Bombay Chartered Accountants Society Fire Side Chat on BEPS 19 th October, Part 3 Explaining BEPS Action Reports

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1 Bombay Chartered Accountants Society Fire Side Chat on 19 th October, 2016 Part 3 Explaining Action Reports CA chatting with CA Sushil Lakhani Mumbai

2 1 Action Reports Action Reports Subject 1 E-Commerce Taxation, e.g. Google. 2 Hybrid Mismatch Arrangements. 3 CFC Apple Computers. 4 Base Erosion via Payment of interest, etc. 5 Transparency & Substance. Vodafone. Cayman Island Company had no substance. 6 Treaty Abuse, Mauritius, UAE, etc.

3 2 Action Reports Action Reports Subject 7 Artificial Avoidance of PE Transfer Pricing Apple Computers 11 Measuring & Monitoring 12 Tax Payers to disclose Aggressive Tax Planning 13 Documentation 14 Dispute Resolution MAP 15 Multilateral Instrument - With one action, a few thousand treaties will be amended.

4 3 Proposals - to - Actions All Action Reports are proposals. OECD Model Treaty & its Commentary will be amended. Then UN Model may be amended with or without modifications. Then if individual countries have to renegotiate their treaties (total over 3000 treaties); it may take time. Hence a Multilateral Treaty is being drafted: Action 15. Once a nation signs the Multilateral Treaty it will be deemed that ALL its treaties have been amended with Post Facto effect.

5 4 We discuss only a few Subjects Out of the 15 Action Reports - We will discuss briefly 1. Action 1 E-Commerce 2. Action 3 CFC 3. Review Apple Computers 4. India FII Tax Avoidance 5. Action 7 Avoidance of PE 6. GAAR 7. Action Transfer Pricing 8. EU & USA 9. Overall Impacts

6 E-Commerce Action 1 Vs. Action 3 5 Google USA / Ireland Face Book USA 40 Crore users in India. Revenue Rs. 5,000 Cr. 16 Crores users in India Revenue Rs. 100 Cr. Action 1 No tax in India. Action 3 All profits taxable in USA.

7 E-Commerce Action 1 Vs. Action 3 After implementing all 15 Action Reports, will India be able to tax these corporations? Except for Equalisation Levy No. And some professionals claim that EL is not as per report. So essence is actions do not protect Indian tax revenue. Even EL, as legislated so far, only forces Indian payer to pay the tax. There is no obligation whatsoever on Google or Facebook. 6

8 E-Commerce Action 1 Vs. Action 3 Action 3 will support US taxing Google, Facebook, Apple etc. But these reports do not support India taxing all these Co.s despite the fact that they do earn billions of rupees from India. OECD Model Article 5 Definition of Permanent Establishment has 7 clauses. We need to add 8 th clause: Significant Economic Presence. Revenue exceeding a threshold: It can be Rs. 10,00,000 or any other amount. 7

9 Action 1 Report Equalisation Levy E-commerce Taxation 8 Some critics of Equalisation Levy say: Action Reports state that - Some E-Commerce MNCs pay no tax. By amending TP & CFC provisions, this situation will be corrected. They will pay COR taxes. That should be fine. Why impose Equalisation Levy?

10 Action 1 - Equalisation Levy 9 Consider Apple & Google Apple deals mainly in products/goods Google deals in services. Both sell by E-commerce, Both avoid COR & COS taxes by basing operations in Tax Havens. Apple - Ireland. Google Ireland, Netherlands & Bermuda. Apple has accumulated more than $ 200 Bn. outside USA. Google has accumulated $ 70 Bn. in Tax Havens.

11 Action 1 - E-Commerce Tax Protect US Tax Revenue 10 Now proposes - Amend TP so that more profits will be allotted to COR- USA. No profits will be allotted to COS India, UK, France & rest of the world other than USA. Note: This is at the root of US - EU Tax War.

12 Action 3 CFC Rules 11 COR COS European Sub US Holding Co Brazil Sub Tax Haven CFC Indian Sub. All profits shifted to CFC Action 3 will ensure that all these profits will be taxable in COR.

13 12 CFC Apple USA (AU) US Holding Co. 100% Sub. Apple Ireland (AI) Corporate Structure Pre. US could not tax Apple Ireland. Post Action Attribute larger incomes to AU Action 3 Whole income of AI taxable in USA.

