The Base Erosion and Profit Shifting (BEPS) project represents a number of coordinated actions agreed upon by several countries, intended to avoid double “non-taxation” that comes to be when companies take recourse in tax treaties. However, its implementation and consequences go well beyond that and touch aspects of businesses that require multinational enterprises (MNEs) to draw up a different set of strategies and restructure operating models. The BEPS project is a response to several developments in the global economy that existing tax treaties had not envisaged, in addition to the overarching nature of the technological advances that allowed MNEs to conduct their businesses legitimately without significant presence on ground represented by people functions. In the process, MNEs could take advantage of fiscal incentives provided by certain countries and retain the share of profits in such jurisdictions, not having to pay taxes where a majority of customers would transact with them digitally across jurisdictions, or structuring transactions by way of capital structures that allowed excessive deductions for cost of financing.
The 15 Actions arising out of BEPS are built on pillars of coherence, substance and transparency and rest on the foundations of the digital economy that represents the ecosystem and the multilateral instrument that breathes life into these actions. The BEPS Actions and, indeed, the MLI are characterised by a resolve by the OECD member countries and the G-20 nations to work in coordination in implementing the measures, that have been formulated and legislated globally in a record time of about 36 months. Certain BEPS actions are more pronounced than others in the impact they have on MNE decision-making in terms of how they do business and in terms of information exchange that MNEs would have to be aware of, as they have the effect of eliminating asymmetry between MNEs and Revenue and, in fact, within Revenue. Turning to BEPS actions that impact decision-making for businesses, particularly in India, one of the most far-reaching actions is that of interest limitation. By placing a ceiling of 30% of ebitda on interest deduction, in respect of borrowings from or borrowings guaranteed by associated enterprises, MNEs will have to reconsider their capital structures, so as to either stay within this limit, or structure the debt in a manner that the interest can be effectively absorbed by the ebitda over a period of eight years. This is a matter of concern for MNEs engaged in capital-intensive businesses, such as infrastructure, that are the backbone of developing economies.
Equalisation levy is a measure introduced by India in response to the digital economy. To this end, Australia and the UK have introduced diverted profits tax. The scope of equalisation levy, charged at the rate of 6% on specified services, presently extends to payments made for online advertising and operates as a deduction from the consideration paid to non-resident e-commerce companies to put them on an even keel with residents; however, it is non-creditable under tax treaties. The scope of services under equalisation levy could increase to include cloud services, for instance, and MNEs have to therefore factor this as a cost for doing business in India. Transfer-pricing aims at structuring transactions between enterprises within the MNE group as if they had been between unrelated parties in uncontrolled conditions. There are a raft of transfer-pricing measures that set up booby traps to prevent MNEs from following intra-group transaction structures that disconnect actual functions performed from the assumption of risk and control of capital. Focused on aligning outcomes with value-creation, these measures include the substitution of post-facto results in place of forecast projections in case of hard-to-value intangibles if the deviations exceed 20%, providing for a risk-free return on capital where the principal is not engaged in active control of the risk associated with a function that is performed by another associated enterprise, definition of low-value services that could qualify for safe harbor markups upto 5%, cost contribution arrangements that are to be commensurate with benefits derived by participants and the proposal for the commodity price method.
Structuring inter-company arrangements, especially involving intangibles, and equally importantly, determining compensation for such transactions, will require MNEs to establish nexus of the functional analysis with the risks and rewards across the value-chain. Which brings up the topic of implications for business on account of information exchange. Country by country reporting (CBCR) and the maintenance of three-tier documentation will provide revenue authorities across the globe “world-on-a-page” profile of the MNE.
Taken together with the compulsory exchange of rulings entered into by MNEs with revenue authorities, these measures will call into question anomalies that stand out and can be detected by analytics, such as revenues and profits parked in low-tax jurisdictions bereft of a significant number of people; or low effective tax rates, borne out by revenues, pre-tax profits and income-taxes paid and accrued; or the quality of earnings, evident from the revenues and the nature of activity. The CBCR is intended to be used as a risk-assessment tool, but its widespread usage and the possibility of making it public in the European Union, could make it a bone of contention for Revenue authorities, leading upto disputes on transfer-pricing or characterisation by adopting profit-split or similar approaches, in line with the principle that enterprises should pay tax where they actually make profits.
The CBCR is intended to be used as a risk-assessment tool, but its widespread usage and the possibility of making it public in the European Union, could make it a bone of contention for Revenue authorities, leading upto disputes on transfer-pricing or characterisation by adopting profit-split or similar approaches, in line with the principle that enterprises should pay tax where they actually make profits.
Businesses have to therefore brace for more controversy in the wake of BEPS, and the unique construct of the MLI—that is to be read alongside existing treaties for the implementation of BEPS—to that end, facilitates dispute resolution by way of mutual agreement procedures. BEPS is a double-edged sword that promises to usher in an era of cooperative competition among Revenue authorities by eliminating harmful tax practices and treaty abuse, while requiring MNE businesses to re-calibrate their geographical presence, asset-allocation and people-deployment strategies in light of this new reality.
-Suchint Majmudar: Partner, BMR & Associates LLP Views are personal