The Base Erosion and Profit Shifting project, initiated by the OECD in 2013, aimed to combat tax avoidance strategies employed by multinational enterprises and promote equitable international tax practices. This concise summary outlines the 15 BEPS actions, including addressing digital economy tax challenges, countering harmful tax practices, and refining transfer pricing rules. India's commitment to aligning its domestic tax regulations with BEPS standards is highlighted, with measures such as the Multilateral Instrument adoption and enhanced transfer pricing documentation. While significant progress has been made, challenges persist, emphasizing the need for ongoing monitoring and refinement of these international tax measures.
History of the BEPS Project
In July 2013, the Organisation for Economic Co-operation and Development (‘OECD’) embarked on a significant effort to address Base Erosion and Profit Shifting (‘BEPS’) issues. This initiative aimed to combat tax avoidance strategies used by multinational enterprises (‘MNEs’) and promote fair and transparent international tax practices. It resulted in an Action Plan comprising 15 BEPS actions.
On 05.10.2015, the OECD and the G20 released final reports and explanatory statements, outlining consensus recommendations as part of the BEPS project. These measures sought to curtail tax avoidance and profit shifting by multinational companies. Since October 2015, the OECD and G20 have maintained their commitment to the BEPS Action Plan through the BEPS Inclusive Framework, which welcomes the participation of a broader group of nations, provided they adhere to the BEPS minimum standards.
Action 1: Addressing Tax Challenges from the Digitalization of the Economy
Action 1 is primarily focused on addressing the intricate tax challenges arising from the digitalization of the global economy. It seeks to identify and resolve the principal issues that digitalization poses to existing international tax regulations.
The final report for Action 1, while not offering specific recommendations, recognizes that potential solutions in this domain may require broader changes to the tax framework that go beyond the scope of BEPS. Consequently, ongoing research and monitoring efforts in this area persist.
In 2017, the OECD renewed its efforts by seeking input on tax challenges associated with digitalization and potential solutions. This effort was conducted as part of the work carried out by the Task Force on the Digital Economy. The current work program under Action 1 consists of two pillars:
(1) Reallocation of profit and revised nexus rules, focusing on determining the appropriate jurisdiction for tax payments and the basis on which tax should be calculated.
(2) Global anti-base erosion mechanism, pertaining to creating a system that ensures that MNEs pay a minimum level of tax, regardless of the extent of their involvement in digital activities.
Given the absence of an international consensus on the taxation of digitalized businesses, several countries have introduced interim unilateral taxes on specific digital services, known as Digital Services Taxes (‘DSTs’). These taxes are typically applied to the gross revenue generated from services provided to users within the taxing jurisdiction. DSTs are an interim measure taken by individual countries until a more comprehensive international agreement on digital taxation can be reached.
Action 2: Neutralizing Effects of Hybrid Mismatch Arrangements
Action 2 is focused on neutralizing the impact of hybrid mismatch arrangements. These arrangements take advantage of differences in tax regulations across various jurisdictions. The final report for Action 2 provides recommendations for domestic laws to counteract these hybrid mismatch arrangements, in addition to proposing modifications to the OECD model tax convention.
Hybrid mismatches occur when rules for distributing income and expenses between a branch and its head office enable a portion of the taxpayer’s net income to avoid taxation in both the branch’s jurisdiction and the jurisdiction of the head office.
The OECD report identifies five fundamental types of branch mismatch arrangements:
(1) Disregarded branch structures: These arrangements treat a branch as a separate entity in one jurisdiction but not in another, leading to inconsistent tax treatment.
(2) Diverted branch payments: These involve the use of hybrid instruments or entities to create deductions in one jurisdiction without corresponding income inclusion in another.
(3) Deemed branch payments: These arrangements create deductions in one jurisdiction without including the corresponding income in another due to differences in characterization.
(4) DD (Deduction/Deduction) branch payments: In these cases, double deductions are claimed for the same payment in two jurisdictions.
(5) Imported branch mismatches: These arise from cross-border activities and can lead to the exploitation of inconsistencies in tax treatment.
These branch mismatches can arise directly or indirectly through investments in transparent structures such as partnerships.
Action 3: Designing Effective Controlled Foreign Company Rules
Action 3 is centred on the development and reinforcement of controlled foreign company (‘CFC’) rules. These rules are designed to provide jurisdictions with the necessary tools to prevent profit shifting to low-tax foreign subsidiaries of MNEs.
CFC rules are aimed at countering profit shifting by taxing the income generated by foreign subsidiaries when certain conditions are met. The final report for Action 3 outlines the essential components of effective CFC rules, allowing jurisdictions to implement or adapt them. These building blocks include defining what constitutes a CFC, specifying exemptions, determining CFC income, outlining the process for computing income, addressing income attribution, and preventing double taxation.
