India: Encountering BEPS: India's Approach And Considerations For MNC's, Funds And Global Investors

Last Updated: 21 October 2015
Article by Joachim Saldanha, Samira Varanasi and Mahesh Kumar

Save The Date – Webinar

Encountering BEPS: India's approach and considerations for MNCs, Funds and Global Investors

In light of the recent release of the OECD BEPS Action Plan we are organizing an interactive webinar to provide our views and insights on considerations for investors focusing on India.

Speakers:

Nishith M. Desai

Rajesh Simhan

Mahesh Kumar

Time:

Tuesday, November 3, 2015, 6:30 PM – 7:30 PM (IST)

Q&A: 7:30 PM to 8:00 PM (IST)

RSVP: ndaconference(at)nishithdesai.com

  • Final 15 BEPS Action Points released by OECD
  • Increased focus on economic substance, preventing treaty abuse, enhanced profit attribution and stringent disclosure norms to combat aggressive tax avoidance schemes
  • Impact on Mauritius / Singapore structures, Indian fund advisors, e-commerce, outsourcing and outbound structures

The OECD recently released a final package of measures and a roadmap to reform the global tax framework by tackling base erosion and profit shifting ("BEPS"). G20 nations (including India) have endorsed the 15 action points ("BEPS Action Plan") stemming from countries' efforts to protect their legitimate tax base in the face of aggressive international tax avoidance schemes. The BEPS initiative clearly reflects the evolving economic and geopolitical dynamic between developed and emerging economies, and signals a major shift in the global tax and regulatory environment.

As the BEPS Action Plan goes into its implementation stage, it is important for multinational companies ("MNCs"), funds and global investors to revisit existing structures from the perspective of substance, securing treaty relief (e.g. Mauritius or Singapore), and additional tax exposure that may arise on account of permanent establishments and intra-group transfer pricing.

A number of measures introduced by India in the last few years have been aimed at countering BEPS. These include broad general anti-avoidance rules ("GAAR"), increased focus on economic substance, taxation of overseas transactions with underlying Indian interests, stringent disclosure norms, enhanced profit attribution to permanent establishments or via transfer pricing and other measures.

The effort to counter BEPS is indeed laudable, but there is also an equally compelling need to focus on providing certainty, protecting taxpayer rights, eliminating double taxation, reducing litigation and increasing the efficiency of dispute resolution. Some of India's policies, especially relating to taxation of e-commerce transactions and overseas share transfers, are inconsistent with international approaches and may be far beyond what the OECD has proposed. India has also strongly objected to tax treaty arbitration recommended by the OECD to improve resolution of international tax disputes, which is emerging as a global best practice. As pointed out by the OECD, unilateral measures by countries "could lead to global tax chaos marked by the massive re-emergence of double taxation."

BEPS will continue to remain high on India's tax policy agenda and will have a big impact on global investors focusing on India. India is projected to grow at 7.4% in 2016 (even ahead of China) and it should proactively retain its competitive advantage among BRIC nations and ensure that the implementation of the BEPS Action Plan is reasonable and balanced without dampening investment flows.

Overview of the BEPS Action Plan

The 15 action points proposed by the OECD lay down minimum standards with broad consensus among OECD and G20 countries including India. The standards are not legally binding but it is expected that they will be implemented through amendments in tax treaties and domestic law, backed by enhanced cooperation between countries.

1. Tax challenges in the digital economy

  • Increasing the scope of permanent establishment ("PE") by limiting exemption for preparatory/auxiliary activities. May include domestic warehouse for delivery of goods sold online to customers if proximity is key to the business model, and domestic entities principally involved in concluding contracts which the foreign company routinely accepts without modification.
  • Imposition of VAT/GST based on the country where the customer is located.
  • Does not recommend extending nexus principle based on economic presence or withholding tax on digital transactions.
 

2. Neutralizing effects of hybrid mismatch arrangements

  • Guidelines to counter multiple deductions or double non taxation by using certain hybrid instruments and hybrid entities.
  • Addressing issues in relation to dual resident entities.
 

3. Designing effective Controlled Foreign Company ("CFC") Rules

  • Outlines essential building blocks for effective CFC legislation that will limit opportunities for tax deferral through blocker entities in low tax countries.
 

