B E P S Action Plan - released by OECD

Base Erosion and Profit Shift
(‘BEPS’) Action Plan
Draft Released by OECD
Saturday, April 25, 2015 1

Base erosion and profit shifting (“BEPS”) refers to tax planning strategies that
exploit gaps and mismatches in tax rules to make profits ‘disappear’ for tax
purposes or to shift profits to locations where there is little or no real activity but the
taxes are low, resulting in little or no overall corporate tax being paid.
“BEPS arises because under the existing rules MNEs are often able to artificially separate
the allocation of their taxable profits from the jurisdictions in which these profits arise.
This can result in income going untaxed anywhere, and significantly reduces the corporate
income tax paid by MNEs in the jurisdictions where they operate, thus affecting
competition, distorting investment decisions and reducing overall trust in the tax system.“
– OECD Webinar
OECD BEPS Action Plan

Areas of discussion
OECD BEPS Action Plan1
Why is BEPS important ?2
OECD BEPS Action Plan3
Action 1 - Address the tax challenges of the digital economy
Action 2 - Neutralise the effects of hybrid mismatch arrangements
Action 3 - Strengthen controlled foreign currency (CFC) rules
Action 6 - Prevent treaty abuse by developing model treaty provisions/recommendations
Action 5 - Counter harmful tax practices more effectively, taking into account transparency and substance
Action 4 - Limit base erosion via interest deductions and other financial payments
Action 7 - Prevent the artificial avoidance of PE status
Action 8 -10 – Transfer Pricing aspects of Intangibles, low value-adding intra-group services
Action 11 - Establish methodologies to collect and analyse data on BEPS and the actions to address it
Action 12 - Require taxpayers to disclose their aggressive tax planning arrangements
Action 13 - Transfer Pricing Documentation and Country-by-Country (CbC) reporting
Action 14 - Make dispute resolution mechanisms more effective
Action 15 - Develop a multilateral instrument

OECD BEPS Action Plan – In a nutshell
On 19 July 2013 the OECD released an Action Plan on Base Erosion
and Profit Shifting (BEPS) which was presented to the meeting of
G20 Finance Ministers in Moscow.
The purpose of the Action Plan is “to prevent double non-taxation,
as well as cases of no or low taxation associated with practices that
artificially segregate taxable income from activities that generate it.”
The report indicates that “no or low taxation is not per se a cause for
concern, but it becomes so when it is associated with practices that
artificially segregate taxable income from the activities that generate
it.”
The Action Plan covers 15 specific Actions which are broadly to be
achieved within a two year time frame (i.e. by the end of 2015). On 16
September 2014, OECD released its first set of recommendations for
7 out of 15 Action Points.
The
coherence of
corporate tax
at the
international
level
Transparency, coupled
with certainty and
predictability
Realignment of
taxation and
substance
15 Actions organized around
three main pillars

OECD BEPS Action Plan – An ambitious timeline
*Forum on harmful tax Practices

Why is BEPS
important?

Why should ‘YOU’ care
about BEPS ?
Political &
Public
attention
Changes in
tax legislation
Tax enforcement
environment
 Media – Fairly negative
light
 Companies’ reputation
at stake : In particular
consumer facing brands
Tax Administrations closely
scrutinize global structures to
identify possible abuses
Multinationals need to be
aware of these
developments and manage
the risk of change in law

What is likely to come out
of BEPS project?
Changes in Domestic and International Tax Laws and Tax treaties leading to:
 Increased reporting to promote transparency: In particular country-by-country
reporting
 Need for consensus in mismatches resulting from differences in laws:
Addressing Hybrid mismatches
 Monitoring anti-treaty shopping provisions to avoid inappropriate use of
treaties i.e. Treaty abuses and aggressive tax planning

Action 8
Transfer Pricing
aspects of
intangibles

Transfer Pricing aspects of
intangibles
Objective
 Prevent BEPS that may result from abuse of
transfer pricing rules related to cross-border
relocation of intangibles and other
transactions involving use of intangibles
 Ensure that transfer pricing outcomes are in
line with 'Value Creation”
Guidance issued has certain areas in “interim
draft”
To be finalised in 2015 along with other BEPS
action points that are closely related (risks and
capital, high-risk transactions and hard to
value intangibles
Key areas covered in the Guidance
 Detailed guidance on location savings,
assembled workforce and MNE group
synergies as part of Chapter I of OECD
guidelines
 Broader definition of intangible property
(six specific categories of intangibles
discussed)
 Ownership of intangibles and entitlement to returns –
who is entitled to returns from intangibles
 Relevant considerations for various transactions
involving intangibles
 Supplementary guidance around determining arm’s
length conditions involving intangibles – considers
unique features of intangible transactions