It is important to note that CFC rules are not limited to situations where companies control CFCs; they should also be designed to address situations where individuals have control over foreign entities. This ensures that both corporate and individual entities are subject to these rules when appropriate.
Action 4: Limiting Base Erosion involving Interest Deductions & other Financial Payments
Action 4 of the BEPS initiative is specifically concerned with mitigating base erosion involving interest deductions and other financial payments. The primary aim is to prevent MNEs from reducing their tax liabilities through the exploitation of excessive interest deductions.
The final report for Action 4 provides recommendations for domestic rules designed to restrain the deductibility of interest expenses. It introduces two significant proposals:
(1) Fixed Ratio Rule: This rule allows entities to deduct interest and other financial payments up to a fixed percentage of their earnings before interest, tax, depreciation, and amortization (‘EBITDA’). It establishes a clear limit on the amount of interest deductions a company can claim.
(2) Group Ratio Rule: This rule is designed to accommodate groups with substantial external debt. It permits deductions for net interest in proportion to the group’s net interest-to-EBITDA ratio. This approach is intended to provide flexibility for companies with varying financial structures.
The report also addresses the complexities of transfer pricing in financial transactions, highlighting the importance of accurately delineating such transactions to ensure that they are conducted at arm’s length, in accordance with international transfer pricing principles.
Action 5: Countering Harmful Tax Practices more effectively, taking into account Transparency & Substance
Action 5 is focused on the more effective identification and counteraction of harmful tax practices while giving due consideration to transparency and substance. The goal is to prevent preferential tax regimes from creating opportunities for tax avoidance and evasion.
The final report for Action 5 underscores the importance of substantial activity in evaluating the potentially harmful nature of preferential tax regimes. It introduces the ‘nexus approach’, which establishes a new standard for substantial activity in intellectual property or patent box regimes. Additionally, the report outlines a framework for the mandatory and spontaneous exchange of information concerning tax rulings related to preferential regimes. This exchange of information enhances transparency and enables countries to scrutinize and address harmful tax practices.
The criteria for evaluating preferential tax regimes include factors such as low effective tax rates, isolating economic activities from the domestic economy, lack of transparency, inadequate exchange of information, and the absence of substantial economic activities within the regime. Other considerations involve artificial definitions of the tax base, non-compliance with international transfer pricing principles, tax exemption for foreign-source income, negotiable tax rates or bases, and provisions related to maintaining confidentiality.
Action 5 serves as a BEPS minimum standard, subjecting countries participating in the Inclusive Framework to peer reviews, which ensure their compliance with the standards established by the Forum on Harmful Tax Practices. This peer review process helps promote global consistency in addressing harmful tax practices.
Action 6: Preventing Granting of Treaty Benefits in Inappropriate Circumstances
Action 6 holds a critical role in its agenda, aiming to prevent the misuse of international tax treaties for the purpose of tax avoidance and evasion, including through practices like treaty shopping. Treaty shopping is when taxpayers attempt to inappropriately access treaty benefits provided by international tax agreements. Action 6 introduces several key elements:
(1) The preamble in tax treaties: This element suggests the inclusion of a preamble in tax treaties that explicitly states that the purpose of these treaties is not to enable situations where there is no or reduced taxation as a result of tax avoidance or evasion. This preamble sets the tone for the treaty’s overarching objectives.
(2) Specific anti-abuse rules: Action 6 recommends the integration of specific anti-abuse rules into tax treaties to counter treaty abuse. These rules are designed to identify and prevent situations where taxpayers try to inappropriately access the benefits offered by tax treaties.
(3) Multilateral Convention: The recommendations from Action 6 are integrated into the provisions of the Multilateral Convention to Implement Tax Treaty-Related Measures to Prevent BEPS (‘MLI’). The MLI serves as a tool used by jurisdictions to amend their existing bilateral tax treaties in line with BEPS measures, promoting international consistency.
Presently, ongoing work related to Action 6 primarily involves peer reviews conducted by the Inclusive Framework. These reviews ensure that jurisdictions effectively implement the minimum standards established by the BEPS initiative. The process assesses the compliance of jurisdictions in incorporating the suggested elements of Action 6 into their tax treaties and domestic laws.
To prevent the granting of treaty benefits in inappropriate circumstances effectively, it is crucial to distinguish between two types of cases. The first type involves scenarios where individuals or entities attempt to circumvent limitations explicitly set by the treaty itself. The second type pertains to cases where individuals or entities aim to exploit treaty benefits to bypass domestic tax law provisions.
Action 7: Preventing Artificial Avoidance of Permanent Establishment Status
Action 7 plays a significant role in the BEPS project by addressing the artificial avoidance of Permanent Establishment (‘PE’) status. The focus here is on redefining the threshold that triggers the establishment of a PE to prevent BEPS.
