base erosion & profit shifting emerging trends and proposed action plans shefali goradia january...

BASE EROSION & PROFIT SHIFTING Emerging trends and proposed Action Plans

Shefali Goradia

January 8, 2014

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CONTENT

Background

What is BEPS?

BEPS Concerns

BEPS Action Plans

Formulation of Action Plans

Timelines and Deliverables

Objective

Action Plans

Base Erosion and Profit Shifting

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BACKGROUND

Globalization and technological advances have increased the pace of integration of

national economies as well as evolved new business models in which Multinational

Enterprise (MNEs) operate

Shift from country specific business models to global models

Domestic laws of countries do not consider tax systems of other countries. Further, gaps

remain in international standards (say in bilateral agreements)

Tax planners are continuously identifying and exploiting the legal arbitrage opportunities

and boundaries of acceptable tax planning to minimize tax burden (say Double Irish Dutch

Sandwich)

In doing so, BEPS concern arises. BEPS relates chiefly to instances where the interaction

of different tax rules leads to double non taxation or less than single taxation. It also

relates to arrangements that achieve no or low taxation by shifting profits away from

jurisdictions where the activities creating those profits take place.


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WHAT IS BEPS?

What is BEPS?

Shifting of profits /income to low-tax jurisdictions or other locations enabling a more

favorable tax treatment

Arrangements involving double non-taxation or less than single taxation

Transfer of intangibles to favorable tax jurisdictions

Stripping legal entities of business functions, assets and risks

Use of “tax attributes” such as tax credits, loss-carry forwards, etc

Use of intermediary companies/ jurisdictions in investment and financing structures

Use of hybrid arrangements to exploit mismatches in tax treatment

BEPS – Causes

Existence of loopholes, gaps or mismatches in the interaction of domestic tax laws of

countries

Inadequacy of current treaty provisions to effectively deal with innovative business models

Ineffectiveness or lack of anti-abuse measures in some tax jurisdictions


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Harm to Governments

Loss of substantial corporate tax revenues

High cost of tax administration

Undermines integrity of tax system

Tax fairness issue

Critical under-funding of public investment

Harm to individual tax payers

To bear a greater share of tax burden

Harm to business

Significant reputational risk for MNEs whose effective tax rate is low

Competitive disadvantage for domestic businesses

Risk of unilateral actions by certain tax jurisdictions

BEPS – CONCERNS

5 | Base Erosion and Profit Shifting

BEPS ACTION PLANS

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BEPS debate received political attention - G20 summits in 2012 and 2013

G20 countries realized the need of preventing BEPS and approached OECD to address the

issue related to BEPS and incorporate a transparent and inclusive consultation process involving

stakeholders

On 19 July 2013, OECD released an Action Plan which was presented to the meeting of G20

Finance Ministers in Moscow

The purpose of the Action Plan is “to prevent double non-taxation, as well as cases of no or low

taxation associated with practices that artificially segregate taxable income from activities that

generate it.”

The report indicates that “no or low taxation is not per se a cause for concern, but it becomes so

when it is associated with practices that artificially segregate taxable income from the activities

that generate it.”

The Action Plan covers 15 specific Actions which are broadly to be achieved within a two year

time frame (ie by the end of 2015)

BEPS – FORMULATION OF ACTION PLANS


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ACTION PLANS – TIMELINES 1/4


ACTION PLAN DELIVERABLES DEADLINE

1 – Address the tax challenges of the digital economy

Report issued for identifying issues and possible actions to address the same.

