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Base Erosion and Profit Shifting

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International Business Transactions has indeed made the world smaller and more developed. However due to the free cross boundary transactions, business entities are now able to generate revenue and not pay the appropriate taxes in their respective countries.

The G20 Countries had assigned OECD to come up with some non tax evasion rules so that the countries of the world may accept the same without any dispute.

This presentation covers the BEPS Rules suggested by OECD and explains the changes in Tax Laws that India has incorporated in order to align with BEPS and to curb Tax Evasion.

This presentation was performed by my GMCS Team during the GMCS 2 Course at Mangalore Branch of SIRC of ICAI.

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Base Erosion and Profit Shifting

  1. 1. BASE EROSION AND PROFIT SHIFTING (BEPS) Demystifying BEPS in the Indian Context
  2. 2. OUTLINE - BEPS OECD and G20 Double “Non” Taxation OECD/G20 Base Erosion and Profit Shifting Project Indian Strategy for BEPS Alignment
  3. 3. OECD AND G20
  4. 4. OECD – ORGANIZATION FOR ECONOMIC COOPERATION AND DEVELOPMENT G20 countries realized the need of preventing BEPS and approached OECD to address the issue related to BEPS G20 Countries approached OECD to come up with model convention to curb double non taxation In 2013 OECD released an Action Plan 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.”
  5. 5. DOUBLE “NON” TAXATION What is BEPS?
  6. 6. BASE EROSION AND PROFIT SHIFTING ▪ Base Erosion = Shifting of the Base (Residential Status) ▪ Resident  Non Resident ▪ Pay Tax only on Local Income of respective taxable territory ▪ Profit Shifting = Sourcing of Profits to another related entity outside taxable jurisdiction ▪ Generally in a tax haven country ▪ Andorra, Bahamas, Bermuda, British Virgin Islands, Cayman Islands, Isle of Man, Mauritius, Monaco, Panama, Switzerland ▪ Exploiting loopholes of tax system in Home Country and Host Country ▪ Aggressive Tax Evasion
  7. 7. EXAMPLE • A is a subsidiary of Holding Company B • A has currently transferred profits to C • A should have transferred profits to B. A tells that it is a PE of C or it is an agent of C • C is in a tax haven country. • No Tax to be paid either in Country A or C or B. Base Erosion Profit Shifting
  8. 8. CAUSES OF BEPS Existence of loopholes, gaps or mismatches in the interaction of domestic tax laws of countries Inadequacy of current treaty provisions to effectively deal with innovative business models Ineffectiveness or lack of anti-abuse measures in some tax jurisdictions
  9. 9. SHIFTING OF INCOME/PROFITS Hybrid Mismatches • Non Taxation • Double Deduction Special Purpose Entities • Dummy Companies Transfer Pricing • Cost • Technology • Intangibles TAX PAYERS ARE SHIFTING THEIR INCOME TO ANOTHER COUNTRY TO EVADE TAX
  10. 10. ACTIONS - ISSUES Action 1 Taxing the Digital Economy Action 2 Hybrid Mismatch Action 3 CFC Rules Action 4 Limiting Interest Deductions Action 5 Curbing harmful tax practices Action 6 Preventing Treaty Abuse/Shopping Action 7 Artificial Avoidance of PE Action 8, 9, 10 Transfer Pricing Provisions Action 11 Monitoring BEPS Action 12 Enhanced Disclosure Action 13 Treaty Documentation Action 14 Dispute Resolution Action 15 Multilateral Instrument
  11. 11. OECD/G20 BASE EROSION AND PROFIT SHIFTING PROJECT 2015 Final Reports on Various Action Items of OECD Challenges/Problem Recommendation
  12. 12. ACTION 1 – TAXING DIGITAL ECONOMY Challenges/Problem Recommendation
  13. 13. ACTION 1 – TAXING DIGITAL ECONOMY Changes to definition of Permanent Establishment Imposing withholding tax at source on digital transactions Consumption tax options – Review threshold exemptions, simplified registrations, etc. Coordination with work on other Action Plans Significant digital presence Challenges/Problem Recommendation
  14. 14. ACTION 2 – HYBRID MISMATCH – UNDERSTANDING THE HYBRID FINANCIAL INSTRUMENT • Payment made by associated enterprise treated as Equity Investment in Country A and Debt Receipt in Country B. • “Dividend” received is exempt • “Interest” paid is an expense Challenges/Problem Recommendation
  15. 15. ACTION 2 – HYBRID MISMATCH Exploitation of loopholes of tax laws/treaties of two or more countries Double Deductions or Income out of scope from ambit of tax laws OBJECTIVE: RECOMMENDATION TO CHANGES IN THE DOMESTIC TAX LAWS IN ORDER TO PLUG IN THE LOOPHOLES PRESENT IN THEIR EXISTING TAX SYSTEMS. Challenges/Problem Recommendation
  16. 16. ACTION 2 – HYBRID MISMATCH Tax Payments covered by hybrid financial instruments • Equity Instrument (Dividend) along with • Debt Instrument (Interest) Prevent exemption or non-recognition of payments in both countries • Tax Dividends of such Hybrid Instruments • Deny deduction for Interest Payments or any other related deductions Agreement between two countries is in the form of tax treaties (DTAA) Primary Rule and Defensive Rule Challenges/Problem Recommendation
