- India has ratified the “Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting”.
- Also referred to as the multilateral convention (MLI), it is an outcome of the OECD/G20 project to tackle Base Erosion and Profit Shifting (BEPS).
- The convention will enter into force for India on October 1, 2019, and its provisions will have effect on India’s DTAAs (Double Tax Avoidance Agreement) from FY 2020-21 onwards.
- The MNCs utilize the loopholes or opportunities available with domestic tax laws as well as shifting income to tax havens to minimise taxes. Hence, tax avoidance is practiced by them to escape from taxes.
- There are many gaps and inadequacies in domestic laws, insufficient foreign company rules, transfer mispricing, double taxation avoidance treaty abuses by MNCs to avoid taxes.
- In 2015, the Organisation for Economic Co-operation and Development (OECD) released Base Erosion and Profit Shifting (BEPS) final reports on the 15 Action Plans.
- To enable jurisdictions to swiftly implement the BEPS recommendations, in 2016, the OECD released the text of the Multilateral Convention.
- The MLI was developed and agreed by approximately 100 jurisdictions, including OECD member countries, G20 countries and other developed and developing countries.
- It was signed by the Indian Finance Minister in Paris in June, 2017 on behalf of India, along with representatives of more than 65 countries.
Base Erosion and Profit Shifting (BEPS):
- Base Erosion and Profit Shifting refers to two common practices for multinationals to lower the taxes that they pay (notably: corporate taxes).
- Base erosion refers to the practice of reducing the taxable base. An example is deducting large interest payments in order to lower the taxable profits.
- Profit shifting refers to the practice of shifting taxable profits from high-tax countries to low-tax countries, especially tax havens. An example is the transfer of ownership of intellectual property and its income from the US (high-tax) to Bermuda (low-tax).
- Once profit is shifted to other countries or to tax havens, the tax base is eroded and there is no tax payment by the company in the concerned country.
- The Indian Government, in its response to the UN questionnaire on country experience regarding BEPS issues, had identified the following as common practices of BEPS in India:
- Shifting of profits by aggressive transfer pricing by way of payments to foreign affiliated companies
- Non Taxation of digital economy in country of source
- Treaty Shopping and
- Artificial avoidance of PE status.
Aspects of the Multilateral Convention (MLI):
- The Convention enables countries to implement the tax treaty related changes to achieve anti-abuse BEPS outcomes through the multilateral route without the need to bilaterally re-negotiate each such agreement which is burdensome and time consuming.
- It is an innovative mechanism to update the network of several bilateral tax treaties that make up the international tax system.
- The convention enables all signatories to meet treaty-related minimum standards that were agreed as part of the BEPS package.
- Post this convention, 90 countries have now implemented the automatic exchange of financial account and tax information.
15-point Action Plan
- Address the tax challenges of the digital economy
- Neutralize the effects of hybrid mismatch arrangements
- Strengthen Controlled Foreign Company (CFC) rules
- Limit base erosion via interest deductions and other financial payments
- Counter harmful tax practices more effectively, taking into account transparency and substance
- Prevent treaty abuse
- Prevent the artificial avoidance of Permanent Establishment (PE) status
- Aligning transfer pricing outcomes with value creation: intangibles
- Aligning transfer pricing outcomes with value creation: risks and capital
- Aligning transfer pricing outcomes with value creation: other high-risk transactions
- Measuring and monitoring BEPS
- Require taxpayers to disclose their aggressive tax planning arrangements
- Re-examine transfer pricing documentation
- Make dispute resolution mechanisms more effective
- Develop a multilateral instrument
BEPS and India
- The Convention will modify India’s treaties in order to curb revenue loss through treaty abuse and base erosion and profit shifting strategies by ensuring that profits are taxed where substantive economic activities generating the profits are carried out and where value is created.
- Out of 93 Covered Tax Agreement (CTAs) notified by India, 22 countries have already ratified the MLI as on date and the Double Taxation Avoidance Agreement (DTAA) with these countries will be modified by MLI.
- For the remaining CTAs, effect of MLI will take place as and when these countries ratify the MLI, it added.
- However, it is important to note that significant jurisdictions such as the United States, Brazil, etc. have not signed the MLI.
- Furthermore, significant treaty partners that account for a substantial amount of investments into India, such as Germany, while having signed the MLI, have not notified its treaty with India in its provisional list of CTA.
Challenges for businesses
- For businesses, the BEPS project helps measure the need for behavioural change, at every level.
- Tax administrations now won’t just introduce stricter measures and look for restricting tax treaty benefits, but would also test arrangements which in their view, lack substance or has a real commercial principal purpose.
- Business groups would have to reshape the business models and might have to adopt the practices for evaluating their position in the new environment.
- Enhanced transparency is one of the key objectives of the BEPS framework. This brings new reporting obligations such as Country-by-Country Reporting (CbCR). Transparency would also mean to anticipate outcomes of extra disclosures that are required to be made. Such requirements could lead to additional transfer pricing challenges or might even cause adverse publicity.
- As the implementation of BEPS quickens, businesses increasingly would require to track how changes to transfer pricing practices and domestic laws, and the revised double tax treaties would affect them.
- All of these changes would need allocation of more resources for tax function.
- Well-executed and timely reaction to the new measures wouldn’t just avoid difficulties – it would ensure that the businesses are better placed to manage the tax burdens, and can have more cost-beneficial and streamlined operational models.
Double Tax Avoidance Agreement
- A DTAA is a tax treaty signed between two or more countries. Its key objective is that tax-payers in these countries can avoid being taxed twice for the same income.
- A DTAA applies in cases where a tax-payer resides in one country and earns income in another.
- DTAAs can either be comprehensive to cover all sources of income or be limited to certain areas such as taxing of income from shipping, air transport, inheritance, etc.
- India has DTAAs with more than eighty countries, of which comprehensive agreements include those with Australia, Canada, Germany, Mauritius, Singapore, UAE, the UK and US.
Need for DTAA
- DTAAs are intended to make a country an attractive investment destination by providing relief on dual taxation. It has also remained a favoured route for foreign portfolio investors.
- DTAAs basically provide clarity on how certain cross-border transactions will be taxed and this encourages foreign investors to take the plunge.
- Such relief is provided by exempting income earned abroad from tax in the resident country or providing credit to the extent taxes have already been paid abroad.
- But the problem is DTAAs can become an incentive for even legitimate investors to route investments through low-tax regimes to sidestep taxation. This leads to loss of tax revenue for the country.