Unanticipated events like the depreciation of the Chinese yuan will affect capital flows, but emerging economies in Asia still receive the bulk of net capital inflows |
BEPS is a comparatively new term encompassing tax structuring or tax planning steps that lead to the depletion of government revenue. It also incorporates issues which, due to lack of clarity or lack of data, lead to double non-taxation despite – or in some cases because of – bilateral tax treaties. The phenomenon of multinational tax planning is not new; the concept of BEPS is.
The concept of BEPS is best defined by the OECD:
"Base erosion and profit shifting (BEPS) is a global problem which requires global solutions. BEPS refers to tax planning strategies that exploit gaps and mismatches in tax rules to artificially shift profits to low- or no-tax locations where there is little or no economic activity, resulting in little or no overall corporate tax being paid.
The BEPS project consists of 15 action plans in key areas endorsed by the G20 nations in July 2013, which identified, among others, specific issue-based projects such as: tackling the tax challenges of the digital economy; countering harmful tax practices more effectively, taking into account transparency and substance; preventing treaty abuse; preventing the artificial avoidance of PE status; looking at value creation and intangibles; re-examining transfer pricing documentation; making dispute resolution mechanisms more effective; and developing a multilateral instrument.
The most commendable aspect of the OECD's BEPS project is that it has managed to identify and compile issues that recur in tax disputes the world over in an organised manner. The project is also to be commended for the painstaking approach of interactive consultations with the developing and developed economies to identify universally valid tax issues and solutions.
The solutions being worked on by the project are action-specific and also include suggestions for introducing measures that aim to address modifications to make tax administration of inter-country transactions more effective.
The relevance of developing countries and India for BEPS
Addressing the tax related concerns of the developing countries is becoming increasingly relevant for the international community as a natural consequence of global trends:
Developed and developing countries are interdependent when it comes to international trade, commerce and industry.
The developing countries provide flourishing markets. Secondly, manufacturing costs are far less in developing countries and underpins competitive export prices. Besides, outsourcing of services and manufacturing by developed countries is a very common practice. There is also an influx of multinational enterprises in the developing countries that bring with them specific tax issues.
Finally, it is noteworthy that developed and developing economies are party to numerous bilateral double taxation treaties agreed between both sets of countries.
As a consequence, they are an integral part of the tax problems identified and being addressed by the BEPS project. A balanced approach to the taxation issues of developing and developed economies is essential.
Developing countries are projecting high growth rates
Statistics released by the UN as part of its Global Economic Outlook database depict a higher growth rate for developing economies than the average growth of world output.
Growth of world output: 2008-2016 - Annual percentage change |
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Year |
a* 2008-2011 |
2012 |
b* 2013 |
b* 2014 |
c* 2015 |
c*2016 |
World |
1.9 |
2.4 |
2.5 |
2.6 |
3.1 |
3.5 |
Developed economies |
0.1 |
1.1 |
1.2 |
1.6 |
2.1 |
2.3 |
Developing economies |
5.6 |
4.8 |
4.8 |
4.3 |
4.8 |
5.1 |
a* average percentage change b* actual or most recent estimates c* forecast |
||||||
Source: Global Economic Outlook, chapter 1 pre-release. World Economic Situation and Prospects; UN/DESA, UNCTAD, ECA, ECE, ECLAC, ESCAP and ESCWA. |
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The UN, in the above report, notes that economic growth in South Asia is set to gradually pick up from an estimated 4.9% in 2014 to 5.4% in 2015 and 5.7% in 2016, led by India which accounts for 70% of regional output.
It has further observed that "several countries, notably India, are likely to make progress in implementing economic policy reforms, thus providing support to business and consumer confidence".
International capital inflows to emerging economies continue to grow
According to the Global Economic Outlook report, across different regions, emerging economies in Asia continue to receive the bulk of net capital inflows, accounting for about 60% of the total in 2014, increasing from 51% in 2013; emerging economies in Latin America accounted for 24%; Africa and Western Asia combined for 8% and emerging economies in Europe for 7%.
No doubt the statistics might change with new phenomena not anticipated in the basic assumptions of the above report, such as the depreciation of the Chinese yuan, but the trend is already clear.
Relevance of BEPS for developing countries and India
The OECD has observed that BEPS is of major significance for developing countries because of their heavy reliance on revenues from corporate income tax. An inclusive approach, with the input of developing countries are needed to ensure the specific challenges they face are taken into account in designing BEPS solutions.
