BEPS & India : In search of a solution

The G20 leaders’ Mexico summit of June’12 crafted the term ‘Base Erosion & Profit Shifting’ with an objective to prevent country’s tax base getting eroded as a result of tax planning strategies adopted by Multinational Enterprises (MEs). Most MEs dubbed BEPS as a political reaction to growing public ire over tax planning rules, though, surely it resulted in mounting pressure on fiscal policy makers to pressurise MEs to pay ‘fair share of tax’ beyond the statutory tax . In response thereto, the OECD at the behest of G20 Finance Ministers unveiled an ambitious proposal last month to reform the current patchwork of international tax rules and treaties. The report titled OECD BEPS plan calls for a fundamental change in rules for taxability of cross-border profits and digital transactions. An unprecedented shift in country wise onerous reporting is predicated on interface of tax rules of different countries, need for countries to collaborate and adhere to a common set of guidelines.

Thankless daunting journey to no man’s land:
I am not questioning the intent to design a consistent set of rules to curb tax evasion for shifting of profits from high to low tax jurisdictions or to prevent economic non-taxation (a phenomenon where tax is not paid in any jurisdiction) of transactions. My concern stems from practicality and implementation challenges for countries with diverse tax systems to achieve such degree of tax harmonisation. Greater wisdom is required prior to embarking on such reforms given that India has been struggling for a decade to move ahead with domestic tax reforms and rushing into such multilateral initiatives runs risk of causing instability for MEs who are under intense radar of the tax administrators.

Having said that, India cannot and should not abdicate its role in G20. Just as India assumed leadership in G20 initiative to raise global awareness of transparency and cooperation on information sharing under tax treaties in post 2008 crises, India has an important, albeit different role to play in BEPS emerging as torch bearer for emerging economies given its advancement in tax laws. It’s important to recognize that as a country, our challenges are different from advanced nations and here are some differences we need to weigh before embarking on BEPS brigade.

Economic realities:
To an objective economic observer, BEPS is a response of advanced nations to combat rising burden of government spending caused by several years of poorly designed entitlement programs – whether it’s the US medical plan or French social security system, growing levels of dependency & unfavourable demographics have contributed to deficits. This has resulted in Governments starved of revenues guiding politicians left with no options but to extract more money from the economy’s productive sector. Deficits across the developed world are the product of slow economic growth and over spending, not tax evasion.

India having faced the consequences of extended expansionary policy pursued in response to the 2008 crisis and impact of its social programs has had ripple effects on deficits. However, the trend in tax revenues is showing consistent growth, its demographics are most favorable and, but for recent slow trend, no one doubts India’s medium to long term growth trajectory.

Compared to OECD nations’ average of 17%, a low tax GDP-ratio of 5.5% and 4.4% for Direct and Indirect tax respectively is due to issues that are inherent to India and not due to shifting of profits. Hence, the primary reason for India to pursue BEPS fails.

Legality versus morality of behaviour:
In wake of findings of Senate & Parliamentary committees in the US & UK, respectively, coupled with tax activism of NGO’s, lately, attention of media has been focused on tax affairs of select MEs. This has put human cost of tax avoidance at the forefront of political discussions.There is growing awareness in public mind that the conduct of targeted MEs though legal has resulted in escaping taxes due to loopholes in regulations across jurisdictions. Double-dip deduction (claiming deduction in multiple jurisdictions), flexibility to characterise financing instruments differently in multiple jurisdictions (debt in one country and equity in another) have become common tax planning ideas and avenues for tax savings. India’s problem is (in)adequacy of tax payers and levels of tax reporting and not tax planning schemes. Given that India has phased out tax holidays, Indian and foreign MEs no longer have tax arbitrage and hence, it’s the domestic market that drives investment decisions – neither is there any scope for shifting profits given that we have amongst the toughest transfer pricing regimes in the world.

Tax & treaty regimes have encouraged tax savings:
US and select OECD countries follow the worldwide taxation (as opposed to India’s territorial)approach under which taxes are imposed on the global profits of MEs. Over the years, the US check-the-box rules (which allows US companies to choose for them how to classify for tax purposes) encouraged US MEs to legitimately retain profits offshore, of course, with adequate disclosures. The Obama administration attempted to scrap the rule, but retreated when business groups argued that it would hurt the economy. BEPS initiative may perhaps discourage US MEs to retain offshore profits; signaling a shift in the US tax policy.

Indian policy makers have to make up their minds in pursuing a balance of source based taxation (territorial) and resident based taxation (worldwide income). On the one hand, India is pursuing the strictest form of source-based taxation by bringing to tax profits of MEs and on the other hand, we also want to pursue worldwide system of taxation by proposing CFC legislation in our DTC code – a balance and harmonisation will be required and if India pursues BEPS, we need
advance clarity.

In conclusion, the aim of BEPS is to support countries efforts to shape effective and efficient systems. Given OECD’s experience, it can deliver and meet expectations of those committed to it. For that to happen, countries while maintaining national sovereignty in tax policy would be expected to follow a set of multilateral tax treaty principles which will have to be ratified by individual countries. One thing is sure – Challenge for MEs to ensure that their existing tax structures evolve in parallel and fit the new worlds order. The impeding September development when G20 nations meet to take stock of BEPS would be closely watched.