What is an intangible?
 “…Something which is not a physical asset or a financial asset, which is capable of being
owned or controlled for use in commercial activities, and whose use or transfer would be
compensated had it occurred in a transaction between independent parties in comparable
circumstances.” (Paragraph 40 of Revised Discussion Draft)
What is required What is not required
• Not a tangible asset or a financial asset
• Capable of being used in commercial
activities
• Capable of being owned or controlled by
single entity
• Does not include local market conditions
such as the high purchasing power in a
particular country
• Does not include MNE group synergies that
are not owned or controlled by a single
member of an MNE group
• Use or transfer would be compensated in
transactions between independent parties
• Need not be an intangible for accounting
purposes
• Need not be an intangible for general tax or
treaty withholding tax purposes – Article 12
Model Tax Convention
• Need not be legally protected
• Need not be separately transferable

Examples of Intangibles
Patents
Know-how and trade secrets
Trademarks, trade names, and brands
Rights under contracts and government licenses
Licenses and similar limited rights in intangibles
Goodwill and ongoing concern value:
“... Not necessary ... to establish a precise definition of goodwill ... for transfer
pricing purposes. It is important to recognize, however, that a ... significant
part of the compensation paid between independent enterprises ... may
represent compensation for ... goodwill or ongoing concern value.”
(Paragraph 61)
Items that are not Intangibles
Group synergies
Market-specific characteristics
Examples

 Legal ownership and contractual arrangements to be only the starting point for analysis
 However, the next steps, more importantly focus only thorough analysis of Functions, Assets and
Risks (FAR) and actual conduct of the various entities
• Who are the parties performing and controlling the functions related to the development,
enhancement, maintenance, protection and exploitation of intangibles?
• Who is contributing the assets, including intangibles, physical assets and funding? Only funding
without assumption of other risks entitles to only return on funding, not the entire intangible
related returns
• Confirm the consistency between conduct of the parties and the legal arrangements
• Recharacterise the transactions as necessary to reflect each party’s contributions towards the
intangibles
Who is entitled to return from intangibles?
Legal ownership by itself is not sufficient to decide the allocation of returns

 Location savings – Even where local comparable are available, specific adjustment on account of
location savings are required – view of Indian Revenue Authorities (IRA)
 Marketing intangibles – Marketer / distributor should be compensated for enhancing the value of
trademarks and other marketing intangibles
 R&D arrangements – appropriate compensation for research services will depend on all the facts and
circumstances (whether research team possesses unique skills and experience, bears risks, uses its
own intangibles etc.)
India perspective (1/2)
Various issues included in the Guidance are contemporary, highly debated, and
frequently litigated transfer pricing issues in India

 Even before the introduction of the BEPS action plan the Indian Revenue authorities issued Circular
no. 6 which discusses circumstances in which profit split method will apply for determination of
compensation in case of R&D centers developing intangibles. India also adopts the ‘Significant
Peoples Function’ as a criteria in allocation of profits relating to intangibles which is in line with OECDs
guidance
India perspective (2/2)
Funding is not the only important criteria – Significant peoples function
also very crucial
Contract R&D
Entities with minimal functions, assets and
risk, foreign entity funds and monitors
progress
Circular No. 6
Entrepreneurial R&D Centers
Entities performing significantly
Important functions, assets and risk
Cost plus remuneration is appropriate
and share in profits not necessary
Intangible related return to be attributed to
the Indian researchers under Profit Split
Method

What do we expect
 Intangibles have been the focus of TP disputes and highly litigated
 Circular 6 of 2013 also points to the Significant Peoples function
(SPF) test as recommended by OECD
 Possibility of in-depth scrutiny by the Indian Revenue authorities
on transactions involving intangibles (location savings, assembled
workforce, group synergies etc) based on OECD guidelines
INDIAN tax authorities are likely to draw
inference and support from OECD guidelines
in determining the return from intangibles
What needs to be done : Companies operating in India need to analyze
 Legal ownership and contractual arrangements vis-à-
vis intangibles to begin with
 But as next steps more importantly focus has to be
on thorough analysis of Functions, Assets and Risks
(FAR) and actual conduct of the various entities
1. Who are the parties performing and controlling the
functions related to the development, enhancement,
maintenance, protection and exploitation of
intangibles?
2. Who is contributing the assets, including intangibles, physical assets
and funding? Only funding without assumption of other risks entitles
to only return on funding, not the entire intangible related returns
3. Confirm the consistency between conduct of the parties and the
legal arrangements
4. Recharacterise the transactions as necessary to reflect each party’s
contributions towards the intangibles
Talking Points : Action 8

