Gear up for modifications in tax legal guidelines, treaties

The international community led by the had initiated the (BEPS) project a few years ago with the aim of ensuring that profits are taxed where economic activities are performed and where value is created. Governments, and social groups have been voicing their concern over the past decade that multinational enterprises are shifting profits to low tax jurisdictions where there is no or little value-creation, and consequently not paying their fair share of taxes. As a member of the G20, India is an active participant in the project.

The most common practices and structures identified by India from a BEPS perspective are:

• Excessive payments to foreign-affiliated companies in respect of interest, service charges and royalties;
• Aggressive transfer pricing, including supply chain restructuring that contractually allocates risks and profits to affiliated companies in low tax jurisdictions;
• Digital enterprises facing zero or no taxation in view of the principle of residence-based taxation;
• Artificial avoidance of permanent establishment status;
• Treaty shopping;
• Incentives in the tax laws for attracting investment; and
• Assets situated in India but owned by companies located in low tax jurisdictions with no substance.

To implement BEPS actions around these issues, India is likely to amend its domestic tax law as well as tax treaties (either through the multilateral instrument being developed as part of the BEPS project, or bilaterally). It is important that taxpayers take note of these developments and prepare accordingly.

Some key areas of impact are as follows, treaty abuse and treaty shopping is a significant source of BEPS concerns for governments. BEPS Action 6 targets tax treaty shopping by multinational enterprises (MNE) that establish ‘letterbox’, ‘shell’ or ‘conduit’ companies in countries with favourable tax. India has now initiated the process of renegotiating some of its existing bilateral tax treaties to combat treaty shopping by inserting anti-abuse rules. Some of the BEPS suggestions on this aspect are similar and need to be evaluated by taxpayers closely in light of their current structure.

With abundant availability of talent pool, discussions on aspects of intangibles, particularly on how such a centre should be remunerated, have dominated the Indian transfer pricing landscape over the past few years. The Organisation for Economic Co-operation and Development (OECD) guidance on Action 8 in relation to intangibles emphasise supplementing (or replacing, where appropriate) the contractual arrangement with an examination of the actual conduct of the parties and economically significant risks. This approach finds support in the Indian context. The view of Indian tax authorities on this aspect appears to be aligned to the OECD. It is important that Indian or foreign taxpayers, who have R&D centres in India, heed this guidance as it lays the foundation of how tax authorities are likely to evaluate the pricing of transactions through these centres. OECD’s BEPS Action 8 revisions also discuss the application of the principles in respect of development, and enhancement of marketing intangibles would also need to align with legal jurisprudence.

The global transfer pricing documentation has undergone a significant change with the G20/OECD having agreed on specific formats of compliance and reporting of global information for transfer pricing risk assessment. The OECD has adopted a three-tiered approach to documentation, which includes country-by-country report (a global financial snapshot of an MNE), master file (a high level overview of the MNE’s global operations and transfer pricing policies), and local file (provides an entity and transaction level transfer pricing analysis for each jurisdiction).

The Indian transfer pricing regulations require maintenance of prescribed information/documents for substantiating the arm’s length price of its transactions with the related parties. While the above documentation requirements broadly cover most of the content of local file, the Indian transfer pricing regulations explicitly do not provide for maintenance of the information contemplated in the master file and CbC (country-by-country) template.

Accordingly, under the Indian regulations, additional rules will need to be framed.

The new BEPS guidance will have a significant impact on Indian taxpayers. Taxpayers need to be aware of and constantly monitor the ongoing BEPS Action Plans as well as the changes that India is bringing about in its domestic law and tax treaties.