In June 2019, the Union Cabinet chaired by the Prime Minister ratified the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting.[i]
Earlier, India and the US had signed an agreement for the exchange of country-by-country report in order to give massive relief to subsidiaries of US-headquartered companies in taxation-related matters. The filing of Country-by-Country (CbC) Report by the multinational companies placed a huge compliance burden on the subsidiary companies. Hence, the agreement signed between India and the US will enable both countries to automatically exchange CbC reports filed by the parent entities.
This was part of the action plan adopted by the Organisation for Economic Cooperation and Development (OECD) in order to mitigate the risks from Base Erosion and Profit Shifting (BEPS). India has remained an active participant of the project.
[Ritwik Sharma is a lawyer based in Delhi and can be reached at email@example.com]
What Does the Convention Say?
The Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (BEPS) was signed in Paris in 2017 by the Finance Minister of India. The Convention came into force on July 01, 2018 and it is an outcome of the OECD/G20 Project to tackle Base Erosion and Profit Shifting.
The Convention seeks to modify the treaties of India in order to prevent revenue losses which occur through base erosion and profit shifting. The Convention would ensure that the profits are taxed where substantial economic activity is taking place and where the value is created.[ii]
The Convention authorises all the signatories to meet treaty-related minimum standards to tackle treaty abuse and prohibit double taxation that were agreed as part of the BEPS package.
What is Base Erosion and Profit Shifting?
BEPS refers to the tax avoidance strategies that exploit gaps and mismatches in tax rules to artificially shift profits to low or no-tax locations resulting in little or no overall corporate tax being paid.[iii] This leads to erosion of the tax base of the high tax jurisdictions and causes significant losses for the high tax jurisdictions.
A report published by OECD in 2017 stated that BEPS is responsible for yearly tax losses of around $240 billion dollars globally.
How Does Base Erosion & Profit Shifting Impact India?
Base Erosion and Profit Shifting takes place through the Double Taxation Avoidance Agreement, Treaty Shopping, Round Tripping and Transfer Pricing which has a cascading effect on the Indian companies.
Double Taxation Avoidance Agreement (DTAA)
A DTAA is a tax treaty signed between two or more countries. Its fundamental aim is to allow taxpayers in the countries to avoid being tax twice for the same income. A DTAA is applicable in cases where a taxpayer resides in one country and earns income in another.
DTAAs are intended to make a country an attractive investment destination providing relief on double taxation. Such relief is provided by exempting income earned abroad from tax in the resident country. India has signed DTAA with more than 80 countries.
However, MNC`s in tax haven countries like Mauritius, Singapore etc have misused them to reduce tax liability in India. For instance, if a shell company is registered in a tax haven and carries out the operations through its subsidiary based in India. Under the DTAA, the company would be liable to pay tax only in the haven country, even for the profits made in India causing significant financial losses for India.[iv]
Under Treaty Shopping, a foreign company routes its investment into India through a tax haven country i.e., it registers a company headquartered in the tax haven and then establishes its Indian subsidiaries to carry out the operations.[v] For example, Hutch’s investment into India was routed through the Cayman Islands.
And since the company is based in a tax haven, it would be liable to pay tax to the tax haven country.
Round Tripping refers to the practice where capital belonging to India goes out to a tax haven country where it is used to set up a shell company. The money is then reinvested back in India in the form of FDI. The profit out of such investment cannot be taxed in India as the capital is coming from a tax haven.[vi]
Transfer price refers to the price at which the parent/subsidiary company sells its goods and services to another subsidiary company.[vii] However, under Transfer Mispricing, a subsidiary company located in India sells its goods and services at higher prices to another subsidiary company located in a low tax jurisdiction.
This leads to higher operating costs of the subsidiary company in India and subsequently, reduces profits. Therefore, the subsidiary company ends up reducing tax liability.
What is the Base Erosion and Profit Shifting Project of the OECD?
The OECD, working under the Group of 20 countries, has taken into consideration certain methods to amend tax treaties, harden rules, and to share more government tax information under the BEPS Project along with issuing action plans in 2015.[viii]
The BEPS Project: Firstly, it aims to increase tax revenues which were earlier lost due to BEPS. BEPS is of key importance for developing countries due to their heavy reliance on corporate income tax, particularly from multinational companies.
Secondly, it would provide a level playing field to both domestic as well as foreign companies by allowing them to conduct businesses under similar circumstances. Tax savings from BEPS provide multinational companies with an edge over domestic companies, who may lack the courage to undertake such measures.
Thirdly and most importantly, it would prevent double taxation and revenue losses emanating from such taxation.
The ratification of the Convention would provide immense relief to companies operating in the country by ensuring that the profits of a company are taxed where substantial economic activity is taking place. The agreement signed between India and the US is proactive measures undertaken to safeguard the interest of the companies operating in both countries. However, BEPS still occurs in certain tax haven countries with which India has not signed any agreement. So, Base Erosion & Profit Shifting needs to be managed in a phased manner with orderly planning in order to streamline its working.
[i] PIB, Ratification by India of the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting, (July 02, 2019), http://pib.nic.in/newsite/PrintRelease.aspx?relid=191125
[ii] PIB, Ratification of the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting, (June 12, 2019), http://pib.nic.in/newsite/PrintRelease.aspx?relid=190417
[iv] Parvatha Vardhini C, All you wanted to know about DTAA, (May 16, 2016), https://www.thehindubusinessline.com/opinion/columns/all-you-wanted-to-know-aboutdtaa/article8607732.ece
[v] GK Today, Treaty Shopping and Round Tripping, (November 22, 2015), https://www.gktoday.in/gk/treaty-shopping-and-round-tripping/
[viii] PTI, India ratifies OECD`s convention to check tax evasion, (July 02, 2019), https://economictimes.indiatimes.com/news/economy/policy/india-ratifies-oecds-convention-to-check-tax-evasion/articleshow/70044825.cms?from=mdr