BEPS - Base Erosion and Profit Shifting and the future of Global Taxes

As a tax observer, it'd be heartening for anyone to see that today, TAX is figured out as one of the top priority items on the agenda of Global Leaders - alongwith phenomenon like Terrorism and Global Warming. It certainly, is that Important! Resultantly, we see BEPS making head-lines across the World & emerging as one of the most keenly watched topics of present era. 

Base Erosion and Profit Shifting [as commonly referred to as BEPS] is a globally recognized phenomenon whereby using aggressive and (sophisticated) tax planning strategies, Multinational Enterprises are able to shift profits from high tax jurisdiction(s) to a low tax jurisdiction(s) for a (undue) tax advantage - there could be several ways to do this. BEPS, has eventually become a global phenomenon that could potentially rob-off the nations from their due share of taxes - a common concern shared by several world countries.

In order to address the above, the G20 nations sponsored the BEPS Project with an underlying idea to reshape the global tax policy - for moving towards a global tax system that would be (largely) fair and acceptable to different Countries, provide them their fair share of taxes & also do good to World economy.

The Organization for Economic Cooperation and Development [OECD] has been identified as the agency to execute this project. Till date (beginning from July 2013), the OECD has come out with a 15 action plans alongwith implementation framework - basis which all the countries are to adopt and modify their respective tax laws. Till now, several countries have carried out (major) amendments in thy tax laws in their attempt to align with the BEPS project.

India is one of the first countries to have adopted many such recommendations and in the last 2 Budgets of Indian Union Government, it has brought in several (unexpected) amendments in the tax laws.  It'd be certainly interesting to analyze where India stand amid all the aforesaid developments & euphoria, lets see : 

OECD has identified 15 action points to combat BEPS :

1.   Tax Challenges of Digital Economy; 

2.   Hybrid mis-match arrangements; 

3.   Strengthen CFC (Controlled Foreign Company) Rules; 

4.   Interest deductions and other financial payments; 

5.   Building Transparency and Substance; 

6.   Prevention of Treaty abuse; 

7.   Prevention of artificial PE avoidance; 

8.   Intangibles; 

9.   Risk and Capital; 

10. High risk transactions; 

11. Collection and Analysis of Data; 

12. Disclosure of aggressive tax planning arrangements by taxpayers; 

13. Transfer Pricing (TP) documentation; 

14. Effective dispute resolution mechanism;

15. Multi-lateral Instruments

Before we move ahead, let us keep in perspective the rationale of BEPS project - to create a tax framework globally whereby Businesses pay taxes in jurisdictions where the economic activities are performed and where the real value is created - to enable the countries get their fair tax piece.

Now, the above-mentioned items identified in the BEPS Project of OECD imply: 

1. On Digital economy, it is recommended to develop a virtual PE standard as an alternate but this is not concluded. It also aims to address issues such as VAT, CFC & artificial PE avoidance - India already has an aggressive source based approach to tax digital economy by treating websites as PE and may also increasingly characterize payment of digital goods as royalties and fee for technical services. 

2.  On hybrid mis-matches : it mainly targets towards hybrid instruments (having features of both debt and equity) such as funding through Compulsorily Convertible Debentures and also, hybrid entities or financial institutions [interposing an intermediate finance company leading to a hybrid mis-match];

3. CFC regulations : in the Indian context, the CFC got introduced as part of Direct tax code but never got implemented - has a close nexus with the Place of Effective Management (PoEM) provisions under the Indian Income-tax Act, 1961;

4. Interest and other financial payments : this action item seem to look at base erosion through use of internet and economically equivalent payments - measures to restrict interest payments up to a certain limit of EBITDA etc could be an alternative to curb this;

5. On Transparency and Substance : it could suggest substantial activity test to determine / freeze down tax ability in a particular situation. Also, to improve transparency through compulsory exchange of information / rulings;

6. Prevention of Tax Treaty abuse has certainly been a priority item for several countries. The mechanism employed for this could be to prevent treaty shopping and use of conduit companies. Also, to Promote Limitation of Benefits (LoB) in tax treaties, introduce Principal Purpose Test (PPT) and include in the tax treaties intention to avoid creation of opportunities for non-taxation;

7. Prevention of artificial avoidance of PE : In the Indian context, it would be fair to believe that India, through its extensive tax treaty network and position therein, interpretation followed in judicial rulings and India's stated position on OECD model convention, is already ahead of OECD on this.

8. Action points 8,9,10 and 13 deal with aspects to assure that transfer pricing outcomes are in line with value creation. It include special measures to ensure there are regulations to look through accrual of inappropriate returns due to one party's assuming certain risks, the Authorities have powers to re-characterize certain transactions and also a three tired approach to TP documentation;

9. On development of a multilateral instrument that would presumably bind the entire BEPS project, it charts out on one of the top priority items for several countries including India, since it would help in combating the tax treaty abuse;

10. On the other action items, the prime focus would be to derive a mechanism to have adequate disclosures of information from taxpayers, collation and sharing of data by the respective tax authorities and have a well developed dispute settlement system in place

India is a member of the G20 Country club and thus, bound by the final BEPS recommendations. India, though a non-OECD member, but has a history of a working relationship and value its association with OECD. India is also a signatory to the SAARC limited multilateral agreement on avoidance of Double Tax Avoidance and Mutual Administrative Assistance in Tax Matters and consented on automatic exchange of information.

The (major) amendments brought in by India in its tax laws to align itself with the BEPS project over the last couple of years could be :

- Introduction of FATCA;

- Implementation of Place of Effective Management [PoEM] concept - akin to CFC rules;

- Implementation of GAAR (from FY 2017-18);

- Introduction of Equalization levy;

- Introduction of Thin Capitalisation from FY 2017-18 wherein deduction of interest payments to a
  foreign AE (in prescribed conditions) is restricted to 30% of payer's EBITDA and carry forward of     excess to 8 subsequent years;

- TP documentation procedures and Country-by-Country Reporting [basis some prescribed limits][;

- addition of Limitation of Benefit (LoB) clause in several Double Tax Avoidance Agreements; 

Certainly, we do expect and look forward to some more changes in future. This apart, Indian tax laws are already ahead of some of the above-mentioned recommendations.

Interestingly, on the acceptability / governance of BEPS recommendations, a reference can also be drawn from the Indian Judicial Precedents such as : Baker Hughes Singapore Pte. Ltd [TS-214-ITAT-2015(Del)] wherein the Hon'ble ITAT observed that BEPS is merely a tax policy consideration for law making and has no role in judicial process and that the judicial process will infringe neutrality if it is to be swayed by such policy considerations.

In view of the aforesaid, it would be right to believe that BEPS will continue to hold a lot of rigor in its store and will continue to surprise us in near future. Businesses must take note of developments in and around BEPS Project and (without an option) must keep a sharp eye hereon. It wont be an exaggeration if we were to believe that in today's business decisions (particularly involving the foreign dealings), a serious and proper consideration MUST be given to BEPS and its likely impact.