Does ‘BEPS’ address developing country issues?
In 2013, the 39th G8 summit in Lough Erne committed to reform the international tax system. The G8 Lough Erne Declaration stated that such reforms would benefit developing countries. The G20 declaration in St Petersburg 2013 also stated specifically that “Developing countries should be able to reap the benefits of a more transparent international tax system”.
As a result of these commitments, the G8 and G20 mandated a process to address the tax avoidance techniques of base erosion and profit shifting. The result was the Base Erosion and Profit-Shifting project (“BEPS project”) which is led by the Organisation for Economic Cooperation and Development (“OECD”), a 34-member body dominated by some of the world’s developed countries.
After two years, on October 5, 2015, the OECD’s Centre for Tax Policy and Administration has published 15 detailed set of recommendations as Action Plans covering areas like complex tax avoidance structures, tax havens, transfer pricing, accessibility of information to tax authorities, etc. These recommendations are meant to be implemented in three ways i.e. by a new multilateral agreement, by updating the OECD’s own guidelines and by changes to local tax laws.
While the BEPS project has created an expectation of transformation and some valid reforms may arise out of it, however, one has to stand back and probe critically what has been achieved and what is yet to be achieved. BEPS project, in its current state, may not curb the deep-rooted issues in International taxation especially the resident versus source rule as the purpose is to address profit shift and not tax allocating rights. In fact developed countries do not want any change in the classic rules as their belief is this would bring more chaos and hardly any clarity. To this extent the BEPS project will not address developing countries issue on tax allocating rights! The BEPS project has its short comings and notable concerns of the developing countries like tax competition, harmful tax practices and the balance between source and residence taxation remains outside the agenda.
Not every deductible payment is “base-eroding” nor does every inter-company transaction result in “profit-shifting”, however, it cannot be denied that one of the most prevalent ways of base erosion in developing countries including India is through excessive payments to foreign affiliated companies in respect of interest, service charges, management and technical fees and royalties. Multinationals claim big tax deductions in source countries for such inter-company payments.
While BEPS project suggest that where it is not certain that a resident country will tax income, the source country can tax it. However, BEPS project emphasises on the need for a general principle that income not taxed in one jurisdiction must be taxed in another. Under Action Plan 4, the proposal on tax deductibility of interest allows a wide range of exceptions like interest cap within a suggested band or using apportioned interest cost which has turned out to provide ample scope for interpretation and tax planning. Further, the recommendations for countering base erosion through excessive payment towards royalties and management fees, under Action Plan 8 and 10, are also quite underwhelming and fail to impress the developing nations.
Talking about digital economy, emerging economies like India provide huge market for the digital economy, however, digital enterprises shell out zero or low tax because of the principle of residence based taxation as against source-based taxation. Since the leading players in the digital sphere like Amazon or Google are not tax residents in India and other source countries, profits sourced from these countries may not suffer full tax except for domestic laws which levy a source based tax on payments similar to section 195 of the Income-tax Act, 1961. Thus, significant base erosion is caused by the inadequacy of existing international tax rules to allocate profits to countries from where these profits are sourced. The BEPS project, Action Plan 1 is inefficient and inadequate in dealing with the rigors of digital economy, so to this extent it is work in progress.
The information about business activities, profits and taxes paid per country is important for tax authorities to do a risk assessment. While the OECD has made a step towards generating such information under its Action Plan 13, it does not go far enough.
The OECD proposes that only very large companies with a turnover above €750 million should have to produce such report, while in developing countries, multinationals below this threshold may still be among the large foreign investors. Besides, the Country-by-Country report would have to be filed only with the tax authority of the country where the company has its headquarters. Other countries will have to rely on information exchange to get the reported data, which is likely to make the system very complex and less efficient. Most developing countries will not get this information at all because either they will not be able to comply with the rigorous conditions required for automatic exchange of information or they do not have tax agreements in place that provide the legal basis for the exchange of confidential tax information.
While developing countries could certainly benefit from disclosure of aggressive tax planning arrangements under Action Plan 12, however, tax planning arrangements are devised and implemented to a large degree from central offices, with only limited details being available in subsidiaries. This can create a challenge in disclosure. Many developing countries will not have access to such information as this has not been accepted as a minimum standard of reporting but as best practice disclosure!
