Daily Current Affairs – 13th January, 2016DEVENDRA VISHWAKARMA
Gear up for changes in tax laws, treaties
- The international community led by the G20 had initiated the Base Erosion and Profit Shifting (BEPS) project a few years ago with the aim of ensuring that profits are taxed where economic activities are performed and where value is created.
- Governments, tax authorities and social groups have been voicing their concern over the past decade that multinational enterprises are shifting profits to low tax jurisdictions where there is no or little value-creation, and consequently not paying their fair share of taxes.
- As a member of the G20, India is an active participant in the BEPS project.
What is BEPS?
- Base Erosion and Profit Shifting (BEPS) refers to tax planning strategies that exploit these gaps and mismatches in tax rules to artificially shift profits to low or no-tax locations where there is little or no economic activity, resulting in little or no overall corporate tax being paid.
- BEPS is of major significance for developing countries due to their heavy reliance on corporate income tax, particularly from multinational enterprises (MNEs).
Research undertaken since 2013 confirms the potential magnitude of the BEPS problem. Estimates conservatively indicate annual losses of anywhere from 4 – 10% of global corporate income tax (CIT) revenues, i.e. USD 100 to 240 billion annually.
The most common practices and structures identified by India from a BEPS perspective are:
- Excessive payments to foreign-affiliated companies in respect of interest, service charges and royalties;
- Aggressive transfer pricing, including supply chain restructuring that contractually allocates risks and profits to affiliated companies in low tax jurisdictions;
- Digital enterprises facing zero or no taxation in view of the principle of residence-based taxation;
- Treaty shopping;
- Incentives in the tax laws for attracting investment; and
- Assets situated in India but owned by companies located in low tax jurisdictions with no substance.
What should India do?
- To implement BEPS actions around these issues, India is likely to amend its domestic tax law as well as tax treaties (either through the multilateral instrument being developed as part of the BEPS project, or bilaterally).
- It is important that taxpayers take note of these developments and prepare accordingly.
- The new BEPS guidance will have a significant impact on Indian taxpayers.
- Taxpayers need to be aware of and constantly monitor the ongoing BEPS Action Plans as well as the changes that India is bringing about in its domestic law and tax treaties.
- Transfer pricing:
- Transfer pricing is the practice of setting up prices for trading valuables between two entities across different tax jurisdictions.
- The valuables can be tangibles, intangibles, services and financial transactions and the entities can be company divisions and departments, or parent companies and its subsidiaries.
For Example: When a US-based subsidiary of Coca-Cola, buys something from a French-based subsidiary of Coca-Cola. When the parties establish a price for the transaction, this is transfer pricing.
- Transfer pricing is not, in itself, illegal or necessarily abusive.
The Arm’s Length principle:
- If two unrelated companies trade with each other, a market price for the transaction will generally result.
- This is known as “arms-length” trading, because it is the product of genuine negotiation in a market.
- This arm’s length price is usually considered to be acceptable for tax purposes.
- But when two related companies trade with each other, they may wish to artificially distort the price at which the trade is recorded, to minimise the overall tax bill.
- This might, for example, help it record as much of its profit as possible in a tax haven with low or zero taxes.
- This is when transfer pricing becomes illegal or abusive.
- Treaty shopping:
- The practice of structuring a multinational business to take advantage of more favourable tax treaties available in certain jurisdictions.
- A business that resides in a home country that doesn’t have a tax treaty with the source country from which it receives income can establish an operation in a second source country that does have a favorable tax treaty in order to minimize its tax liability with the home country.
- Most countries have established anti-treaty shopping laws to circumvent the practice.
India has now initiated the process of renegotiating some of its existing bilateral tax treaties to combat treaty shopping by inserting anti-abuse rules.