Supplementary report

September 2014

December 2015

2 – Neutralize the effects of hybrid mismatch arrangements

Report issued for recommendations regarding design of domestic rules and revise OECD model tax convention

September 2014

3 – Strengthen CFC Rules Recommendations regarding design of domestic rules

September 2015

4 – Limit base erosion via interest deductions and other financial payments

Recommendations on design of domestic rules

Changes to transfer pricing guidelines

September 2015

December 2015

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5 – Counter harmful tax practices more effectively, taking into account transparency and substance

- Report issued on member country regimes- Expand participation to

non-member- Revision of existing criteria

for preferential regimes

September 2014

September 2015

December 2015

6 – Prevent treaty abuse Report issued for changes to OECD model tax convention and recommendations regarding domestic rules

September 2014

7 – Prevent the artificial avoidance of PE status

Recommendations on changes to OECD model tax convention

September 2015

8 – Assure that transfer pricing outcomes are in line with value creation- Intangibles

Report issued for changes to the transfer pricing guidelines and possibly to the model tax convention

Supplementary report

September 2014

September 2015

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9 – Assure that transfer pricing outcomes are in line with value creation- Risks and capital

Report on changes to the transfer pricing guidelines and possibly to the model tax convention

September 2015

10 – Assure that transfer pricing outcomes are in line with value creation- Other high risk transactions

Report on changes to the transfer pricing guidelines and possibly to the model tax convention

September 2015

11 – Establish methodologies to collect and analyze data on BEPS and the actions to address it

Recommendations on data to be collected and methodologies to analyse the same.

September 2015

12 – Require taxpayers to disclose their aggressive tax planning arrangements

Recommendations regarding design of domestic rules

September 2015

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13 – Re-examine transfer pricing documentation

Report issued on changes to transfer pricing guidelines and recommendations regarding design of domestic rules.

September 2014

14 – Make dispute resolution mechanism more effective

Recommendations for changes to model tax conventions

September 2015

15 – Develop a multilateral instrument Report issued on identifying relevant public international law and tax issues

Develop a multilateral instrument

September 2014

December 2015

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ACTION 1 – DIGITAL ECONOMY


Significant challenges:

1. Nexus

2. Characterization

3. Value AttributionB Co. (outside India)

Indian Advertisers

Online Advertising Fees

India Co

Marketing Support

A Co.(outside India)

Transfer of IP

Data

Development of algorithms (IP) for targeted display of advertising through use of data

Challenges in the digital economy – Example

Users of free

online services

Where is the value created?

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Challenges posed by digital economy

Digital economy raises 4 main tax challenges: Nexus- Reduced need for physical presence

Characterisation- new digital products or means of delivery

Data- Possibility to gather and use information from various sources is a primary input into process of value creation in digital economy. How to attribute value to such data?

Collection of VAT- Exemption for imports of low value goods in countries and cross border B2C transactions

Ring fencing the digital economy from rest of the economy would be difficult

High mobility of intangibles, users, business functions – adds to the difficulty to identify the

location of business

Avoiding a taxable presence – increasing reliance on automated process (eg websites or

fragmentation of activities to qualify for exemption from Permanent Establishment (‘PE’) status)

Minimising functions, assets and risks in market jurisdictions – assets (particularly intangibles)

and risks may be allocated to other group entities in low tax jurisdiction



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Challenges posed by digital economy

Maximising deductions in market jurisdictions – hence, camouflaging the taxable profits (eg use

of intangibles)

Profit extraction - Reduced or no withholding tax on royalties/ interest by locating entities in low

tax jurisdiction

Eliminating or reducing tax in intermediate country and/or in the country of residence of the

ultimate parent

Administrative challenges-Identification, determining extent of activities, etc



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Potential Options

Changes to the definition of PE

Modification to the exemption of the PE status (eg eliminate the listed exemptions or making

such exemptions subject to an overall condition of being preparatory or auxiliary in nature)

New ‘nexus rule’ for enterprises engaged in ‘fully dematerialized digital activities’ based on

significant digital presence. For instance, a significant digital presence be deemed to exist when: Significant number of contracts for provision of digital products are remotely signed

Digital products are widely used or consumed in the country

Substantial payments are received as part of enterprise’s core business or

Existing branch in the country offering secondary functions (marketing, consulting functions etc) are strongly related to the core business of the enterprise

Virtual PE (say websites-fixed place PE, online contracts-agency PE, etc)

Imposing withholding tax at source on digital transactions

Consumption tax options – Review threshold exemptions, simplified registrations, etc

Coordination with work on other Action Plans



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ICAI Recommendations

Provide criteria to distinguish core and preparatory and auxiliary activities; withholding tax-

beyond threshold and not to apply on ‘B2C’ transactions; presumptive tax regime; simplified

single VAT registration in all states; defer VAT on B2C transaction till GST is introduced; etc

Few Questions

E-commerce business models likely to be subjected to increased scrutiny in India on

withholding tax, attribution of value to data, characterization, etc?