Tax base erosion also takes place on account of tax giveaways. In an effort to attract FDI, many countries are engaging in ‘Tax Competition’. Tax competition is a process by which countries use tax breaks and subsidies to attract investment without a proper cost/benefit analysis. In response to competitive pressures they cut taxes on wealthy individuals or on corporations and then make up the difference by hiking taxes on poorer sections of society thereby fuelling the Inequality. For India revenue lost due to tax incentives to attract FDI amounted to 5.7 per cent of GDP in the financial year 2012-13. The developing countries must review all their tax incentives and scrap those whose benefit to the society does not justify the tax forgone!
One of the major concerns from the point of view of developing countries is regarding the approach adopted for making dispute resolution mechanisms more effective which includes introduction of mandatory and binding arbitration in the Mutual Agreement Procedure (“MAP”) under Tax Treaties. A view strongly expressed is that this may impact the sovereign rights of developing countries, which however is legally debatable and also limit the ability of the developing countries to apply their domestic laws for taxing non-residents and foreign companies. India has expressed reservations on mandatory and binding MAP arbitration and hence this might be a stumbling block on MAP disagreements. Hope to see some changes to this position in the years to come.
Further, tax base erosion takes place by multinational adopting strategies to avoid tax paid when assets situated in source countries are sold owned by companies located in low tax jurisdictions with no substance. Here we could say that, India has taken the lead position by amending its domestic tax laws to tax such “indirect transfers” after the famous/infamous Vodafone ruling !
While India is on the governing Board of the OECD’s Development Centre it has been actively questioning the OECD’s dominance on tax matters. Minister of State for Finance from Indian Government, at the G-20 Finance Ministers’ Meeting on International Tax in Cairns, in 2014, stated that while India support the BEPS Project, however it is necessary to underline that the concerns of developing countries regarding BEPS may be different from those of developed countries and that the said concerns are required to be taken on board in a more consultative manner, while developing consensus on the various issues. Probably here there is the need for United Nations to get its acts together.
Similarly, in 2012 a strongly worded letter from India was written to the Financing for Development Office, United Nations Department of Economic and Social Affairs, stating that the OECD Model Tax conventions and OECD Transfer Pricing guidelines has been developed on the basis of consensus arrived by the government of 34 countries (all developed countries) and that these guidelines only protect the interest of the OECD countries which are parties to such convention. The letter further states that “It is inconceivable as to how a standard developed by Government of only 34 countries can be accepted by Governments of other countries as a ‘standard’ of sharing of revenue on international transactions between source and resident country particularly when it only take care of the interest of developed countries and has seriously restricted the taxing power of source country”.
Having said that, Action Points 8, 9 and 10 would indeed help developing countries such as India as the traditional concept of “risk and rewards” goes together is getting rewritten. Now that BEPS report talks of value creation, this should help developing countries to get a larger share of the pie depending on the value created in the countries. It is to be seen how countries like India would go on this by way of amendment to its domestic laws i.e. profit-split or apportionment !
Regardless of the outcome of the BEPS project, the international taxation landscape in India is slowly shifting. To curb shifting of profits out of India through transfer pricing, India has developed a robust transfer pricing audit system over the last decade. The system has made notable progress and has resulted in curbing any aggressive transfer pricing approach adopted by multinationals. Moreover, the Indian judicial system and the alternative dispute resolution mechanisms [APAs, Safe Harbours, etc.] are there to ensure moderation and reasonableness in transfer pricing outcomes, which we see is working now and this should address the stated objectives.
The General Anti-Avoidance Rules have been introduced in the Income-tax Act, 1961 and the same shall apply with effect from 1st April, 2017 in respect of the tax benefit obtained from an arrangement and the said arrangement, subject to certain conditions, may be declared to be an impermissible avoidance arrangement. It needs to be seen that this does not become an impediment in making India an attractive investment destination.
While India, just as other developing countries, is progressively protecting its share of taxes, however, this will not be enough to keep up with the pace of global tax norms that are being rewritten by the OECD. It would be interesting to witness how the future will unfold whether the developing countries and low income countries will accept the hegemony of the OECD on global tax practices or flex their muscles and commit towards a second generation of tax policies realignment on a truly genuine global forum like the United Nations Organisation.
However, for time being we should complement the OECD and G-20 countries which has agreed on a consensus approach to address the problem of profit shifting within a very short time frame and that by itself can be hailed as a great achievement.