Action 7 provides recommendations for changes in the definition of a PE, which aim to address situations where non-resident companies engage in sales activities in a jurisdiction through commissionaires or dependent agents who do not formally conclude contracts in that jurisdiction. It also addresses the exploitation of specific activity exceptions, such as warehousing.
Moreover, the Action 7 report mandates the development of additional guidance on the attribution of profits to PEs under Article 7 of the OECD Model Tax Convention. This takes into account the changes made to the definition of a PE, ensuring that profits arising from core business activities in a country can be subject to taxation in that country.
Addressing one of the significant challenges related to BEPS concerns, the fragmentation of activities, an anti-fragmentation rule was proposed in the Action 7 report. This rule prevents businesses from dividing a cohesive operation into smaller entities to claim that each part is only involved in preparatory or auxiliary activities exempt from PE status. These changes aim to ensure fair and equitable taxation in the context of cross-border business operations by appropriately attributing profits to the jurisdictions where value is created.
Actions 8 to 10: Transfer Pricing
Intangibles and Cost Contribution Arrangements: Action 8 centres on transfer pricing issues concerning transactions involving intangible assets and cost contribution arrangements. It emphasizes the importance of aligning transfer pricing outcomes with the actual value created. The guidance provided in Action 8 assists both tax authorities and MNEs in determining the appropriate pricing for transactions involving intangible assets, with the overarching goal of promoting fairness and consistency.
Risks and Capital-Rich Companies: Action 9 addresses the allocation of risks within contracts and its impact on profit allocation. It underscores the necessity of aligning profits with genuine economic activities, particularly in situations involving capital-rich group companies. The primary objective of this action is to prevent profit shifting based on risk allocation.
High-Risk Areas: Action 10 focuses on various high-risk aspects of transfer pricing, encompassing the recharacterization of transactions, transfer pricing methods in abusive scenarios, and the handling of management fees. It aims to eliminate abusive transfer pricing practices and ensure equitable pricing.
Actions 11 to 15: Measuring, Monitoring, and Enhancing Tax Practices
Action 11 focuses on establishing methodologies to collect and analyse data related to BEPS and measures taken to address it. The objective is to gain a better understanding of the scale and economic impact of BEPS. The report suggests indicators of BEPS and provides a toolkit to help countries evaluate the fiscal effects of BEPS countermeasures. Ongoing work includes the development of a Corporate Tax Statistics database to study corporate tax policy and BEPS measures’ effectiveness.
Action 12 aims to create a framework for the design of mandatory disclosure rules for countries that opt to adopt them. These rules help countries obtain early information on potentially aggressive or abusive tax planning schemes. The framework covers rules targeting international schemes and encourages information exchange and cooperation between tax authorities.
Action 13 focuses on re-examining and developing rules on transfer pricing documentation to enhance transparency for tax authorities while considering the compliance costs for businesses. It introduces a three-tiered structure for transfer pricing documentation, consisting of a Master file, Local file, and Country-by-country report, aimed at providing tax authorities with valuable information for assessing transfer pricing and BEPS risks.
Action 14 aims to enhance the effectiveness of dispute resolution mechanisms by addressing issues that hinder the resolution of treaty-related disputes under mutual agreement procedures (‘MAPs’). It includes measures to improve the efficiency and timeliness of the MAP process and sets out best practices. The peer review process evaluates the implementation of the minimum standard established by BEPS.
Action 15 seeks to develop an MLI to enable jurisdictions to swiftly and consistently amend bilateral tax treaties in line with certain BEPS recommendations. The MLI covers measures related to hybrid mismatches, preventing tax treaty abuse, changes to the definition of PEs, and dispute resolution.
Conclusion
In India, the implementation of BEPS recommendations has been a pivotal development in the realm of international taxation. Since adopting the BEPS Action Plan, India has taken significant steps to align its domestic tax regulations with global standards. Notably, the introduction of measures such as the MLI to amend bilateral tax treaties reflects India’s commitment to combatting tax avoidance and ensuring greater transparency.
The country has also taken proactive measures to address specific BEPS concerns, including introducing a comprehensive framework for Transfer Pricing Documentation and Country-by-Country Reporting. However, the effectiveness of these measures is still evolving, and challenges remain in terms of consistent enforcement and addressing complex tax avoidance schemes.
India has made significant strides in aligning its tax framework with BEPS recommendations, but the full impact and success of these measures require continuous monitoring and further refinements to ensure a fair, transparent, and equitable international tax environment.
Authored by Srishty Jaura, Advocate at Metalegal Advocates. The views expressed are personal and do not constitute legal opinion.