Action 10
Intra-group services –
Discussion Draft

Intra-group services – Discussion Draft
Objective
 Focus on developing rules to prevent
BEPS through the use of transactions
(management fees, head office expenses
etc) which would not, or would only very
rarely, occur between independent
parties
 Revision of chapter VII of the OECD guidelines
related to Intra-Group Services (IGS)
 Simplified approach suggested to deal with “low
value-adding intra-group services (LVIGS)” – New
section D proposed to be added to chapter VII
Key areas covered in the Draft guidance
 Determining whether intra-group
services have been actually rendered.
Focus areas – Benefit Test,
Shareholder activities, Duplicative
services and Agency services
 Determination of arm’s length price –
Direct charge methods vs. Indirect
charge methods
 What constitutes LVIGS
 Clarifying the meaning of shareholder activities
and duplicative costs in context of LVIGS
 Guidance on mark-ups, appropriate cost allocation
methodologies, benefit tests and required
documentation in context of LVIGS

Determining whether intra-group services have been rendered
 Benefit Test
 Whether the activity provides economic or commercial value to enhance or maintain commercial
position ?
 Whether a comparable would be willing to pay for the activity to an independent enterprise or would
perform itself i.e. in-house activity ?
 Shareholder activities
 Activities that group member perform solely because of its ownership interest in one or more other
group members i.e. in capacity as a shareholder, would not be considered as an intra-group
service but would be referred to as shareholder activities
 Important to determine whether the group companies would or would not be willing to pay for such
services to independent enterprises
 Shareholder activities distinguishable from the broader term “stewardship activity”
Intra-group services – Determining the receipt of intra-group services

 Shareholder activities contd..
 Cost relating to the following activities would be termed as shareholders activities:
i. Stock exchange listing of the parent company
ii. Audit of subsidiaries accounts carried out exclusively in interest of the parent company
or consolidation of financial statements of the MNC
iii. Raising funds for the acquisition and costs relating to the parent company’s investor
relations such as communication strategy with shareholders of the parent company,
financial analysts, funds and other stakeholders in the parent company
iv. Compliance of the parent company with the relevant tax laws
v. Costs which are ancillary to the corporate governance of the MNE as a whole

Definition
 Services of supportive nature and not a part of core business of the Group*
 Do not require the use of or lead to the creation of valuable and unique intangibles
 No assumption, control or creation of substantial or significant risk
Low value-adding Intra-group services – LVIGS
The following activities are likely to meet the
definition of LVIGS
The following activities would not be
considered LVIGS
Accounting and auditing Services relating to the core business of the Group
Processing and management of account receivable and
account payable
R & D , manufacturing and production services
Human resource related activities Sales, marketing and distribution activities
Monitoring and compilation of data relating to – health, safety,
environment etc
Financial transactions
Information technology services Insurance and reinsurance
Internal and external communication and public support
services
Extraction, exploration or processing of natural resources
Legal services / activities relating to tax obligations / general
services of administrative or clerical nature
Services of corporate senior management
Accounting and auditing Services relating to the core business of the Group
* business of the Group and not of the legal entity providing the service

 It is pertinent to understand the nature of the services in order to classify them as LVIGS. The LVIGS
should be supportive in nature and should not form part of the core business of the Multinational
enterprise (MNE) group. See e.g. below
Credit Risk
Analysis (CRA)
Outside India
India
Parent (Shoe
Manufacturer)
Subsidiary (CRA
Co)
 Group’s primary business – Shoe
Manufacturing
 Established another entity to provide
Credit Risk Analysis (CRA)
 Although CRA is the principle
business of the subsidiary, however,
at the group level, these services do
not relate to the core business
activity of Shoe manufacturing
 Thus, CRA activity will qualify as
LVIGS.
Intra-group services – LVIGS…contd.

