifying persons) or/and a PPT rule (subjective rule based on a principal purpose test denying benefits of a treaty to an arrangement); What this spells, would be increased focus of the Government of India to renegotiate its tax treaties to avoid double non taxation and restrict treaty benefits to situation of treaty shopping and conduit arrangements.
Action 7: The OECD report on Action 7 seeks to address arrangements by tax payers to artificially avoid formation of PE in a country of source by way of measures as mentioned above relating to Action Plan 1 and 6. Such recommendation, leads to the objective addressal of certain specific PE Avoidance measures (through the proposed amendment to the definition of a Permanent Establishment and its list of exemptions), while also dealing with other possible measures (through the subjective PPT rule). The Revenue may welcome the increase in tax base of taxable business operations by the formation of a PE in India.
Such recommendations that resonate with its thoughts on prevention of BEPS should be welcomed by the Government. Combined with the global and fully reciprocal implementation of the Common Reporting Standards on Automatic Exchange of Information, the tools at the disposal of the Government would improve its abilities at prevention of international tax avoidance.
Obliged with the commitments extended as a G20 member sponsoring OECD’s BEPS project the Government of India may adopt measures and propose legislative measures to address aggressive transfer pricing strategies and tax treaty abuse. Tax payers may be driven to relook at their supply chains, holding and financing structures to determine if they can continue to stand unchallenged in the emerging paradigm. The Government of India should undertake to further deliberate the recommendations with stakeholders, to ensure their amicable integration into the Indian tax and economic scenario. The Governments’ past commitment to improve its competitiveness should be kept in perspective when considering its next course of action towards creating a tax environment coherent with international practices.