BEPS II

BEPS Overview

• Base Erosion and Profit Shifting (BEPS) refers to tax avoidance strategies that exploit gaps and mismatches in tax rules to artificially shift profits to low or no-tax locations.

Action 2: Neutralise the Effects of Hybrid Mismatch Arrangements

• Hybrid mismatch arrangements exploit differences in the taxation of instruments or entities between two or more jurisdictions.

Action Plan 3: Strengthen Controlled Foreign Company (CFC) Rules

• Controlled Foreign Corporation (CFC): A foreign company controlled by domestic shareholders, with advantages of shifting income to subsidiaries in low tax jurisdictions.

• Example: X Ltd. (USA) avoids higher taxes by parking profits in subsidiary Y Ltd. (Mauritius) to defer taxation until repatriated.

  • Repatriation leads to higher tax obligations when dividends move from Y Ltd. to X Ltd.

CFC Rules: OECD Recommendations

• Key components include:

  • Computation and attribution of CFC income.

  • Prevention and elimination of double taxation.

  • Definition of CFC and CFC exemptions and threshold requirements.

Indian Taxation Regime: CFC Related Provisions

• Section 115BBD allows a concessional tax rate of 15% on dividends from a foreign company in which the Indian company owns 26% or more shares, promoting profit repatriation.

Action Plan 4: Interest Deductions and Other Financial Payments

• MNCs utilize debt placement in high tax countries and intra-group loans to optimize tax benefits.

• BEPS Recommendation: Develop domestic rules to prevent tax base erosion via excessive interest deductions and other financial payments equivalent to interest.

Indian Taxation Regime: Section 94B (Thin Capitalization)

• Establishes caps on interest expense deductions related to associated enterprises,

  • Total interest paid exceeding 30% of earnings (EBITDA) is non-deductible.

  • Applicability: Indian companies and PEs of foreign companies in associated transactions.

  • Threshold: Interest expenditure over 1 crore from debt issued by non-residents triggers the provision.

  • Banks and insurance businesses are excluded from this provision.

Action Plan 5: Harmful Tax Practices - Transparency Framework

• One of the BEPS minimum standards focused on identifying harmful tax practices and ensuring transparency in tax rulings to counter base erosion.

  • Peer review on preferential tax regimes.

  • Compulsory exchange of information on taxpayer-specific rulings to prevent BEPS concerns.

Indian Taxation Regime: Promotion of R&D

• Finance Act, 2016 introduced Section 115BBF, applying a concessional 10% tax rate on royalties for patents developed in India to encourage R&D initiatives.

Action Plan 6: Preventing Treaty Abuse

• Minimum standards include:

  • Clear preamble in treaties to avoid facilitating non-taxation through treaty shopping.

  • Comprehensive limitation of benefits (LOB) articles and Principle Purpose Test (PPT) inclusion.

Indian Context

• Under Section 90, the Finance Act, 2020 details India's stance on LOB in DTAA specifically with Mauritius.

Modifications to Existing Tax Treaties via MLI

• Multilateral Instrument (MLI) modifies tax treaties under the Covered Tax Agreements (CTA).

  • Key articles include:

    • Art. 7: Prevention of treaty abuse.

    • PPT and simplified limitation on benefits clauses.

Impact of PPT on Treaty Partners

• Indo-US DTAA: No impact of PPT as the US is not an MLI signatory.

  • Indo-Singapore DTAA: PPT applies alongside existing LOB clause.

  • India-Mauritius DTAA: MLI provisions do not apply due to Mauritius not being listed as CTA.

Action Plans 7-10: Addressing Permanent Establishment and Transfer Pricing

• Action Plan 7: Preventing artificial avoidance of Permanent Establishment (PE).

• Actions 8-10: Focus on aligning transfer pricing outcomes to value creation, ensuring risks are allocated appropriately, and addressing high-risk transactions to curb profit erosion.

Action Plans 11-14: Measurement, Disclosure and Dispute Resolution

• Action Plan 11: Monitoring and measuring BEPS.

• Action Plan 12: Disclosure of aggressive tax planning arrangements.

• Action Plan 13: Re-evaluating transfer pricing documentation.

• Action Plan 14: Develop procedures to minimize uncertainty and double taxation through efficient resolution of disputes.

Action Plan 15: Developing a Multilateral Instrument (MLI)

• As of Nov 24, 2016, over 100 jurisdictions agreed on MLI to modify bilateral tax treaties to prevent BEPS.

  • India signed MLI on June 7, 2017, and ratified it on June 12, 2019. Effective from Oct 1, 2019 for certain tax treaties. Ii