 The draft guidelines will enable the taxpayers and tax administrations to focus their resources on high risk
transactions while they can adopt a standard norm for routine low value-adding IGS .
 For a Captive Shared Service center, certain points such as nature of services outlined as ‘low value-
adding’, manner of classifying core and non-core business activities, and proposed mark-up in the range in
2 per cent to 5 per cent etc. may be challenged by IRA;
 MNCs need to take cognizance while planning the cross charge for services which might be routine i.e. low-
value adding or high end.
 The adoption of simplified approach for LVIGS may be advantageous for both the taxpayers and tax
administrations, as it not only reduces the compliance burden of the taxpayers but also reduces disputes
between taxpayers and tax administration.
For Inbound IGS, it would be interesting
to see how India adopts above Guidance,
in light of the fact that IRA has been
adopting aggressive approach in
proposing adjustments and seeking
voluminous documentation for such
services
For Outbound IGS, it remains to be seen
how India will adopt the above Guidance,
once implemented given the fact that IRA
has been claiming much higher markups
compared to the recommended range of 2
to 5 percent for certain low end services

Action 13
Transfer Pricing
Documentation and
Country-by-Country
(CbC) reporting

Three-tier documentation structure proposed for all countries
 Master file to provide the MNE’s blueprint i.e.
 The group’s organizational structure
 A description of the group's business, intangibles, intercompany financial activities, and financial
and tax positions
 Local file to provide material transfer pricing positions of the local entity/ taxpayer with its
foreign affiliates
 Demonstrates arm’s length nature of transactions
 Contains the comparable analysis
 Country by Country (‘CbC’) Report to provide
 Jurisdiction-wise information on global allocation of income, taxes paid / accrued, the stated
capital, accumulated earnings, number of employees and tangible assets.
 Entity-wise details of main business activities which will portray the value chain of inter-company
transactions
Action 13 - TP Documentation and CbC report
India had sought
for more detailed
information to be
incorporated in
CbC Reporting,
during the course
of discussions
between G20
countries. But
post-final
discussions, the
requirements have
been watered down
and are now final.

Purpose of the three-tier documentation structure:
 Ensure that taxpayers give appropriate consideration
to transfer pricing requirements in establishing prices
and other conditions for transactions between
associated enterprises and in reporting the income
derived from such transactions in their tax returns
 Provide tax administrations with the information
necessary to conduct an informed transfer pricing risk
assessment
 Provide tax administrations with useful information to
employ when conducting a thorough audit of the
transfer pricing practices of entities subject to tax in
their jurisdiction, although it may be necessary to
supplement the documentation with additional
information as the audit progresses
Action 13 - TP Documentation and CbC report

Implementation:
 OECDs endeavor to balance:
 usefulness of TP documentation under 3-tier structure to tax authorities, and
 increased compliance cost and efforts for taxpayers
 Though consented by OECD member countries and G20 countries, which includes India:
 Mechanism for sharing information with tax administrations yet to be formalized
 – whether Master File and CbC report to be filed by Parent Co. or local entity
 Taxpayers concerns about sharing business sensitive data
 CbC report ought not be used by tax administrations to propose transfer pricing adjustments based on a
global formulary apportionment of income.
 Indian Competent Authority commented – India is actively and closely involved in BEPS action plan
and will seek to implement OECDs recommendations on TP documentation*
Implementation and India perspective
*www.tp.taxsutra.com

Country by Country Reporting template

What do we expect
 Increased compliance cost and burden on taxpayers
 Section 295 of the I.T. Act, 1961 states that CBDT
may, subject to the control of the Central Government,
by notification in the Gazette of India, make rules for
the whole or any part of India for carrying out the
purposes of this Act.
 Indian Revenue authorities may expect that the
Master File and CbC report for all companies
operating in India should be filed locally
 As per OECD guidance the Master File and CbC Report should
be used only for risk assessment procedures, but there may be a
temptation to use it for allocation of revenue and profits based on
functions of various group entities rather than only looking at
Indian entities functions.
IRA authorities expect :
 To issue the revised documentation regulations for public
consultation first
 To introduce the new documentation rules based on BEPS
recommendations starting fiscal year 2016-17 (i.e. w.e.f. April 1,
2016)
What needs to be done
 Companies operating in India especially Indian headquartered
companies need to tie up the functional analysis of Indian
operations vis-à-vis global operations as CbC report maps the
groups functions
 Have Management discussions to re-align functions and
pricing to ensure that profits/income are allocated in
accordance with value creation in each jurisdiction
 Should analyse their internal accounting systems and MIS data,
and upgrade the same to enable gathering of information
required in Master File and CbC report
Necessary to highlight to the
company’s management / Audit
Committee the importance of
implications and meeting the
objective of Transparency of BEPS
Project.

Thank You
_______________
Yatin Mehra
Manager – Advisory, Consulting & Transfer pricing

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