THE BIG STORY. Are you ready for BEPS?

If you thought the world of tax havens and the battle between tax authorities and multinational corporations does not matter to you, think again. The gifts you purchase on Amazon or your investment in an Indian pharma company can also be impacted by the changes currently taking place.

India is not the only country engaged in such litigation. Other countries are also in the same boat, fighting to reclaim tax that they think rightfully belongs to them.

These struggles will get a big boost once the action plan suggested by the Base Erosion and Profit Shifting (BEPS) project of the OECD is implemented. The 15-point action plan put out by OECD seeks cooperation of all nations to arrest corporate profits from disappearing or artificially shifting to low or no-tax countries. India has been active in this project right from the drafting stage and was one of the first countries to put this plan into action through a series of proposals in Budget 2016-17.

Adoption of these rules will have major implications for foreign companies doing business in India as well as Indian multinational companies that have overseas subsidiaries. Foreign portfolio and direct investors are also likely to be impacted through some of these rules.

The OECD report states that developing countries are the worst affected by this profit shifting. It is estimated that the loss in global corporate tax collection due to this profit shifting is around 4 to 10 per cent of total tax collections.

Here are the proposals from the BEPS action plan adopted in Budget 2016-17 and their implications.

The BEPS connect: The growth of e-commerce where a company’s operations span the globe has made it quite difficult for tax authorities to make companies pay tax in countries where the transaction takes place. The Action plan 1 in the BEPS report deals with the challenges arising from a digital economy, the difficulty in ring-fencing the digital economy from the rest of the economy for tax purpose.

The Budget too explains the challenge that arises in establishing a nexus between a taxable transaction and a taxing jurisdiction and the difficulty of locating the transaction and identifying the taxpayer for income tax purposes.

The BEPS report suggests modifying the Permanent Establishment (PE) rule to take into account the digital presence, a virtual fixed place of business when an enterprise maintains a website on a server of another enterprise located in another country and carries on business through that website. The BEPS report also recommends imposing a final withholding tax or an equalisation levy.

Change in the Budget : The Centre has adopted the recommendation of the BEPS report by proposing an equalisation levy of 6 per cent of the value of consideration paid for specified services to a non-resident who does not have a permanent establishment in India. The payment should have been made by a resident who is engaged in a business or a non-resident having a permanent establishment in India. The levy will not be charged if the consideration is less than ₹1 lakh.

The definition of ‘specified services’ in the Finance Bill is, however, a little vague as it talks mainly about online advertisement and digital advertising by a non-resident entity. But the ambit is expected to be widened soon to ensure that foreign e-commerce majors do not get away by avoiding a permanent establishment in India. The Finance Bill says that “other services as may be notified by the Central Government in this behalf,” may also attract the equalisation levy.

Impact: Right now this impacts only companies that advertise through digital media. But in future, the operations of e-commerce companies such as Flipkart, Amazon and so on can also get affected. The equalisation levy could extend to all payments made by locally registered affiliate companies or other local companies that act on behalf of these companies — to the e-commerce major that is the ultimate beneficiary.

You will be affected as a consumer if the tax incidence on these e-commerce companies rises. The discounts offered on these sites could reduce or some new fee or charge can be introduced in future.

There are hardly any listed companies operating in the e-commerce space in India. However, if you have invested in Alibaba, Amazon, eBay, etc, on overseas exchanges, watch out. These companies might see their tax incidence go up if countries start slapping equalisation levies or withholding taxes on their worldwide operations.

The BEPS Connect : Action 13 of the BEPS report recommends detailed documentation by multinationals that gives tax authorities in every jurisdiction an overview of the operation of the entire group, thus helping to evaluate transfer pricing deals and identify possible evasions.

A three-tiered structure was suggested by the OECD for reporting a) a master file containing standardised information relevant for all group members of a Multi National Entity (MNE) b) a local file referring specifically to material transactions of the local taxpayer and c) a country-by-country report containing certain information relating to the global allocation of the MNE’s income and taxes paid together with certain indicators of the location of economic activity within the MNE group.

The Budget proposal : In line with the OECD’s suggestion, the Finance Minister has said that from April 1, 2017, multinational companies, resident in India and having consolidated group revenue of over €750 million or ₹5,395 crore, shall submit a country-by-country (CbC) report containing aggregate information on revenue, profit and loss before tax, amount of income-tax paid and accrued, details of capital and reserves, number of employees, tangible assets in each country or territory, along with details of each constituent’s residential status, nature and detail of main business activity. Foreign companies in India, belonging to international groups, shall provide details of the country of residence of the parent. Indian MNCs are also required to submit information for a master file as required by OECD BEPS Action 13 report. This file will provide an overview of the group’s business, its overall transfer pricing policies, and its global allocation of income and economic activity in order to assist the taxmen in evaluating the transfer pricing risk in the group.

Impact: These reporting requirements can have widespread ramifications for both companies as well as investors. Many Indian MNCs will find the cost of complying with these requirements a drag.

Some companies that have been playing the tax arbitrage game will now have to re-think these arrangements, resulting in increase in tax incidence.