14 CFC Apple 13 Apple USA Holding Co. Apple Ireland 100% Subsidiaries Irish Tax Rate 12.5% Actual Tax paid 0.005% The Credit that Apple USA will get for tax paid in Ireland will be 0.005% & not 12.5%.

15 Action 3 - CFC Protect U.S. Tax 14 US has proposed to amend CFC provisions with RETROSPECTIVE effect to tax all the profits stored outside USA by US MNCs. Action 3 Report on CFC recommends this. Clearly, US will gain. India & rest of the world will continue to suffer. And Indian tax consultants say This is all fine. Let this continue.

16 15 CFC Action 3 1. Control over CFC Legal Control Economic Control De Facto Control Consolidation of Accounts Acting in Concert How are you going to prove that you do NOT control a foreign Co.? 2. CFC Income. Not just Passive income. Any Income. 3. Whole of CFC Profits to be taxed in the hands of Holding Co. Proportionate to control.

17 16 CFC US has proposed a law to change domestic CFC provisions. Action Report 3 should help USA. It permits USA to change law. US is ready with draft law. US internal politics is what may prevent such rules.

18 Review Apple Computers Jurisdiction & Attribution 17 Understanding Jurisdiction to tax and attribution of profits by some illustrations. 1. Jurisdiction - Tata Group has the registered offices of most of the Tata Group Companies in Bombay House. Hence it pays all its income-tax in Mumbai. TELCO s factories are in Pune etc. TISCO s mines & factories lie in Jamshedpur, etc. Similarly almost all Tata Companies have their business units outside Mumbai.

19 Review Apple Computers Jurisdiction & Attribution 18 TCS has staff of more than 4,00,000 software developers. Only a small number works in Mumbai. Mumbai boasts of contributing highest income-tax revenue in the country. Who should have jurisdiction to tax the profits Pune / Jamshedpur or Mumbai? Where the profits should be attributed?

20 Review Apple Computers Jurisdiction & Attribution 19 If we had detailed rules of Attribution of Profits amongst Head Office, mines, factories & sales offices etc. then probably 90% of Tata Group profits would be attributed outside Mumbai. You can select any illustration from a wide range of Indian MNCs. State Bank of India, Infosys, Wipro, ONGC, Indian Oil & so on. Same issues of Jurisdiction & Attribution can be raised.

21 Review Apple Computers Jurisdiction & Attribution 20 We never think of it. India is one country. Within India, Government has a fair system of collecting taxes & spending the revenue. 2. Imagine the huge amount of litigation that we have avoided by having a system where (i) Throughout India all income-tax is collected by one Central Government.

22 Review Apple Computers Jurisdiction & Attribution 21 Then (ii) Allocation of the tax to various States & Union Territories is Government s look out. Even if the State Governments have a dispute with the Central Government the tax payers is least bothered.

23 Review Apple Computers Jurisdiction & Attribution Supposing we had a single Global tax; and further supposing the allocation of revenue could be done fairly all over the world - How much litigation would be avoided? It is an ideal dream. People who see dreams are first ridiculed & ignored; Then criticised; and then at some point of time. Dreams become realities.

24 Review Apple Computers Jurisdiction & Attribution Attribution of Profits I am coming back to the illustration of Bombay House. How much profits you would attribute to the following parts of Tata Group: My estimates are given. You give your estimates.

25 24 Review Apple Computers Jurisdiction & Attribution Percentage of Value Tata Group Organisation Addition. Hence Profit Attribution. Hence Tax Collection. Mining & Manufacturing operations outside Mumbai. 50% Sales organisation outside Mumbai. 40% Head office ownership of all finance, Intellectual Property, Risk 10% taking etc. etc. Total 100%

26 Review Apple Computers Jurisdiction & Attribution 25 Notes: There is no scientific attribution of profits in the above table. I have no knowledge of real facts. You can have your own estimates. This is just an illustration. The key issue in this illustration is Not how much profits to attribute to different functions, assets, risks & market. Issue is, profits can be attributed to all the functions / profit centers of an MNC and not just to Head office / COR.

27 Review Apple Computers Jurisdiction & Attribution 26 In case of Apple Ireland the attribution of profits is as under: Production 0% Sales 0% Irish Branch 0.005% Non-Existent HO % Total 100% And this is perfectly legal. Now consider this query: 5. Don t you think OECD model of DTA; and several OECD reports need significant changes?