  17. 17. ACTION 5 – CURBING HARMFUL TAX PRACTICES (INTANGIBLES) Country A • India • Pays Royalty Expenses to Country C in account for Royalty • Claims as Expense Country C • Cayman Islands • Doesn’t Pay tax on Royalty Received Country B • USA • Controlling Entity for Country A and Country B Challenges/Problem Recommendation
  18. 18. ACTION 5 – CURBING HARMFUL TAX PRACTICES (INTANGIBLES) ▪ Trend of across the board corporate tax rate reductions on particular types of income ▪ Income From Financial activities ▪ Intangibles ▪ Determination of Revenue for Intangibles – ▪ Substantial Activity Requirement (Nexus Ratio) ▪ India has opted a different approach for taxing intangibles ▪ Intangibles ▪ Patents, Copyrighted Software, other assets having nature of a patent Challenges/Problem Recommendation
  19. 19. ACTION 7 – ARTIFICIAL AVOIDANCE PERMANENT ESTABLISHMENT Country A • USA • Controls Country B Country B • India • Earns Profit on behalf of A • Transfers all balances to Country A Challenges/Problem Recommendation
  20. 20. ACTION 7 – ARTIFICIAL AVOIDANCE PERMANENT ESTABLISHMENT ▪ Entities mandatorily covered as Permanent Establishment ▪ Delivery Branch ▪ Purchasing offices ▪ Offices for collection of information Challenges/Problem Recommendation • Artificial Avoidance of Permanent Establishment • Commissionaire Agreements • Transferring all assets, liabilities, profits, balances to the holding company • SALE IS PURPORTED TO HAVE BEEN MADE OUTSIDE THE COUNTRY • Specific Exemptions • Artificial Fragmentation of operations among group entities • Splitting of Contracts Genuine Case? Exemption for Preparatory and Auxiliary Services Units only.
  21. 21. ACTION 8, 9 AND 10 – TRANSFER PRICING ▪ Action Plans focuses on developing transfer pricing rules to provide protection against common types of base eroding payments such as management fees and head office expenses. ▪ Regular Approach or Simplified Approach Option ▪ Determination of Arm’s Length Price charges for low value adding intra-group services ▪ An entity that elects to apply the simplified method is required to identify, on an annual basis, a pool of costs associated with categories of low value-adding services which are provided to multiple members of its group. ▪ The costs so identified need to be allocated among members by selecting an allocation key, dependent on the nature of the services consistently throughout the year. ▪ Actual business transactions undertaken by associated enterprises are identified and transfer pricing is not based on contractual arrangements that do not reflect the actual economic reality Challenges/Problem Recommendation
  22. 22. ACTION 14 – DISPUTE RESOLUTION MECHANISMS ▪ Minimum Standard will have the following: Treaty obligations related to the mutual agreement procedure are fully implemented in good faith and that Mutual Agreement Procedure (MAP) cases are resolved in a timely manner Implementation of administrative processes that promote the prevention and timely resolution of treaty-related disputes and Taxpayers can access the MAP when eligible Challenges/Problem Recommendation
  23. 23. ALIGNMENT STRATEGY OF BEPS IN INDIA Adaptation of BEPS in the Indian Tax Laws
  24. 24. BEPS MEASURES IN INDIA Equalization Levy – BEPS Action 1 Section 6 – Place of Effective Management Virtual Permanent Establishment Patent Box Incentive Regime – BEPS Action 5 CbC Report - BEPS Action 13
  25. 25. EQUILISATION LEVY – BEPS ▪ Chapter-VIII of the Finance Bill, 2016 ▪ Equalization levy means the tax leviable on consideration received or receivable for any specified service under the provisions of this chapter. ▪ Section 163 of the Finance Bill, 2016 provides that every resident carrying on business or profession or a non- resident having PE in India shall deduct equalization levy from the amount paid or payable to a non-resident in respect of the specified service at the rate of 6% where the consideration for the specified service exceeds Rs.1 lakh
  26. 26. PATENTS – BEPS ▪ Section 115BBF - Income by way of Royalty in respect of patent developed and registered in India attracts income tax on income by way of Royalty @ 10%. ▪ No expenditure or allowance in respect of such Royalty income shall be allowed under the Act. ▪ Royalty/Copyright/Patent defined.
  27. 27. CBC REPORT – ACTION PLAN 13 ▪ Introduced by Finance Act, 2016; effective from FY 16- 17. ▪ MNE’s having consolidated annual revenue greater than EURO 750 million. ▪ Summary data and economic activity in each country. ▪ Prepared by ultimate parent entity for consolidation purposes. ▪ Submitted to the tax authorities of the ultimate parent entity. ▪ Shared with other tax authorities through official channels.
  28. 28. SECTION 6 – RESIDENTIAL STATUS
  29. 29. VIRTUAL PERMANENT ESTABLISHMENT ▪ No physical establishment in the Host Country. ▪ Website may constitute a Virtual Permanent Establishment ▪ Delhi Tribunal in the cases of Galileo International and Amadeus Global Travel vs DCIT
  30. 30. THANK YOU AND QUESTIONS  Anusha Dharmaraj Dalen D’Souza Janardhan Gouda Jyothi Vidyashree Roopika Shetty Shinoj Isac Shravan Kumar Sneha Rao Bharath Rao

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