Synopsis
Base Erosion and Profit Shifting (BEPS), a term coined by OECD, proposes 13 action plans to address important issues which the world is facing and/or may face in the field of international taxation and transfer pricing in this decade. BEPS refers to tax planning strategies that exploit gaps and mismatches in tax rules to make profits ‘disappear’ for tax purposes or to shift profits to locations where there is little or no real activity but taxes are low resulting in little or no overall corporate tax being paid. The learned authors vide this article provide insights on BEPS, its action plans and impact on India.
“Base Erosion and Profit Shifting” (BEPS) is a buzz term or expression these days in the arena of International Taxation. What is BEPS? Why do we need to study it? How does it affect us? Why G20 Nations vigorously pursue it? What is the role of OECD in BEPS? These and many other questions naturally arise in readers’ mind. This write-up attempts to put across the concept of BEPS and recent developments in this regard.
Introduction
Developments in national tax laws have not kept pace with developments in global businesses and technology. Physical presence based taxation in traditional ways is simply not adequate to cover all situations of business where the determination of source of income and the tax residence of an entity itself is a challenge. E-commerce or digital economy has changed the ways in which we used to transact businesses. Today, we live in a virtual global village. This, coupled with skewed development of the world economy, where developed countries are worried about the erosion in their tax base, whereas developing countries are more concerned about investments, technology and job creations, compel countries to adopt different tax systems or rules. Differences in tax systems pose challenges to Multi National Enterprises (MNEs) as well as provide an opportunity for tax planning. Proliferation of tax havens and low-tax jurisdictions over the past few decades have only helped MNEs to lower their tax incidence further.
In February 2013, OECD published its report ‘Addressing Base Erosion and Profit Shifting’ which has been a subject matter of much discussion on this topic.
BEPS
Base Erosion and Profit Shifting, (BEPS) in simple words means either erosion of base by claiming dubious allowances/deductions or shifting of profits from a high tax jurisdiction to a low tax jurisdiction/ tax haven by using gaps in the tax laws of the high tax jurisdiction. The FAQ on the OECD website on BEPS gives following meaning:-
“Base erosion and profit shifting (BEPS) refers to tax planning strategies that exploit gaps and mismatches in tax rules to make profits ‘disappear’ for tax purposes or to shift profits to locations where there is little or no real activity but the taxes are low resulting in little or no overall corporate tax being paid.”
Thus, BEPS poses serious questions concerning fairness and equity as MNEs are able to reduce their tax liability through various means, whereas individuals or SMEs (Small and Medium Enterprises) bear the brunt of higher taxes. This discourages voluntary compliance on the part of both individuals and SMEs.
It is said “tax” is an obligation in the home country and a cost in the host country. MNEs try to reduce cost to increase profitability. If MNEs pay the full rate of tax in one country, then also it may not be of much concern, but in reality “some multinationals end up paying as little as 5% in corporate taxes, when smaller businesses are paying up to 30%”. Even though MNEs may be resorting to legal ways to exploit gaps in tax systems of home and host countries, resulting in BEPS, it creates wider economic risks as resources of countries are depleted which may be used for generating employment and other social projects.
BEPS and OECD
BEPS is the result of aggressive tax planning. The OECD has been providing solutions to tackle aggressive tax planning for years. According to OECD, BEPS is not a problem created by one or more specific companies (barring some cases of blatant abuse of tax laws) but is a result of inefficient tax rules. BEPS is the result of gaps arising due to interaction of domestic tax systems of different countries and therefor, unilateral action by any one country will not be able to solve the problem. Therefore, OECD has put in place “BEPS Action Plan” with a view to provide a consensusbased plan to address the issue.
BEPS Action Plan by OECD
OECD’s Action Plan on BEPS will address the issue in a comprehensive and co-ordinated way. These actions will result in fundamental changes to the international tax standards and are based on three core principles, namely, (i) coherence (ii) substance and (iii) transparency. OECD plans to work towards elimination of double non-taxation through BEPS Action Plan and also elimination of double taxation through and including increased efficiency of Mutual Agreement Procedure (MAP) and Arbitration.
BEPS and G20 Nations
OECD’s initiative and work on BEPS has been strongly supported by G20 Nations. Key member countries of G20 which are not part of OECD (i.e. Argentina, Brazil, China, India, Indonesia, Russia, Saudi Arabia and South Africa) were also involved in work related to BEPS, as they all participated in the meeting of the Committee on Fiscal Affairs where the Action Plan was adopted. In order to facilitate greater involvement of non-OECD economies in the ‘BEPS Project’, G20 countries who are not OECD Members will participate in the BEPS project on an equal footing. Other non-G20 and non-OECD members may be invited to participate on an ad hoc basis. The idea seems to be to make the BEPS Action Plan as broad-based as possible so that the Plan becomes effective and practical. India is part of G20 Nations as well as an observer country at OECD and it has actively participated in BEPS Project so far.