28 27 FIIs avoid Indian Taxes US FII Funds from Foreign Investor Rest of the World Singapore SPV India Invested in India Indian Black Money Round Tripping

29 28 FIIs avoid Indian Taxes Rest of the World US FII Singapore SPV Funds from Foreign Investor India Independent Agents Stock Exchange Brokers Buys Securities within India. Sells securities within India As per Actions ; Probably No profits will be attributed to India. Indian Black Money As per plain logic, 90% profits should be attributed to India. Research Analysts Banks Custodian

30 29 FIIs avoid Indian Income Tax 1. They fragment their activities amongst several players. Will Action 7 on Artificial Avoidance of PE help India? If all Indian operators are independent third parties; it will not help. If Indian parties are Controlled Related Parties, Action will help partially. No.

31 30 FIIs avoid Indian Income Tax 2. Since FIIs are doing their Indian business on the internet, it is Electronic Commerce. Will Action 1 help? Will Equalisation Levy help? 3. After all 15 Actions Reports are implemented, will Round Tripping of Black Money Stop? are not targeted against Black Money. No. No. No.

32 31 Action 7 Avoidance of PE MNC Sale of Goods Order concluded in USA MNC has No presence in India Indian Importer Unrelated Party Business with India. MNC s profits are not taxable in India. Article 7 of OECD Model. NO PE. No Tax. Note 1 - If MNC sets up a PE in India for local marketing & sales; the profits attributable to Indian PE will be taxable in India. Note 2 Existing injustice of no profit attribution to the Country of Sales continues even after.

33 Action 7 Avoidance of PE 32 MNC Sale of Goods Order concluded in USA Closely Related Parties New Definition Indenting Agent Warehouse Service Canvassing / Liaison office Habitually plays principal role in conclusion of contract. Subjective matter. Difficult to prove either way. Indian Importer of goods Pre Post No PE in India A PE shall be deemed No profits taxable in India Profits shall be attributed to deemed PE & taxable in India. Mere conclusion of orders outside India won't help

34 33 Action 7 Avoidance of PE 1. Fragmentation of Activities - Several parties. 2. Splitting up of Contracts To remain under the threshold of Period. If these are artificial, they shall be ignored & PE shall be deemed to exist. However all the amendments still require a Place of Business in India. Hence E-Commerce Companies will still escape. FIIs not having Closely Related Parties will also escape.

35 34 GAAR Hutchison of Hong Kong sold 67% shares in Hutchison Essar Indian Company To Vodafone UK Sale price $ 11 Billion Tax Payable Rs. 11 Billion. 1. Will any of the Action Reports prevent this Tax Avoidance? No. 2. Will the 2 nd part of action Information Exchange Agreements avoid this tax avoidance? No.

36 35 GAAR The Anti Tax Evasion measures - Information Exchange Agreements work if there is secret tax avoidance. Hutchison & Vodafone did it openly. India will have to rely on GAAR. Explanations 4 & 5 added to S.9 (1) (i) still do not help as DTA overrides ITA.

37 Transfer Pricing TP Reports See Pages Emphasis is laid on several factors. - Capacity to take decisions SPV in Tax Haven Directors won t have capacity to take decisions. - Actual Performance. Assuming that the SPV director has the capacity. In reality he is not going to actually perform.

38 Transfer Pricing Risk Taking, Holding meeting of executives, Maintaining Minutes Books & Setting up policy environment. Is this direct attack on Apple s planning? All these are not adequate for profit attribution. If this is applied to POEM, then most planning will fail. That is the purpose of. G20 wants Reality. No planning.

39 Transfer Pricing Risk, Intellectual Property etc. were allocated to companies with zero economic activities but cash boxes. Now these are to be connected to economic activities. Indian CBDT has for long taken a stand If foreign television companies broadcast their programmes in India; If goodwill and intellectual properties are used in India, the same are taxable in India. Now Reports accept this position but for COR.

40 Transfer Pricing Today tax practitioners are comfortable with a legal position that Written Documents contracts etc. would prevail. Form prevails upon Substance. However Action Reports state that Actual Conduct of the Controlled Relatives will supplement or even replace contractual arrangements We have huge litigation in EPC & FTS split between supply of goods & FTS

41 Transfer Pricing These action reports state that Post tax departments will look at actual conduct, real transactions. If contracts are not in line with actual conduct, then the contracts will be ignored. See Executive Summary Page 10, Action Reports 8 to 10.

42 Transfer Pricing Written contracts may or may not mean much. Company will have to prove actual performances, capabilities etc. When an MNC group has executed several contracts amongst several AEs, will they have to go on proving the truth behind every contract?

