Due to growth in cross-border trade and investment, it was in the interest of all countries to ensure that undue tax burden is not cast on those who earn income, by taxing them twice: once in the country of residence and again in the country where the income is derived/accrued. To encourage global investment and trade by avoiding profits being taxed twice, Double Taxation Avoidance Agreements (DTAA) were agreed upon among nations.
However, with the development of global economies, DTAAs couldn’t keep pace. Various MNCs had designed business/investment structures to prevent double taxations which ended up facilitating double non-taxation. These tax planning strategies are called Base Erosion and Profit Shifting (BEPS).
BEPS has become a concern for developed countries. Gaps between tax systems across nations assisted MNCs to make profits shift to tax havens and achieve double non-taxation. This resulted in crises for developed countries, with huge reduction in tax collection.
Indian tax authorities had been favouring source/activity-based taxation, which has been upheld by Indian judiciary in various case laws, while in other cases the same has been struck down by courts due to lack of specific provisions under domestic tax laws.
Global action plan against BEPS and India-relevance
OECD’s 15-point action plan on BEPS intends taxing companies where real/economic activities take place and where value is created.
w Anti-abuse provisions to prevent treaty shopping—by introducing provisions such as principal purpose test or limitation of benefit (LOB) clause to ensure that only genuine enterprises having substance avail benefits of tax pact.
India-relevance: Similar provisions can be seen under the India-Singapore tax treaty for capital gains exemption. India has been attempting to incorporate a similar rule in its treaty with Mauritius. Recently, India negotiated some tax treaties to include the LOB clause. The domestic tax law mandates a Tax Residency Certificate to claim tax treaty benefits. The General Anti-Avoidance Rules (GAAR), effective from April 1, 2017, provide to override tax treaties where the arrangement lacks substantial commercial purpose.
* Change in definition of permanent establishment—to prevent artificial avoidance of PE by contractual term.
India-relevance: In India, the commissionaire model is common. In the past, the actual conduct of the parties in determination of agency PE has been considered by the judiciary. Most Indian treaties don’t have delivery-related exclusion clause form PE test. Some Indian treaties exclude ‘occasional’ delivery.
* Counter harmful tax practices by building transparency—through improving transparency including compulsory spontaneous exchange on rulings related to preferential regimes.
India-relevance: India has started measures on Tax Information Exchange Agreements (TIEA) through either negotiating tax treaties or agreeing new TIEA, including with tax havens. India has notified Cyprus as unfavourable jurisdiction for countering tax evasion, which does not cooperate in information exchange. Indian courts have focused on ‘substance over form’ principle for analysing the transaction.
* Interest expense deduction—the concern is with interest deductions with no corresponding taxation of interest for the lender in a tax-friendly jurisdiction. To prevent that, a fixed ratio/group ratio rule is recommended. This would bring in a similar concept like thin capitalisation.
India-relevance: Currently, no thin capitalisation provisions exist under domestic tax laws. In light of BEPS plan, a reliance on the Bombay HC ruling in the Besix Kier case would be impaired.
* Digital economy provides to review different business models and get a better understanding of value in the digital sector, including tax guidance.
India-relevance: No specific provisions for taxation of digital economy. But the definition of royalty has been widened in domestic tax laws to include software payment.
* Hybrid mismatch arrangements—putting an end to multiple deductions for a single expense, deduction without corresponding taxation or generation of multiple credits. They also provide for applicability of tax treaties for entities that are not treated as taxpayers by either or both the countries.
India-relevance: In the past, treaty eligibility for fiscally-transparent entities had been challenged. Some Indian treaties deny treaty benefit to dual-resident entities (India-US), while others provide for resolution by competent authorities (India-Japan). In India, financing through CCDs (akin to debt unless converted) provides for payment of interest to the investor along with interest deduction to Indian firm. After BEPS plan, this funding alternative may not be a relevant option for foreign investors.
* Controlled foreign companies rules—to ensure reduction in incentives for taxpayers to shift profits to a low-tax jurisdiction.
India-relevance: No CFC rules notified under domestic tax laws. However, it was proposed in the draft DTC, which has been dropped by the government. Also, the corporate residency rule has been changed from ‘control and management’ to ‘place of effective management’, aligning with global practices.
BEPS cannot be brought into effect until multilateral agreements between nations get executed—scheduled by December 31, 2016. Specific amendments will be required under domestic tax laws and tax treaties in order to enforce the reports released on BEPS by OECD.
The author is partner, Direct Tax, PwC India