Simplifying BEPS Action Plan BEPS and GST Conference 2 nd September 2016 1 About the pic: 16 Nov 2015, In Antalya, Leaders expressed support for the package of measures developed under the G-20/OECD Base Erosion and Profit Shifting (BEPS) project to make the global business taxation system more fair and efficient.
Contents 12 out of 15 action points covered Simplified snapshots of action points Take away elements to practically implement in business Thinking areas 2
Structure of the slide deck 1. Root cause - Scenarios that give rise to BEPS concern 2. Suggestions made by the action plans Introduction 3. India Impact 3
4 Introduction
5 Introduction
Action 1: Addressing the tax challenges of Digital Economy 6
G Inc. Root Cause (Typical model)- Action 1 2,000+ employees G. Ireland Op Co IP Rights Sublicenses IP Rights Customer- $ 2,000 (Advt.) 7 G. Ireland Holdco 2 employees Total taxability in Ireland Amount ($) Sales 2,000 Less: Service fee 400 Less: Employees cost 500 Less: Royalty pay out 1,000 Profit 100 Service fee $ 400 (Cost plus) Tax @ 12.5% 12.5 0.625% of sales G. India Serco
Irish structure in practice Apple as used herein means: Apple Inc., located at 1 Infinite Loop, Cupertino, California, for users in North, Central, and South America (excluding Canada), as well as United States territories and possessions; and French and British possessions in North America, South America, and the Caribbean; Apple Canada Inc., located at 120 Bremner Blvd., Suite 1600, Toronto ON M5J 0A8, Canada for users in Canada or its territories and possessions; itunes K.K., located at Roppongi Hills, 6-10-1 Roppongi, Minato-ku, Tokyo 106-6140, Tokyo for users in Japan; Apple Distribution International, located at Hollyhill Industrial Estate, Hollyhill, Cork, Republic of Ireland, for all other users. For users in territories where Apple means Apple Distribution International, itunes S.à r.l, located at 31-33, rue Sainte Zithe, L-2763 Luxembourg, shall be the seller of subscription storage upgrade services for the Services offered by Apple Distribution International. Apple Distribution International shall be the operator and data controller of the Services. 8
Suggestions/ Solutions Digital Economy Nexus Approach Withholding tax Equalisation levy Based on significant economic presence Gross tax principal Simplicity of WHT with threshold set to evaluate significant economic presence 9
India Impact- Equalisation levy Applicable on specified services (Digital advertising services) Provided by non resident not having a PE in India ( after 1 June 2016) Threshold: Aggregate amount of consideration is INR 100,000 or more Liability to pay: Payer @ 6% No other tax on the recipient of income Service tax on import of service continues Procedure similar to TDS compliances 10
Action 2: Hybrid Mismatch Arrangements 11
Root Cause - Action 2 What is Hybrid Mismatch Arrangements? An arrangement that exploits the different tax treatment in two jurisdictions to produce a mismatch in tax outcomes Mismatch is either double deductions for the same payment or a deductible payment that is not included in income by the recipient Examples: Company A - Parent D/NI Company A - Parent D/D Equity Dividend Expense Debt Company B - Subsidiary Interest Company A Foreign branch Payer Expense 12
Suggestions/ Solutions 1. D/NI Instruments / entities Special rule on dividend exemption for instruments Linking rules General rule: deny deduction Secondary rule: DD Entities only Include in Income 2. Changes to OECD model conventions: Examine issues of dual resident entities (Article 4 Resident) Examine issues related to transparent entities (Article 1- Scope) Interactions between recommendations in Part 1 and provisions of OECD model conventions 13
India Impact- GAAR Main purpose or one of the main purposes is to obtain a tax benefit AND Not at arm s-length OR Misuse/abuse" of tax provisions OR Lacks commercial substance OR Not for bona-fide purposes Impermissible Avoidance Arrangement Consequences Disregard / combine / recharacterize whole / part of the arrangement Disregard corporate structure Deny treaty benefit Re-assign place of residence / situs of assets or transaction Re-allocate income, expenses, relief, etc. Re- characterize Equity- Debt, Income, Expenses, relief, etc. Applies to both Indian Residents and Non-Residents GAAR to override Treaties 14
Action 3: Controlled Foreign Company Rules 15
Root Cause - Action 3 A CFC is foreign body corporates controlled by the taxpayers of resident country which has potential to strip off the taxable base of resident tax jurisdiction subsidiary Export of Goods $100 Export of Goods $1,000 Profit shifted: $900 (Tax rate= 5%) subsidiary Can effective transfer pricing regulations solve this? 16
Suggestions/ Solutions Type of entity Type of Control Level of control Effective credit mechanism to avoid double taxes on the same income 6. Preventing double taxation 1. Defining CFC 2. Fixing threshholds Setting minimum income threshold Tax rate exemption ETR concept CFC rules Parent company jurisdiction should frame rules that ensure 100% CFC income attribution 5. Attributing income 4. Computing income 3. Defining income Dividends Interest Royalties and IP Sales and service Related party income Use tax laws of parent company 17
India Impact- POEM and CFC 1. Adoption of Place Of Effective Management concept- Whether a form of CFC? 2. CFC featured in the Direct Tax Code (2010 and 2013) Whether a reality? 18