43 Transfer Pricing Every sales & purchase invoice is a contract. Every year assessment will take 10 years. So far, the emphasis was on Tax Compliance. Meaning paying taxes & complying with legal requirements. Now every assessment can be a massive job. How Indian CBDT actually administers is an important matter to observe.

44 Transfer Pricing OECD is known for drafting theoretical reports. One can write fine reports on attribution of profits based on FAR analysis. But all that is subjective & theoretical. Making the law impractical. After Action Reports 8, 9 & 10 it will be even more impractical. All of the following - Tax Payer, Tax Administrator & Judiciary - can have different opinions on the same set of accounts.

45 Substance Over Form 44 Let me submit Golden Rules of Taxation. There can be no conflict between Form & Substance. Form must always represent substance. If form does not represent substance the form has to be rejected. The Tax Payer who submitted incorrect form corporate structure etc. - is liable to action for telling lies on verification in his tax returns. Whether you like my theory or reject it, please note that tax laws & Treaties are changing. Be prepared.

46 Substance to be disclosed in Tax Returns by Assessee 45 There is an analogy. A King is always expected to act right. King is an authority acting for the benefit of the people. Just & Fair. Hence it is said: King Can do No Wrong. Now this is no licence for Kings & Governments to do anything & then claim that whatever I did has to be right.

47 Substance to be disclosed in Tax Returns by Assessee 46 Correct King must do only right. Wrong Whatever King does is right. Correct Similarly, the tax return & audited accounts & all attachments must tell true & fair taxable profits. Wrong Whatever papers are presented by tax payer are right.

48 47 Substance shall prevail over Form All Treaty shopping; All Use of Tax Havens is Wrong. They spoil the True & Fair view. Assessees are liable to action under existing law. Now will make it clear in Domestic Law & Treaty Models

49 48 International Tax After Since 1987 we (BCAS + ICAI + others) have popularised FEMA & International Taxation. At that time I used to say International Taxation is easy. Understand the concepts & any CA can practise it. Now I say: International Taxation has become too complex. After implementation of it will be Complex & Complicated.

50 49 International Tax After Reasons: Every Regulator be it RBI + DOE, ROC, SEBI considers that- His Regulation is most important. All businessmen are out to violate the regulations. Because of loopholes in the regulations, the rich & powerful people escape the regulations.

51 50 International Tax After So Each Regulator demands extensive powers to deem violation - where none may exist + very high punishment provisions. Parliament at highest levels is passing these laws. What PM & others at highest levels ignore are these facts: Corruption exists at all levels business & industry, bureaucracy & politics. Corruption is not eliminated & cannot be eliminated. And to such a system you are giving very wide discretionary powers.

52 51 International Tax After The corrupt businessman will escape the rigours of regulations. Honest businessman cannot afford to do business. Business Friendly Environment goes for a Toss. GDP can t grow. It can fall.

53 52 European Union is acting European Commission is taking action/ has taken action against: Countries Ireland Belgium Luxembourg Netherlands Luxembourg Companies Apple Computers Inc. 35 MNCs Fiat Starbucks Amazon There are two root issues/ Systemic Weaknesses: 1. Why don t you isolate Tax Havens? When they are part of the system, whole system gets complicated.

54 53 European Union is acting 2. Apple, Amazon, Google etc. sell billions of dollars worth of goods & services into Europe. And they don t pay any income-tax in Europe. What needs to be changed is fundamental basis of current International Tax system. European Commission ignores both root causes & fights at a different level.

55 54 European Union Vs. US Coming back to 1. Some nations, are only looking at their revenue losses. Not concerned with losses suffered by others. Remember Vested Interest Lobbies Scuttling GATT talks & delaying WTO agreements. Same story for Nuclear Non-Proliferation; and Environment Control.

56 EU & US - Tax War? 55 Similar vested interest actions can be seen in Action Reports. 2. Now a Tax War is emerging between US & European Union. If US is loosing tax revenue, Amend the OECD DTA model & change domestic law. If India is losing tax revenue, ignore it. (E-commerce Action 1) And if US MNCs are avoiding taxes of rest of the world, don t allow any changes in DTA & domestic law.

57 56 Consequences of Consequences have been stated in Part 1 itself. Tax Compliance & Tax Administration will be impossible. Corruption will increase. There can be a break down of the system. Taxation will hurt Global GDP.