4. Limiting base erosion through interest deductions

  • Proposes certain fixed ratio rules based on net interest/EBITDA to limit an entity's deductions for interest payouts.
 

5. Addressing harmful tax competition and special tax regimes

  • Requirement of substantial activities in a country to avail preferential tax regimes.
  • Monitoring preferential tax regimes and ensuring a framework of transparency including sharing of tax rulings, advance pricing agreements, etc. between countries.
 

6. Preventing treaty abuse

  • Countering treaty shopping through (i) clear statements in treaties that the treaty does not seek to provide opportunities for tax evasion or avoidance, (ii) inclusion of a principal purposes test that denies treaty relief if one of the principal purposes of the transaction or arrangement is to obtain relief not consistent with the treaty's objectives, and (iii) limitation of benefits rules that limit the availability of treaty relief to entities that meet certain criteria based on their legal nature, ownership, and general activities.
 

7. Preventing the artificial avoidance of PE Status

  • Expanding the scope of PE by covering commissionaire arrangements or similar strategies where a domestic enterprise substantially carries out all negotiations while the foreign enterprise concludes the contract only as a matter of formality.
  • Addressing fragmentation of activities to avoid PE status and more guidance on attribution of profits to a PE.
 

8-10. Aligning transfer pricing outcomes with value creation

  • Key changes to the OECD transfer pricing guidelines including (i) guidance on transactions involving valuable intangibles to prevent misallocation of profits, (ii) allocation of risk based on actual activities rather than contracts or level of funding, and (iii) re-characterizing transactions that are not commercially rational.
 

11. Data collection

  • Implementing better data collection and sharing tools for monitoring the scale of BEPS and determining counter-measures.
 

12. Disclosure rules

  • Recommendations for mandatory disclosure of specific 'reportable schemes' in order for countries to be able to identify potentially aggressive and abusive tax planning arrangements, along with enhanced information sharing between countries.
 

13. Transfer pricing documentation and country-by-country reporting

  • Widening transfer pricing documentation and reporting obligations to include (i) a master file providing an overview of the groups global business and global transfer pricing policy; (ii) a local file containing more detailed information relating to intercompany transactions; and (iii) Country-by-country report (where annual consolidated group revenue equal to or exceeding EUR 750 million) with details of allocation, taxes paid and activities in each jurisdiction.
 

14. Making dispute resolution mechanisms more effective

  • Minimum standards and best practices for resolution of disputes through Mutual Agreement Procedure ("MAP") in a timely (within an average timeframe of 24 months) and transparent manner;
  • 20 countries including US and UK (involved in more than 90% of MAP cases) have committed to binding treaty arbitration. India is opposed to this idea.
 

15. Developing a multilateral instrument

  • Developing a Multilateral Treaty framework which will amend all bilateral tax treaties between signatories for expediting implementation of BEPS action points
  • Multilateral Treaty expected to be finalized and open for signature by December 31, 2016.
 

Considerations for MNC's, Global Investors and Funds Investing into India

Impact on Mauritius / Singapore structures: Anti-treaty shopping provisions recommended by BEPS are not new to investors investing from countries such as Singapore or Luxembourg, since the relevant tax treaties with India have limitation of benefits criteria. In addition to the business purpose test, Singapore based investors may satisfy an expenditure threshold (of SGD 200,000 per year) to avail treaty relief. The Mauritius tax treaty is in the process of being re-negotiated and a similar limitation of benefits provision is expected to be introduced. In addition, the GAAR rules to be implemented from April 1, 2017 will override tax treaties and create a greater need for establishing substance in Mauritius or Singapore. These developments are in line with the BEPS Action Plan.

Specific considerations for PE/VC and Hedge Funds: Going forward the additional focus on commercial substance is an important consideration for PE/VC and hedge funds investing into India from countries like Singapore, Mauritius, Netherlands and Luxembourg. Although India does not have thin capitalization rules, the GAAR provisions, once implemented, will allow re-characterization of debt into equity in abusive cases. This may impact typical debt structures including hybrid convertible debt, listed bonds or non-convertible debentures. Further, the BEPS Action Plan seeks to tackle hybrid mismatch arrangements leading to double deduction or double non-taxation.