These reporting requirements are likely to affect Indian companies which have subsidiaries across the world and have group turnover exceeding ₹5,395 crore. Major companies that figure in this list include Tata Steel, Tata Motors, Hindalco, TCS and Bharti Airtel.

Many pharma companies such as Sun Pharma and Dr Reddy’s, etc, which have been aggressively buying overseas companies, will now have to make higher disclosures and will also have the taxman on their heels, sniffing at every deal.

The profitability of some Indian multinationals can be hit by larger tax incidence. This will hit you as an investor.

The BEPS connect : India has become a large R&D hub, especially in pharmaceutical research. But the patents, once developed, are transferred to companies in low-tax jurisdictions to avoid paying tax at a higher rate in India.

The Action Plan 5 of the BEPS project recommends the nexus approach which prescribes that income arising from exploitation of intellectual property should be attributed and taxed in the jurisdiction where substantial research and development activities are undertaken, rather than the jurisdiction of legal ownership only.

The proposal in the Budget : The Budget has recognised the need to retain the patents developed through research and development activity in India, within the country. The Centre, therefore, proposes to tax income from patents at a concessional rate. This is expected to give an additional incentive for companies to retain and commercialise existing patents and to develop new innovative patented products.

The royalty income received for a patent developed and registered in India shall be taxable at the rate of 10 per cent (plus applicable surcharge and cess) on the gross amount of royalty.

Impact: This will impact companies that have large research and development spends, such as pharma, automotive, electronic and some chemical companies. Due to the higher rate of corporate tax in India, over 30 per cent, the ownership of patents created is shifted to subsidiaries in low-tax regimes so that profit by way of royalty is shifted to these jurisdictions. Lower tax on royalty income can now result in companies re-thinking these tax-planning strategies.

The IT department is thus taking a softer route towards ending these tax-planning methods. If companies take up this offer, there can be higher transparency in corporate accounts, as far as ownership of intangible assets goes.

Misuse of double tax avoidance agreements signed bilaterally between countries is one of the common ways in which tax evasion takes place. The BEPS Action 6 on ‘Preventing the granting of treaty benefits in inappropriate circumstances’ deals with such double tax agreements and the way to tackle their misuse.

The Action plan lays down three ways in which to prevent treaty shopping and abuse of double tax treaties by entities that are not residents of either of the countries signing the agreement. This is to be achieved by way of:

A clear statement has to be issued by the States signing such treaties that they will not create opportunities for non-taxation or reduced taxation through treaty shopping arrangements

Inclusion of Limitation of Benefit (LoB) clause in treaties so that treaty benefits are available only to entities that meet certain conditions (such as minimum revenue, registration with a regulator and so on). A Principal Purpose of Transaction (PPT) rule to check if the sole purpose for setting up a company in a low-tax jurisdiction is to evade tax. In such cases, treaty benefit is to be denied.

Proposal in the Budget : It is not surprising that the Finance Minister has not dealt with BEPS Action plan 6 in the Budget since the General Anti Avoidance Rules that are to come into effect from April 1, 2017, already deal with these issues. The GAAR state that the tax authorities will have the right to scrutinise tax arrangements whose sole purpose is to save on tax.

The Indian government has also been aware of the pitfalls in double tax treaties and the DTAA with Singapore has a LoB clause that specifies only companies with minimum annual expenditure of Singapore dollar 200,000 and track record of two years can avail the treaty benefits.

There are reports that similar clauses are also being included in the DTAA with Mauritius. Once that is done, the bane of Indian revenue will be dealt with.

Another reason why the Centre has not implemented Action 6 is because the threat of GAAR is already resulting in incremental foreign portfolio and foreign direct investment flows coming in from jurisdictions with whom the Indian government has signed more fool-proof DTAA such as Singapore and the US.

Impact: These rules affect the foreign portfolio investors investing in Indian equity and other instruments. It is no secret that many FPIs and FDIs have routed their investments through Mauritius in the past to make the most of the DTAA between India and Mauritius and get away without paying any capital gains tax on profits.

Investors investing through such brass-plate companies will now come under the taxman’s lens. Growing intolerance of India towards these practices means that these investors will now have to get ready to pay additional tax.

The BEPS connect : Action 7 dealing with ‘Preventing artificial avoidance of permanent establishment status’ deals with this issue, which has been haunting Indian Tax Authorities for some time now.

The Budget proposal : Upto financial year 2014-15, a foreign company was treated as resident of India, if during the year, control and management of the affairs of that company was wholly situated in India.

As per the amendment brought in by Finance Act, 2015, a foreign company will be regarded as a tax resident of India, if its POEM in that year is in India. POEM has been defined to mean “a place where key management and commercial decisions that are necessary for the conduct of the business of an entity as a whole are, in substance made.”

Determination of control will be based on place where meetings of Board of Directors are held, place from where the chief executive officer and other senior management carry on their activity and so on.

The implementation of the POEM rules has, however, been deferred by one year in the Budget citing difficulties experienced by the stakeholders in changing to the new system.

Impact : These rules will impact Indian companies that have formed overseas subsidiaries to which a bulk of profits have been shifted using the ‘Permanent Establishment’ rules. Some alternate investment funds could also be impacted by these changes.

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