Action 4: Limiting Base erosion over Interest deductions 19
How does interest create BEPS Issue? Part A: Outbound investments Root Cause - Action 4 (1 of 2) Tax rate 30% with Dividends tax exempt Pre tax profits = $ 100 Post tax profits = $ 70 Pre interest profits = $ 100 After interest = $ 90 Post tax profits = $ 63 subsidiary Contributes $ 100 through additional equity Tax rate 10% Borrows $ 100 @ 10% Uses $ 100 and generates operating profit of $ 20 After interest = $ 10 After Tax profits @ 10% = $ 9 Post tax profits = $ 79 Uses $ 100 and generates operating profit of $ 20 Interest cost = NIL After Tax profits @ 10% = $ 18 Post tax profits = $ 81 20
Invest $ 100 How does interest create BEPS Issue? Part B: Inbound investments Root Cause - Action 4 (2 of 2) Tax rate 10% Pre tax profits = $ 100 Interest expense = $ 10 Post tax profits = $ 81 Borrows $ 100 @ 10% Pre interest profits = $ 100 Post tax profits = $ 90 subsidiary Tax rate 30% Borrows $ 100 @ 10% Uses $ 100 and generates operating profit of $ 20 Interest Cost = NIL After Tax profits @ 30% = $ 14 Post tax profits = $ 95 Uses $ 100 and generates operating profit of $ 20 Interest cost = $ 10 After Tax profits @ 30% = $ 7 Post tax profits = $ 97 21
Best Practice approach Suggestions/ Solutions Step 1: Identify the payments that could be considered as interest or debt obligations ( interest obligations) Step 2: Identify MNE entities to which such best practice approach would apply set minimum threshold Step 3: Identify net interest expense (interest expense interest revenue) Avoids double taxation Step 4: Identify denominator EBIDTA Step 5: Fixed Ratio rule Step 3 / Step 4 = 30% or less [ as per a study 87% of companies would be able to claim full interest benefit] Step 6: Group Ratio rule Group net third party interest/ Group EBIDTA Step 5: Interest could be allowed to the extent of maximum of group ratio Step 6: Carry forward / backward of disallowed interest 22
India Impact Expected clarity on interest benchmarking in Indian TP regulations 23
Action 5: Countering harmful tax practices 24
Root Cause- Action 5 Preferential tax regimes a. Low or no tax rates b. Reduction in tax base c. Lacks economic substance d. Benefit without underlying activity e. Special consideration for the type of income generated f. Special ruling initiatives for foreign companies/ investors g. Non transparent h. No effective exchange of information i. Failure to adhere transfer pricing principles 25
Nexus Approach Suggestions/ Solutions ( 1 of 2) IP Regimes Expenditure on R&D is considered as a proxy for substantial activity Income receiving tax benefits = Qualifying expenditure incurred to develop IP / Over all expenditure X over all income from IP Non IP Regimes Headquarters regime Distribution and service centres Financial and leasing regimes Shipping regimes Holding company regimes Asset holding Holding company regimes Shareholder ( exchange of information, hybrid mismatches, CFC regimes) 26
Transparency through ruling Suggestions/ Solutions ( 2 of 2) Which rulings are covered? Unilateral APAs which could have downward impact on group ETR Which countries' information needs to be exchanged? ultimate parent and the resident country with whom the transaction is entered Which all ruling to be covered? Ruling post 1 Jan 2010 existing till 1 Jan 2014, for future rulings time is provided to make local jurisdictional changes for a period post 1 April 2016 27
India Impact Patent box New section 115BBF has been incorporated, detailing provisions relating to patent box regime Royalty income earned against patent developed and registered in India shall be taxable at a rate of 10% on gross basis Developed means 75% of expenditure incurred in India by the person resident Royalty includes income other than capital gains from transfer or patents and products manufactured out of the patent Patentee to be true and first inventor 28
Action 6: Prevent granting of treaty benefits in inappropriate circumstances 29
Root Cause- Action 6 Treaty Shopping Abuse of treaty provisions either by treaty shopping, domestic rules, Resident Conduit company 30
Suggestions/ Solutions Using treaty provisions for Abuse of treaty provisions Abuse of domestic law Treaty Shopping Other situations Addressed by : GAAR 31 Addressed by minimum standard: Combined approach of LOB and PPT rule Clear statement that contracting state will avoid creating opportunities for treaty shopping Targeted rules: Anti-fragmentation rules Action 7 Hiring out labour Art 15 Dividend characterisation Action 2 Judicial rulings SAAR Clear statement on intent for avoidance of double taxation and non creation of opportunities for double non taxation
India Mauritius DTAA (Ammended) Article 27A : LIMITATION OF BENEFITS 1. A resident of a Contracting State shall not be entitled to the benefits of Article 13(3B) of this Convention if its affairs were arranged with the primary purpose to take advantage of the benefits in Article 13(3B) of this Convention. 2. A shell/conduit company that claims it is a resident of a Contracting State shall not be entitled to the benefits of Article 13(3B) of this Convention. A shell/ conduit company is any legal entity falling within the definition of resident with negligible or nil business operations or with no real and continuous business activities carried out in that Contracting State. 3. A resident of a Contracting State is deemed to be a shell/conduit company if its expenditure on operations in that Contracting State is less than Mauritian Rs.1,500,000 or Indian Rs. 2,700,000 in the respective Contracting State as the case may be, in the immediately preceding period of 12 months from the date the gains arise. 4. A resident of a Contracting State is deemed not to be a shell/conduit company if: (a) it is listed on a recognized stock exchange of the Contracting State; or (b) its expenditure on operations in that Contracting State is equal to or more than Mauritian Rs.1,500,000 or Indian Rs.2,700,000 in the respective Contracting State as the case may be, in the immediately preceding period of 12 months from the date the gains arise. Explanation: The cases of legal entities not having bona fide business activities shall be covered by Article 27A (1) of the Convention. 32
