Introduction: BEPS is acronym for Base Erosion and Profit Shifting. 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.
BEPS is of major significance for developing countries due to their heavy reliance on corporate income tax, particularly from multinational enterprises.
Background: Globalization has enabled businesses to reach out to international consumers. It also, opened the path for Multi-National Enterprises (MNEs) to do business worldwide. The intangible property of digital services enables to deliver them over the internet. The nation bound service providers are subject to domestic tax of their country. Whereas MNEs have advantage of sophisticated tax planners, who identify and exploit gaps in International Taxation and help them to park their profits in tax heaven economies’ rather than paying corporate tax in resident country.
Challenges of globalization (limited to taxation):
- The resident country is losing corporate tax revenue.
- More competition and high tax rates for domestic players.
- When taxpayers see multinational corporations legally avoiding income tax, it undermines voluntary compliance by all taxpayers.
- International taxation has sought to avoid double taxation but there are gaps in them, which are legally arbitraged by MNEs.
- MNEs offer tax at much lower rate thereby increases their profitability and enables them to grow at rocket speed.
- This challenges the fairness and integrity of tax systems because businesses that operate across borders can use BEPS to gain a competitive advantage over enterprises that operate at a domestic level.
Cognizance of challenges:
- A number of countries have expressed a concern about how international standards on which bilateral tax treaties (DTAA) are based allocate taxing rights between source and domestic country.
- Over 100 countries and jurisdictions are collaborating to implement the BEPS measures and tackle BEPS.
- The G201 finance ministers called on the OECD2 to develop an action plan to address BEPS issues in a co-ordinated and comprehensive manner.
The BEPS Package: The BEPS package (developed by OECD and G20 countries) provides 15 actions that equip governments with the domestic and international instruments needed to tackle BEPS. Countries now have the tools to ensure that profits are taxed where economic activities generating the profits are performed. These tools also give businesses greater certainty by reducing disputes over the application of international tax rules and standardizing compliance requirements.
OECD and G20 countries along with developing countries that participated in the development of the BEPS package are establishing a modern international tax framework under which profits are taxed where economic activity and value creation occur. Work will be carried out to support all countries interested in implementing the rules in a consistent and coherent manner.
Action Plan: Fundamental changes are needed to effectively prevent double non-taxation, as well as cases of no or low taxation associated with practices that artificially segregate taxable income from the activities that generate it. New international standards must be designed to ensure the consistency of corporate income taxation at the international level. A realignment of taxation is required to restore the indented effects and keeping pace with changing business models and technology.
Actions- BEPS is a worry in the context of the digital economy. The actions will help address these worries. This will require a thorough analysis of the different business models. Moreover, indirect tax aspects should also be considered. Drawing on the other actions included in this plan, a dedicated task force on the digital economy will be established. List of 15 action plans is-
Action 1-Addresses the tax challenges of the digital economy: Identify the main difficulties that the digital economy poses for the application of existing international tax rules and develop detailed options to address these difficulties, taking a holistic approach and considering both direct and indirect taxation.
Action 2- Neutralize the effects of hybrid mismatch arrangements3: Develop model treaty provisions and recommendations regarding the domestic rules to neutralize the effect (e.g. double non-taxation, double deduction) of hybrid instruments and entities.
Action 3- Strengthen controlled foreign company rules4: Develop recommendations regarding the design of controlled foreign company rules.
Action 4- Limit base erosion via interest deductions and other financial payments: Prevent base erosion through the use of interest expense, for example through the use of related-party and third-party debt to achieve excessive interest deductions or to finance the production of exempt or deferred income, and other financial payments that are economically equivalent to interest payments.
Action 5- Counter harmful tax practices more effectively, taking into account transparency and substance: It consists of two parts. One part relates to preferential tax regimes, a peer review is undertaken to identify features of such regimes that can facilitate base erosion and profit shifting, and therefore have the potential to unfairly impact the tax base of other jurisdictions. The second part includes a commitment to transparency through the compulsory spontaneous exchange of relevant information on taxpayer-specific rulings which, in the absence of such information exchange, could give rise to BEPS concerns.
Action 6- Prevent treaty abuse: Tax treaties are not intended to be used to generate double non-taxation and to identify the tax policy considerations that, in general, countries should consider before deciding to enter into a tax treaty with another country.
Action 7- Prevent the artificial avoidance of PE (Permanent Establishment) status: Develop changes to the definition of PE to prevent the artificial avoidance of PE status in relation to BEPS, including through the use of commissionaire arrangements5 and the specific activity exemptions.