In July 2015 an event was organised in Addis Ababa, Ethiopia by the OECD in partnership with the UN Department of Social and Economic Affairs (DESA), aimed at raising awareness about the impact of BEPS on developing countries and how the OECD/G20 BEPS project is tackling BEPS as a collective international effort.
While the base erosion of tax revenue due to the diversion of profits is a universal phenomenon cutting across countries, region-specific issues also come into play.
In India, one of the major sources of tax litigation in transfer pricing cases is the lack of availability of documented data.
In that context, the three-tier documentation recommended by the BEPS project under Action Point 13 is very important for India as well as other developing countries, where the availability of data and the database required by the tax authorities are grossly inadequate.
Data on an MNE's group business, global allocation of income and of taxes as contained in the three tiered reporting recommended by the project would be helpful to the tax authorities in curbing the dwindling of revenues due to base erosion and tax inversion. On the other hand, it would also help the taxpaying MNE get relief from high-pitched assessments, and long, drawn-out litigation.
The inflow of foreign investment largely depends on the country's political stability and the level of certainty its tax regime provides. Today, India enjoys enviable political stability and benefits from the positive approach of the present government with the catchy 'Make in India' investment invitation to MNEs.
However, a cautious and watchful approach seems to be prevalent in foreign investors due to uncertainty surrounding the tax implications of certain structures. The issue of retrospective taxation during the Vodafone tax dispute is well-documented and, along with examples including the recent uncertainty over the application of minimum alternate tax (MAT) for foreign investors, has undoubtedly contributed to the wait-and-see approach now being exhibited by investors.
Litigations on treaty abuse in India
Action Plan 6 of BEPS is very important for India as interpretation of tax treaty clauses has been the subject of frequent controversies and a prime source of litigation.
The term 'treaty abuse' may be considered by some to be a partisan and inequitable term coined by tax authorities. The reality is that each time there is an issue of treaty abuse, there is a tax dispute and the judiciary has to step in. Since it involves international transactions and the stakes are very high, the litigation is inevitably prolonged, and normally settled by the Supreme Court of the country. Treaty abuse stems from unequal domestic tax laws of different countries. It also has its origins in the disparate terms of bilateral double taxation avoidance treaties between countries, determined by the relative economic strength, and commercial considerations involved.
On the applicability of tax treaty versus domestic law: in India most of the disputes have been decided finally by the courts.
A landmark judgment was delivered by the Andhra Pradesh (AP) High Court (in Hyderabad) in 2013 in the case of Sanofi Pasteur Holding vs Department of Revenue.
In this case, the issue was whether capital gains arising from the transfer of shares of an Indian company by two French companies to a third French company are taxable in France or taxable in India as per article 14(5) of the India-France tax treaty; and whether the domestic tax provisions of India applied in the light of retrospective amendment of sec. 2(47) of the Indian Income Tax Act, by the Finance Act 2012. The High Court of AP (India) held that in light of the ratio laid down by the Supreme Court in Azadi Bachao Andolan and Vodafone International Holdings there was no intention on behalf of the French Company to avoid Capital Gains tax.
It was further held that the retrospective amendments in Income Tax have no impact on DTAA and the transaction falls within article 14(5) of DTAA and the resulting tax is allocated exclusively to France. The Income Tax Department is understood to have filed special leave petition (SLP) against the judgment of the AP High Court before the Supreme Court of India
A recurring loss of revenue in India can be traced to taxpayers treaty shopping for attractive regimes and tax havens. India has a comprehensive double taxation avoidance agreements (DTAA) network, with agreements in place with 88 countries. A large number of foreign institutional investors who trade on the Indian stock markets operate from Singapore or Mauritius and the capital gains arising therefrom escape taxation altogether due to the treaty terms and the domestic law of those countries.
Way ahead
It has to be recognised that issue-based action plans are interlinked, and the implementation of each action plan will have a knock-on effect on other action plan items which must also be factored in. Stakeholders will be left standing on the shores of a sea of intertwined measures, which they must now prepare to wade through.
Action Plan 13, calling for three tier documentation of transfer pricing will perhaps be the toughest for the MNEs to implement. No doubt it would give some relief from high pitched assessments by tax authorities but the flip side is that it might also open up new lines of queries which would have to be settled in due course. It would also increase the compliance burden by requiring MNEs to compile substantially more information.
Stakeholders have already identified three key elements for implementation of the BEPS project actions. Given the G20 backing for the project, and the resulting political momentum behind it, now is the time for a reality check since negotiations are to be held at the highest levels of government and policymaking. Undoubtedly, there will (need to) be a convergence of interests of the stakeholders on many recommendations and deliverables which will make it possible to initiate the implementation process.