In the context of fund advisory companies in India, it is also important to track the proposed widening of the scope of permanent establishment, since the BEPS Action Plan seeks to capture domestic entities that substantially negotiate contracts but where the foreign entity (e.g. the fund or investment manager) habitually concludes such contracts without material modifications. Fund advisory companies should also be cognizant of transfer pricing compliances and the risk of income attribution based on changes in the OECD transfer pricing guidelines where the focus is shifting towards location of commercial activities rather than the mere contractual allocation of functions, assets and risks.

Impact on e-commerce and outsourcing: Global e-commerce platforms and market places may be impacted if the typical PE related exemptions are narrowed down. For instance, the BEPS Action Plan suggests that the preparatory/auxiliary activity exemption may not apply if the foreign enterprise running the web platform has a warehouse in India and proximity to customers is integral to the business model. While in some cases, Indian tax authorities have argued that a website or intangible property could itself create a PE, the OECD does not endorse such a broad concept of nexus based on significant economic presence.

Another contentious issue in India is the withholding tax on software licenses applied on the basis that such payments are royalties taxable even without a PE in India. This view is not consistent with the OECD's approach. In fact, the BEPS Action Plan does not endorse proposals such as nexus rules based on economic presence and withholding taxes on specific e-commerce transactions on a global level.

Changes in the transfer pricing guidelines may impact outsourcing arrangements and there may be increased pressure on captive BPO and KPO entities to justify their profit margins in line with activities performed and the overall value generated.

Impact on outbound investments by Indian MNC's and Entrepreneurs

Bolstering substance in offshore holdings: As Indian companies globalize, it is important to track proposed measures such as limiting the benefits of preferential tax regimes (including IP or innovation boxes in countries such as Netherlands, Switzerland, Singapore etc.) in the absence of substantial activity in the relevant country, demonstrating substance in the foreign holding company jurisdiction and ensuring rigorous transfer pricing compliance.

The change in threshold for corporate residence also impacts Indian companies and entrepreneurs going global. If overseas subsidiaries are effectively managed from India, such entities may be treated as being Indian resident and taxed on worldwide income. In light of the GAAR rules it is also important to demonstrate substance and commercial justification of any overseas holding and investment structures.

An incentive has been provided for repatriation of funds back to India through a concessional 15% tax rate on dividends received by Indian companies from overseas subsidiaries. With respect to CFC rules, there is sense in deferring implementation for at least a decade till Indian companies have established a stronger global footprint.

Disclosures and information sharing: The emphasis on transparency and exchange of information under the BEPS Action Plan will continue to add force to measures that are already being taken by India towards this end. Indian residents are required to disclose all assets and bank accounts located outside India and the recently enacted black money law prescribes stringent penalties and prosecution in relation to undisclosed foreign income and assets. Most of India's tax treaties also have exchange of information clauses on par with OECD standards and India has also entered into specific information sharing agreements with countries like BVI, Cayman Islands, Bahamas, Hong Kong, Jersey, Guernsey, etc. where tax treaties don't exist. India was also one of the early adopters of the common reporting standard for automatic exchange of tax information which is expected to be implemented from 2017 onwards.

Concluding Comments

The biggest issue with the BEPS initiative is the lack of international consensus on the limits of a country's legitimate tax base. For instance, some of India's views regarding taxing e-commerce transactions, services, overseas share transfers, and permanent establishments are inconsistent with global approaches and create a risk of double taxation.

A related issue is the sheer uncertainty that is inherent in anti-avoidance rules and, at times, it is difficult to differentiate between what is permissible and what is not. The resulting litigation risks and compliance costs will have a big impact on MNC strategy and may further distort investment flows.

The BEPS Action Plan should not be implemented in a manner that increases the risk of double taxation. India should also avoid unilateral measures that override tax treaties. While countering BEPS it is equally important to increase certainty for investors and provide an efficient dispute resolution framework (including timely conclusion of advance rulings and advance pricing agreements). India should also embrace international arbitration of tax disputes which several developed countries have endorsed as a best practice. It is also time for India to introduce a formal charter of taxpayer rights to provide further reassurance to investors.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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Joachim Saldanha
Samira Varanasi
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