India Impact Mechanisms in IT Act Requirements to obtain tax residency certificate (TRC) Form 10F Reporting requirement at withholding Form 15CA/CB GAAR Place of effective management 33
Action 7: Prevent artificial avoidance of PE status 34
Root Cause - Action 7 Avoidance of PE Commissionaire /Agency 5(5) Exemptions 5(4) 5 (5): Exercises in source state, an authority to conclude contracts in the name of the foreign enterprise 5 (6): No PE- If business carried through independent agent (a) use of facility storage, display or delivery (b)- stock for storage, display or delivery (c) stock for processing (d) fixed place for purchase of goods (e) Any other auxiliary of preparatory activity (f) - Combination of (a) to (e) if the over all activity is preparatory and auxiliary 35
Suggestions/ Solutions Commissionaire arrangements Changes proposed to Article 5(5) of the treaties Principle Role in conclusion of contracts introduced - Action over contractual obligation Changes to exclusions of independent agents from PE Not an independent agent, if closely related Closely related control through beneficial interest ( direct or indirect holding more than 50%) TP regulations? Changes to exclusions from PE taking cover of auxiliary or preparatory activities Changes proposed to Article 5(4) of the treaties Overall objective of the business has to be auxiliary and preparatory Anti- Fragmentation rules 36
India Impact Watch out for treaty changes : change the way indenting and sourcing agents do business 37
Action 8-10: Transfer Pricing 38
Guidance Income to be taxed where value is created Chapter I- Section D on application of ALP revised to including detailed discussion on risk evaluation Chapter II Additional guidance Commodity transactions Use of quoted prices allowed Guidance on transactional profit split method Work yet to be done Chapter VI- Intangibles- revised: Meaning: Not a physical asset and is capable of being owned or controlled for use in commercial activities Group synergies and market specific characteristics are not intangibles DEMPE* Functions : remuneration in line with functions and risk along with contractual obligations Legal owner only eligible for functions and risks undertaken Performance and control functions Specific guidance on marketing intangibles Whether such function would be done by independent enterprises Guidance on R&D function low end R&D Cost plus 39 Development, Enhancement, Maintenance, Protection and Exploitation
Guidance Chapter VI- Intangibles- revised: Highly Uncertain transactions Predict anticipated benefits, fulfilment of short term goals renegotiations Hard to Value intangibles - No reliable comparison exist and cash flows are uncertain. Taxpayer can value such intangibles with contingent assumptions. Difficult for tax authorities to evaluate. Compare pre and post valuation Chapter VII- Intra-group services- addition/ revision: Low value adding Intra-group services: Accounting, processing, HR, Consolidation, IT, PR, Legal etc. Cost + 5% suggested as a model Chapter VIII- Cost Contribution Arrangements- revision 40
Action 13: Transfer Pricing documentation and CbC Reporting 41
Guidance Three tiered structure Master File Organizational structure Description of the MNE business MNE s intangibles Group financial activities MNE s Financial and tax position Local File Local entity Controlled Transactions FAR Economic analysis Financial information Country by country reporting Overview of allocation of Income, profits, taxes, number of employees and business activities by tax jurisdiction Details of all constituent entities of the MNE group Automatic exchange of information CBC reporting for groups with Sales Euro 750 mio and above Applicable for FY 2016-17 42
Action 15: Multilateral instrument 43
What will Action 15 address - A solution to modify Bilateral tax treaties but respecting sovereign autonomy in tax matters. - Precedents not in international tax field but there are several precedents in various other areas of public international law. - Three advantages : Highly targeted instrument All Bilateral treaties to be modified in a synchronized way for more than 3000+ Treaties Political imperative to drive BEPS project. - Governments can achieve the objective without violating Bilateral Tax Treaties. - Work on other areas like Action 5 Harmful tax practices and Action 6 Treaty Abuse, Action 2 Hybrid Mismatches, Action 7 PE and Action 14 MAP can be swiftly implemented. - Instrument will be open to signature by December 31, 2016. 44
45 Next steps
Next steps Watch out Domestic law changes Treaty changes Exchange of informaion India - BEPS related changes in Finance Bill, 2016 - GAAR reality by 2017? 46
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