Action 8- Assure that transfer pricing outcomes are in line with value creation: intangibles: Develop rules to prevent BEPS by moving intangibles among group members.
Action 9- Assure that transfer pricing outcomes are in line with value creation: risks and capital: Develop rules to prevent BEPS by transferring risks among, or allocating excessive capital to, group members. This will involve adopting transfer pricing rules or special measures to ensure that inappropriate returns will not accrue to an entity solely because it has contractually assumed risks or has provided capital.
Action 10- Assure that transfer pricing outcomes are in line with value creation: other high-risks transactions: Develop rules to prevent BEPS by engaging in transactions which would not, or would only very rarely, occur between third parties. This will involve adopting transfer pricing rules or special measures like transfer pricing methods, Management fees.
Action-11- Establish methodologies to collect and analyze data on BEPS and the actions to address it: to monitor and evaluate the effectiveness and economic impact of the actions taken to address BEPS on an ongoing basis.
Action 12- Require taxpayers to disclose their aggressive tax planning arrangements: design of mandatory disclosure rules for aggressive or abusive transactions, arrangements, or structures, taking into consideration the administrative costs for tax administrations and businesses and drawing on experiences of the increasing number of countries that have such rules.
Action 13- Re-examine transfer pricing documentation: to enhance transparency for tax administration, taking into consideration the compliance costs for business. The rules to be developed will include a requirement that MNE’s provide all relevant governments with needed information on their global allocation of the income, economic activity and taxes paid among countries according to a common template.
Action 14- Make dispute resolution mechanisms more effective: that prevent countries from solving treaty-related disputes under mutual agreement procedure6 (MAP).
Action 15- Develop a multilateral instrument: Analyze the tax and public international law issues related to the development of a multilateral instrument and amend bilateral tax treaties.
Timing- Addressing BEPS is critical for most countries and must be done in a timely manner. The pace of the project must be rapid so that concrete actions can be delivered quickly. At the same time, governments also need time to complete the necessary technical work and achieve consensus.
Methodology-The BEPS project marks a turning point in the history of international co-operation on taxation. The following points should be considered while developing its methodology.
- An inclusive and effective process: launching the OECD/G20 BEPS project and involving developing countries
- Efficient process: Political expectations are very high in most countries and the results and impact of the BEPS work must be in line with these political expectations.
- Consulting with business and civil society: Consultation with non-governmental stakeholders is also key. Business and civil society representatives will be invited to comment on the different proposals developed in the course of the work.
India’s efforts on BEPS: With regard to find a solution to BEPS, India had set up a committee on taxation of E-commerce. The Committee took cognizance of the report on Action 1 of Base Erosion & Profit Shifting (BEPS) Project, wherein very significant work has been undertaken for identifying the tax challenges arising from digital economy. The Committee recommended the Equalization Levy to address the tax challenges of digital economy and provide greater certainty and predictability in its taxation. Implementing the recommendations of the committee, Equalization Levy was introduced in the Union Budget 2016.
For further insight to Equalization Levy, read this
1. The Organization for Economic Co-operation and Development (OECD) is an intergovernmental economic organization with 35 member countries, founded in 1960 to stimulate economic progress and world trade. It is a forum of countries describing themselves as committed to democracy and the market economy, providing a platform to compare policy experiences, seeking answers to common problems, identify good practices and coordinate domestic and international policies of its members. Most OECD members are high-income economies with a very high Human Development Index (HDI) and are regarded as developed countries. OECD is an official United Nations Observer.
2. The G20 (or G-20 or Group of Twenty) is an international forum for the governments and central bank governors. Founded in 1999, the G20 aims to discuss policy pertaining to the promotion of international financial stability. It seeks to address issues that go beyond the responsibilities of any one organization.
3. Hybrid mismatch arrangements is the result of a difference in the characterization of an entity or arrangement under the laws of two or more tax jurisdictions that result in a mismatch in tax outcomes.
4. Controlled foreign corporation (CFC) rules are features of an income tax system designed to limit artificial deferral of tax by using offshore low taxed entities.
5. Commissionaire arrangement wherein a person sells products in a given State in its own name but on behalf of a foreign enterprise which is the owner of these products. Through such an arrangement, a foreign enterprise is able to sell its products in a state without creating a PE. The person doing the selling (the commissionaire) in the State would typically be taxed on the remuneration it receives for its services (often a commission) rather than on the profits derived from such sales.
6. MAP is a procedure which allows the Competent Authorities or designated representatives of the Competent Authorities from the governments of the Contracting States/Parties to interact with the intent to resolve international tax disputes.
Disclaimer: This article is provided for information purposes only it could not be considered as legal or financial advice.
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