BEPS and Double Non-taxation
Countries enter into bilateral agreements with each other in order to avoid double taxation of income and to prevent tax evasion. However, more often than not, MNEs are able to structure their affairs in a manner that the income is not taxed either in home or in a host country and goes totally taxfree resulting into “Double Non-taxation.” Double non-taxation could be a result of aggressive tax planning, hybrid mismatches etc. The focus of BEPS Project is on avoidance of double non-taxation. Double non-taxation may be a result of interaction of domestic tax laws and international tax laws. It may be perfectly legitimate as well. For example, a Mauritius Company deriving dividend income from India or earning capital gains on sale of securities in India would not be paying any tax in India and generally not taxed Mauritius. It would be interesting to see how BEPS Action Plan tackles such issues.
BEPS and India
In India whether tax treaties can result in ‘double non-taxation’ is an issue debated over a number of years. As stated earlier, tax can be a powerful tool for attracting foreign investments. India being a developing country, its priority is to attract for- eign investment and technology for its economic development. Section 90 of the Income-tax Act, 1961 [the Act] was amended vide the Finance Act, 2003 with effect from 1st April 2004 to pro- vide that the Central Government may enter into agreement with foreign governments to promote mutual economic relations, trade and investment. These objectives are also in line with objectives of bilateral tax conventions as laid down by the United Nations.
Keeping in mind the above objectives, it appears that India’s tax treaties with UAE, Malta, Kuwait, Cyprus, Luxembourg etc. have been entered for the purpose of attracting foreign investments than avoiding double taxation. In M.A. Rafik’s case AAR No. 206 of 1994, 213 ITR 317 which related to India- UAETax Treaty, the Authority for Advance Ruling (AAR) observed that “India is also in the process of looking out for foreign countries interested in investing in India and must have considered the DTAA as providing an opportunity to improve the economic relations between the two countries and to encourage the flow of funds from Dubai”. In its subsequent Rulings, applicability of India- UAE Tax Treaty to UAE residents was upheld by AAR. The Supreme Court, in case of UOI (Union of India) vs. Azadi Bachao Andolan (2003) 263 ITR 706, held that ‘the preamble to the Indo-Mauritius Double Tax Avoidance Convention (DTAC) recites that it is for the encouragement of mutual trade and investment’ and this aspect of the matter cannot be lost sight of while interpreting the treaty provisions. These observations were very significant, whereby the Apex Court upheld the economic considerations as one of the objectives of a Tax treaty.
The dissenting judgement by AAR in case of Cyril Pereira (1999) 239 ITR 650 stated that DTAA is not a device for evasion of the only tax imposed by a country on the income of the person resident in the another country. In other words, provisions of DTAA cannot result in Double Non-Taxation. However, the said argument was discarded by the Supreme Court in its subsequent ruling in case of Azadi Bachao Andolan. Recently, the Apex Court in case of Vodafone followed the approach of ‘look at rather than look through’ any transaction and interpreted provisions of the Income Tax Act more liberally in favour of the taxpayer. In essence, it gave weightage to the ‘form’ of a transaction/entity rather than ‘substance’of it. In India, presently, the issue under debate is ‘whether one needs to look at the moral aspects while interpreting tax laws’. The opinion seems to be divided on the issue.
Coming to the trends in the Indian tax treaties, we find India encouraged tax sparing/exemption method by its treaty partner countries (developed nations) in respect of income arising to their resi- dents in India. This was done keeping in mind, that India is a net capital importing country. However, there is a perceptible change in India’s recent tax and treaty policy. India has introduced Article on Limitation of Benefits (LOB) in many of its tax treaties (for e.g. UAE, Singapore, etc.) to prevent their abuses. It is gathered that India is in the process of signing LOB articles with many other countries. Recently, India notified Cyprus as a non co–operative jurisdiction denying treaty benefits to residents of Cyprus. Recent tax treaties signed by India do not carry provisions of Tax sparing.
On the domestic tax front, India amended the definition of section 9 of the Act, pertaining to royalty with retrospective effect from 1st June 1976 to bring in ‘computer software’ within its ambit. It further amended the definition of section 9 to tax the indirect transfer of shares where the underlying value of shares were derived from the assets situated in India(to nullify the effect of Vodafone decision). India has tightened its tax policy of giving effect to tax treaties by providing mandatory submission oftax residency certificate for claiming treaty benefits. Section 206AA has been introduced making it mandatory to obtain PAN by non-residents. The domestic tax rate for royalty and FTS is substantially increased from 10 % to 25 %. India proposes to introduce GAAR provision with effect from 1st April 2016. From the above discussion, one can conclude that the Indian Government has taken several steps to prevent BEPS. However, Indian judiciary have been liberal in giving benefit to the tax payers for what may be called permissible tax avoidance within four corners of the law.
Conclusion
There is no doubt that BEPS is not good for any country. However, as pointed out by OECD, BEPS arises due to a variety of reasons and often, unintentional and/or due to legitimate tax planning. When developing countries resort to lower tax rates to attract foreign investment and technology, they are blamed to be supporting BEPS. On the other hand, certain low tax jurisdictions or so called tax heavens, are ruled by Developed Countries. Advocating home truths but not implementing the same in letter and spirit, is self-defeating and cannot promote a healthy order of growth and development.
Perhaps, we have to strike a balance between growth and taxation.
