With BEPS, tax havens will be viewed differently
With the final details of the OECD’s BEPS initiative—Base Erosion and Profit Shifting—out, the taxman’s ability to tax international transactions as well as those of foreign firms operating in India will go up dramatically; the idea behind the initiative is to treat all cross-border transactions in the same manner across countries. Immediately, once the agreement on preventing treaty abuse is ratified by various countries, for instance, a country like Mauritius will simply have to accept renegotiating the treaty with India—G-20 ministers will discuss this in Lima on October 8.
India has, for a long time, been wanting to renegotiate the treaty for ‘limitation of benefits’, to ensure that only genuine residents of Mauritius get treaty benefits as opposed to the current situation where any firm can avail of this provided the Mauritius taxman gives it a residency certificate—under BEPS, the taxman can examine whether effective management of a firm is actually in Mauritius or whether its directors are ordinarily resident there; if the taxman is not satisfied, the tax benefit can be denied. This is what the taxman is prevented from doing due to the Supreme Court judgment in the Azadi Bachao Andolan case. Of course, what position India takes will also be determined by what happens to inflows from FIIs that come in through the Mauritius route.
Similarly, the draft proposal on country-by-country reporting requires MNCs to file with each tax jurisdiction the details of the drivers of its business and the value addition in each one. As a result, in the case of a pharma MNC operating out of India, for instance, the taxman will now know how much value addition is being generated in different countries—so, for instance, the taxman can question why the R&D centre in Malaysia, say, is showing a lot more value addition than the one in India when the same number of people are employed in both centres. The permanent establishment (PE) definition is also being tackled, which will help India tax e-commerce transactions—the income of a US firm selling goods to an Indian resident over the internet, for instance, does not get taxed in India today. The issue of patent box planning will also prevent firms from locating all their intellectual property (IP) in a tax-haven while not paying taxes here—once the BEPS proposals are accepted by all countries, the IP will be deemed to reside in the country where it is being used.
International best practice, of course, is not just about being able to tax more, it is also about how such taxation is done and how disputes are to be resolved. So far, India’s track record has been poor on both counts and while it is true that BEPS will allow the Indian taxman to tax certain transactions that were out of his reach earlier, India’s tax resolution practices remain archaic, so as part of the BEPS process, the country will have to make many changes in this—routinely rejecting international arbitration, for instance, may no longer be an option. Similarly, since no country taxes business reorganisation transfers, the kind of taxes levied on Cairn will still be taboo; levying higher transfer pricing on Microsoft just on the basis of the number of employees its India-centre had, similarly, will not be allowed automatically though an initial reading of the BEPS rules may indicate it is possible. While incorporating various BEPS changes in the Budget, finance minister Arun Jaitley will also do well to ensure the taxman has as much exposure as possible to international best practices in taxation procedures/policy.