The Organisation for Economic Co-operation and Development (OECD) released its final reports on Base Erosion and Profit Shifting (BEPS) on October 5, 2015. One Action Plan proposed in the report is Action Plan 12—Mandatory Disclosure Rules.

This addresses the challenges tax authorities face globally due to the lack of information on aggressive tax-planning strategies adopted by taxpayers. The objective is to increase transparency by providing the tax administration with early access to information regarding potentially tax aggressive or abusive schemes.

These Rules require reporting by taxpayers and third-parties (promoters, advisors and other intermediaries)
involved in formulation or implementation of tax planning schemes. Further, it specifies that reporting regime should include a mixture of generic and specific hallmarks, based on which taxpayers are required to report tax aggressive schemes.

Action Plan 12 further requires that information generated through such mandatory disclosure regimes be used to define the scope of these Rules and improve compliance.

Where India stands

The Indian tax regime is supported by an extensive reporting framework, formulated to ensure compliance. The tools used for such reporting are—tax audit reports, certification by auditor of tax positions and benefits availed, income tax returns requiring the disclosure of incentives, special treatment items, etc, availed by the taxpayer, independent certification of tax benefits and tax holidays availed of by taxpayers and a comprehensive withholding tax regime which assists in tracking the other half of the transaction symmetry. This is further supported by a robust audit environment, wherein a taxpayer is required to obtain certification from auditors on the veracity of the financial statements for any fiscal year.

The information gathered by Revenue forms the basis for scrutiny where the eligibility of taxpayers for tax benefits availed is evaluated and requisite adjustments are made.

Why India needs mandatory disclosure provisions

Though the reporting framework in India is comprehensive, it does not provide for structured methods of identification of aggressive schemes either at the ideation or implementation level.

This leads to post facto action, i.e., litigation, wherein a lot of time and costs are spent by Revenue and taxpayers both to resolve the issue of treatment of tax benefits and schemes already implemented. As a consequence, the recovery of taxes becomes a lengthy and painful process.

Therefore, Revenue is challenged by the lack of structured information on potentially aggressive or abusive tax schemes. Consequently, it is unable to respond to such tax risks swiftly through well-informed assessments, audits or change in legislations, where required.

Implementation challenges

Indian Revenue must ensure that any amendments or new regulations, to bring the country’s reporting regime in sync with Action Plan 12 must also safeguard the genuine interests of taxpayers. Revenue should ensure that reporting obligations are triggered only when the taxpayer or the third-party is in possession of the relevant information in the ordinary course of business. For instance, in the case of a large MNC, the Indian subsidiary party to a transaction may not be aware if the overall transaction triggers reporting requirements. Similarly, a third-party may be involved in a clinical aspect of the transaction without knowing the likely outcome. Likewise, parties involved in a transaction may not envisage the outcome during ideation, but it may become apparent at the end of the year.

Therefore, it is essential that regulations prescribed by the revenue authorities clearly define who may be regarded as ‘reporter’ and also prescribe guidelines on what would trigger mandatory reporting. Further, the legislations formulated must clearly prescribe the types of schemes requiring mandatory reporting—covering schemes in the areas of known risk as well as potential risks.

It is also imperative to lay down the content required to be reported for such schemes so as to ensure that the information is precise and does not cause burden of unnecessary compliances for the taxpayers. For instance, an issue may arise in a scheme involving tax benefits for different parties across various international jurisdictions wherein the involvement of the Indian party is limited and therefore domestic tax benefits may be nominal. In such scenarios, adequate care needs to be taken in prescribing reporting requirements in order to avoid undue hardship to the taxpayers.

With regard to non-compliance with disclosure requirements, Revenue may prescribe penalties, as is prevalent in the existing regime. In certain circumstances, non-compliance may also trigger regulatory sanctions by professional bodies. For example, where accountants or tax advisors are obligated to report a scheme, non-compliance may also trigger action from the professional body.

It is imperative to ensure that the regulations or amendments do not create any unnecessary burden on the taxpayer as this would adversely affect the business environment in India.

Further, it is necessary to keep in mind the General Anti-Avoidance Rules (GAAR) framework —with a similar objective—is to be introduced from FY18, though it is a post facto measure.

Going forward

It is essential that while formulating Mandatory Disclosure Requirements, Revenue clearly specifies the types of schemes and content required to be reported to ensure that no unnecessary compliance burden arises. Further, formulation of such schemes should be done with the intent of reducing tax litigation in these aspects so as to improve and preserve the ease of doing business in India.

Such reporting requirements should also be regularly reviewed and updated in order to analyse its effectiveness of with regard to curbing tax avoidance and reducing litigation. In this regard, IT-enabled methods and systems should be implemented in order to track triggering of reporting requirements so as to ensure adequate compliance and mitigating exposure to penalties. It is also imperative to bring higher level of maturity in tax functions of both taxpayers and Revenue, to deal with the commercial and reputational consequences as well as impact on the business environment in India due to disclosure requirements proposed.

The author is leader (direct tax), PwC India