For the government, the tax base is the income or profit earned by companies. Tax is levied as a percentage on this income/profit. Once this income/profit shifts to another country or tax haven (s), the tax base is eroded, and no tax gets paid by the company to the country that generates the revenue. As a result of this, the government finds itself in a fix as their revenues from taxes get reduced.
There is a growing concern with respect to the serious losses of tax revenues due to BEPS. These hurdles resulted in the launch of the BEPS project by the Organisation for Economic Co-operation and Development (OECD). OECD has designed a 15 point action plan for tackling this problem of shifting profits.
Base Erosion and Profit Shifting (BEPS) indicate tax avoidance strategies which Multinational Corporations (MNCs) employ for reducing their tax bases. Typically, a company needs to pay tax for the incomes or profits they earn. In recent times, MNCs are developing sophisticated and refined tax planning practices to avoid tax by shifting their incomes/profits to other countries, especially to tax havens. Such practices eroded the tax base.
What is the BEPS-OECD project?
When MNCs misuse the gaps and mismatches present in the tax systems of various countries, tax revenue to governments reduce. Today, businesses operate globally, so all respective governments must act together to restore the trust in domestic as well as international tax systems for ensuring fair competition.
All concerned nations could join G-20 and the OECD member countries on an equal footing to implement the BEPS package. It could assist:
1. Nations facing fiscal deficits
Every country may tax the supply chain differently. However, despite the increasing digital business environment globally, the recommendations by OECD highlight the significance of allocating the profits to the location where you have real substance, including both the tangible assets as well as people actively performing the business operations. This change in the approach can cause a shift in how and where the income is taxed. It will reduce the overall fiscal deficit a country faces due to the loopholes in its tax structure.
2. A strict environment and improved focus on involvement from the businesses
Business information would be disclosed and accessible through automatic information exchanges. This information will be made available to tax authorities wherever a company has a presence. Companies would have to explain to the authorities clearly the need their operational purpose of the business arrangements which might include tax advantages.
3. Reporting requirements
The new reporting requirements for large companies would make a detailed Country-by-Country (CBC) financial and tax information visible, to various eyes and possibly not just to the tax authorities. Additionally, the amount of data disclosed would be much higher than what companies are reporting presently. So, the compliance burden would grow substantially.
What are the challenges for businesses?
For businesses, the BEPS project helps measure the need for behavioural change, at every level.
1. 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.
2. 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.
3. As the implementation of BEPS quickens, businesses increasingly would require 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.
BEPS and India
The involvement of India in the BEPS initiative has been intensive. India has been part of the forum in devising action plans, and also part of various working groups, committees and task forces that were set up for examining different aspects of these action plans. After the publication of the final BEPS deliverables, several Indian Government officials have taken active participation in addressing various public forums and gave statements to press on views of the Indian Government. These offer valuable insights about the possible transformation of a tax regime which might be in the offing due to the BEPS project, and how Government intends to deal with it.
India is following BEPS initiative actively and has been active in bringing the amendments into its domestic law and trying to make the tax framework in line with BEPS regulations. There are a number of proposals in the Finance Act, 2016 which are influenced by BEPS recommendations. Some of these include the implementation of:
1. Master File and CbC (Country-by-Country) Reporting
2. Patent Box tax regime with respect to royalty income
3. Equalization levy requiring withholding on the gross basis for payments for certain specified digital services
As mentioned previously, India is a key contributor to BEPS action plans and it has already implemented some BEPS recommendation through amendments in domestic tax law such as CbCR, thin capitalization, secondary adjustments, etc.
Response to BEPS needs to be managed in an orderly and phased manner and would need timely and proactive planning. Companies would need building consideration of possible BEPS impact into their current tax planning and arrange for different scenarios for its application.