BEPS tax implications for corporate India

When the Organisation for Economic Co-operation and Development (OECD’s) Base Erosion and Profit Shifting (BEPS) project was launched in early 2013, there was some skepticism as to whether it would achieve much. After all, tax was still firmly a sovereign matter for countries with the occasional bilateral component (i.e. tax treaties). No focused multilateral initiative on tax issues had ever been attempted before on this scale, and some feared that this would not amount to anything more than an exercise in producing a few high-quality (if ultimately irrelevant) reports.

Still, in a span of hardly four years, the BEPS project has changed the face of the global tax system. A broad consensus on the approach to addressing these challenges was evolved, and its recommendations are fast becoming a part of domestic laws and treaties.

The government of India was an early and enthusiastic participant in the project, and identified with many of the issues that it sought to tackle. As a result, India has embraced many of the project’s recommendations and made several important changes in its tax regime. For instance, the introduction of the equalisation levy on digital advertising payments, the patent box regime giving a concessional tax rate on royalty from patents, the country-by-country reporting standards for transfer pricing and the thin capitalisation norms introduced this year, all have their origins in the BEPS project.

Implementing the BEPS recommendations through changes in Indian law is an easy exercise. How would one go about incorporating the BEPS recommendations that relate to tax treaty changes? The conceptually simpler answer would have been for countries to take up their bilateral treaties one by one, and renegotiate them to incorporate the BEPS recommendations. For example, India could have renegotiated its treaty with Mauritius, Cyprus or Singapore to introduce a “limitation on benefits” article recommended by the BEPS project to deny treaty benefits to abusive structures. This approach, however, is time-consuming. It took India close to a decade to renegotiate its treaty with Mauritius (a process that was finally concluded last year). And although Mauritius was a unique case with its own set of challenges, one can imagine how long it could take to renegotiate over 90 bilateral treaties. Incidentally, India has a strong administrative set-up with considerable technical expertise within the tax department. This can be leveraged to renegotiate multiple treaties simultaneously. Many smaller countries, however, would find this virtually impossible to do.

The multilateral convention is intended to address this specific problem. In layman’s terms, it is nothing but a multi-country treaty (much like the UN charter, or the Paris accord on climate change) that (unlike the UN charter or the Paris accord) operates only to modify bilateral treaties that exist between all of its signatories. Thus, a single multilateral convention avoids the need to individually renegotiate over 3,000 bilateral treaties.

This multilateral convention was signed by 68 countries, including India, last week. Although some procedural aspects such as ratification by countries and final notification of reservations and options are still pending, it is only a matter of time before its provisions come into force.

The multilateral convention will have far-reaching implications in an Indian context and Indian companies and investors will need to plan ahead to stay on top of these changes.

The most important impact of the multilateral convention relates to tax treaty access. Until now, structuring intellectual property arrangements, group financing arrangements, group holding companies etc. required nothing more than identifying a country with a favourable tax regime and a treaty network and setting up a company there with few or no employees. This will change. Treaty access will become subject to a GAAR-like “Principal Purpose Test”, which will allow tax authorities to deny treaty benefits if the principal purpose of any arrangement or transaction is to obtain treaty benefits. This will apply, not only to new structures, but to existing ones as well. Thus, both investors who invest in India through debt or equity held by an SPV (special purpose vehicle) in a favourable tax/treaty jurisdiction, as well as Indian investors who have set up SPVs to finance investments and acquisitions overseas could be affected by this.

Esoteric tax planning involving hybrid instruments/entities and dual-resident entities (i.e. instruments that are considered debt in one country and as equity in another, entities that are treated as corporations in one country and as partnerships in another, or entities resident in more than one country) will also face significant challenges in the post-BEPS era. Tax benefits arising to persons seeking to exploit differences in characterisation of these instruments and entities may no longer be available.

Genuine commercial activities could also come under increased scrutiny under some of the BEPS provisions. One main factor in structuring commercial operations in a foreign country is whether the activities undertaken create a taxable presence there (i.e. a permanent establishment). Under the multilateral convention, certain activities that hitherto would not have constituted a permanent establishment (i.e. use of certain agency models, or carrying on of storage, display, processing etc. of goods) could now result in the creation of a permanent establishment. This may affect both activities undertaken in India by overseas businesses, as well as outbound forays by Indian companies.

All in all, businesses with global reach or aspirations, will have to adjust to a radically new regime, where transparency, and substance will hold the key to successfully navigating tax challenges.

Kanabar is CEO and Gangadharan is partner, Dhruva Advisors

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