What is BEPS?
- BEPS refers to the erosion of a country’s tax base because of the shifting of profits by multinational companies to other regimes with low or zero tax rates.
- So,
even though a company may do the bulk of its business in a high-tax
country such as the US, it camouflages its profits as emanating from some
low- or no-tax country, in order to bring down its tax liability.
- It
transfers the profits through sophisticated tax planning strategies to a
‘letter-box company’ (with just a mailing address and no real business
activity) set up in low tax regimes such as Luxembourg, Cayman Islands,
Macao or Monaco for this purpose.
- As
a result, the country which is the actual centre of economic activity is
wrongfully deprived of tax revenues.
So how do companies shift profits?
Here’s
one illustration. Take a US-based tech company that despite carrying out all
product development and making the most of its sales in the US, pays hardly any
tax in the country. How does it achieve that?
- The
company transfers the intellectual property rights that it holds over its
products to its letter-box subsidiary.
- It
then pays royalty to the subsidiary at an arbitrarily high rate to bump up
its expenses and reduce its profits in the US, thereby shrinking its tax
outgo.
- At
the same time, the subsidiary escapes taxation on income (royalty) earned
by it as it is based out of a tax haven.
- But
do note, though unfair, BEPS is not illegal. When companies engage in
BEPS, they legally avoid taxes simply by taking advantage of the
exemptions in a country’s tax regulations.
- What
also works in their favour are the wide variations in tax regimes across
countries, leaving ample scope for arbitraging taxes.
Why is it important?
- With
governments deprived of tax revenues, BEPS has attracted the ire of tax
authorities and taxpayers the world over.
- BEPS
is estimated to cause an annual revenue loss of $100-240 billion, which
amounts to 4-10 per cent of global corporate income tax revenues.
- This
in turn means a higher burden on other taxpayers and less funds in the
government coffers for funding welfare and essential infrastructure.
- BEPS
is also discriminatory. Tax savings from BEPS give multinational companies
an edge over domestic companies, who may lack the wherewithal to employ
such strategies.
Ok, then what is TREATY SHOPPING ?
- “Treaty shopping” generally refers to a situation where a person, who is resident in one country (say the “home” country) and who earns income or capital gains from another country (say the “source” country), is able to benefit from a tax treaty between the source country and yet another country (say the “third” country).
- This
situation often arises where a person is resident in the home country but
the home country does not have a tax treaty with the source country.
For example, a corporation
(“CayCo”) resident in the Cayman Islands (the home country) may own a
corporation (“USCo”) in the U.S. (the source country). Dividends paid
from USCo to CayCo would be subject to a 30% U.S. withholding tax. If
CayCo were to form a corporation (“UKCo”) in the U.K. (the third country) and
transfer the stock of USCo to UKCo, dividends would be paid from USCo to UKCo
and, without anti-treaty shopping rules, these dividends would qualify for
benefits under the U.S.-U.K. Income Tax Treaty.
If this approach were successful,
the dividend withholding tax of 30% on dividends paid by USCo could be reduced
to zero. In addition, because the U.K. does not impose any withholding
taxes on dividends paid to non-U.K. residents, the overall tax rate of the
group may decrease.
So why is it in news ..and why should
it concern for we UPSC guys ?
- In 2013, Group of 20 (G20) countries requested the Organisation for Economic Cooperation and Development (OECD) to formulate measures to address concerns on international tax avoidance by multinational companies and reform the interantional tax system.
- Since
then, OECD has outlined 15 focus areas to tackle so-called Base Erosion
and Profit Shifting (BEPS), released 23 discussion drafts, and had several
intense rounds of public consultations.
- The
BEPS initiative was the result of the perception that some multinational
corporations resort to opaque structures to achieve a low taxable income
and park their profits in low-tax jurisdictions.
What is India's stand ?
- India,
a member of the G20, has always maintained it has been at the receiving
end of BEPS, and was an active participant to this initiative.
- From
an Indian perspective, while some of the measures suggested by OECD may
not be relevant in the near future, others are significant.
- These
include the
1. taxation
of the digital economy (Action 1);
2. treaty
shopping and abuse (Action 6);
3. avoidance
of permanent establishments (Action 7);
4. transfer
pricing rules in the key area of intangibles (Action 8);
5. transfer
pricing documentation and country-by-country reporting (Action 13);
6. agreement
to implement BEPS action steps through a multilateral instrument (Action 15).
What OECD has suggested as far as
dealing with Treaty shopping is concerned ?
OECD
has suggested three approaches to eliminate treaty shopping:
(i)
To incorporate a clear statement in the title and preamble of the tax treaties
that tax treaties do not intend to create opportunities for treaty shopping;
(ii)
Limitation-on-Benefits (LOB) rule—largely similar to the rule existing in tax
treaties entered by the US;
(iii)
A more general anti-abuse rule based on principle purposes of transactions or
arrangements (PPT test).
(we
dont need to go into details as to what this LOB test and PPT test are unless
Ecnomics is our optional ! However a rough idea.)
- The
LOB rule is based on treaty eligibility rules found in US treaties. This
is also present as Article 24 of the India-US treaty. As the US Model
Convention is presently undergoing a change, follow-up work is expected in
2016.
- The
PPT rule is similar to the “main purpose” test found in UK treaties, which
is a treaty general anti-abuse rule (GAAR). This rule is included in the
India-UK treaty in 2012.
An LOB article
containing anti-abuse provisions appears to be the norm in India’s treaties
rather than exception.
- Even
existing treaties are amended to include an LOB article; for example,
India’s treaty with Israel.
- Presently,
close to 40 of India’s treaties contain an LOB article.
- India
has a LOB test in its tax treaty with the US and Singapore.
- It
has been attempting to incorporate an LOB clause in its treaty with
Mauritius, which exempts capital gains earned by its residents. Given the
current draft of LOB test, large number of multinational companies
investing through group holding structures incorporated in a low tax
jurisdiction may fail this test.
- India’s
treaties with Mexico, Iceland, Tajikistan, Tanzania, Sri Lanka, Albania,
Uruguay and Romania contain a combination of the main purpose test
(comparable to the PPT rule) along with US-styled LOB rule.
- India’s
treaties with countries such as the UK, Finland, Syria, the UAE, Norway
and Kuwait contain only the PPT rule.
- The
India-Switzerland treaty has a specific provision to deny treaty benefits
on conduit arrangements.
How must India react this is BEPS initiative ?
The
development of such an instrument is aimed to be completed by December 2016.
India’s approach on each of the action steps will need to be closely observed
as it could have an overarching and long-lasting impact on basic principles and
interpretation of international taxation and transfer pricing laws in the
country.
So now what is the issue for BEPS to move forward ?
- BEPS
cannot be brought into effect until multilateral agreements between
nations get executed.
Moral of the Story?
- · The BEPS project is extremely relevant for India, especially the action plans dealing with treaty abuse, permanent establishment, intangibles, digital economy and transfer pricing country-by-country reporting.
- · Several Indian companies feel that BEPS initiatives should be rolled out in a way that it is applicable prospectively and not retrospectively.
- · Moreover, it should not adversely impact Indian headquartered multinationals adversely and allows them a level playing field while competing with foreign multinationals.
- · 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.