Is a final WHT an equitable solution?

Practicality of registration for consumption tax?

Tracking attribution of profits in highly mobile digital businesses-challenge the already

challenge transfer pricing?


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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

What Action 2 is trying to achieve?

Recommendations for changes to domestic law and OECD Model Convention to deal with

hybrids ie to develop model treaty provisions and design domestic rules to neutralize the effect of

hybrid instruments / entities by not permitting: Multiple deductions for a single expense

Deduction in one country without corresponding taxation in another

Generation of multiple foreign tax credits for one amount of foreign tax paid

Clear, automatic and comprehensive rules that neutralize the tax mismatch without disturbing the

commercial or regulatory consequences

ACTION 2 – HYBRID MISMATCH ARRANGEMENTS


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Changes to Domestic tax rules:

Specific changes: (i) Denial of dividend exemption (ii) proportionate limitation on withholding tax credits (iii) improvements to Controlled foreign corporations (‘CFC’) and other regimes; and imposition of information requirements and (iv) rules restricting tax transparency of reverse hybrids

Hybrid Mismatch rules: To adjust the tax outcomes in one jurisdiction to align them with tax consequences in another through ‘primary rule’ and ‘defensive rule’. It targets 2 types of payments:

Payments deductible under payer jurisdiction - Not includible in ordinary income of the payee

Duplicate deductions for the same payment

Further, to avoid risk of double taxation it calls for guidance on coordination or tie breaker rules, if more than one country seeks to apply the rules

Changes to OECD model conventions:

Examine issues of dual resident entitiesExamine issues related to transparent entitiesInteractions between recommendations in Part 1 and provisions of OECD model conventions

Limited applications of situations covered in report in Indian context due to regulatory restrictions

ACTION 2 – HYBRID MISMATCH ARRANGEMENTS


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ACTION 2 – Overview of proposed rules


Linking rules

D/NI Instruments / entities

Indirect D/NI Instruments / entities

DD Entities only

Special rule on dividend exemption for

instruments

General rule:deny deduction

Rule order

Scope

Primary rule & defensive rule

Controlled groups and structured arrangementsRelated parties for instruments

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ACTION 2 – HYBRID MISMATCH ARRANGEMENTS (Example)


A Co

B Co

Country A

Country BHybrid

Financial instrument

(ie equity injection for

Country A and debt for

Country B for tax purposes)

DEDUCTION IN ONE COUNTRY

WITHOUT TAXATION IN ANOTHER:

B Co issues a hybrid financial

instrument to A Co, which shall be

characterized as debt in Country B

and as equity in Country A

Country A treats the payment as

‘dividend’, which is entitled to

participation exemption

Country B allows deduction to B Co

for interest payments made on the

instrument

BEPS Recommendations:

Country B to deny deduction to

Payer (B Co)

Defensive rule: Country A to treat

receipt as ordinary income of A Co

Interest

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Need for Action 3

Creation of affiliated non-resident taxpayers and routing income of a resident enterprise through

the non-resident affiliate

Objective of Action 3

CFC rules already prevalent in many countries. Need to strengthen the same

Develop recommendations regarding the design of CFC rules

CFC rules lead to inclusions of passive undistributed income in the residence country of the

ultimate parent

A positive spillover effect in source countries as taxpayers have no (or much less) incentive to

shift profits into a third, low-tax jurisdiction

ACTION 3 – CFC RULES


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Limit base erosion via interest deductions and other financial payments

To address base erosion and profit shifting using deductible payments such as interest or such

other equivalent payments that can give rise to double non-taxation

From an inbound perspective, concern regarding interest expense deduction wrt lending from a

related entity in a low-tax regime

From an outbound perspective, a company may use debt to finance the production of exempt or

deferred income while claiming a current deduction for interest expense

Plan

Develop recommendations regarding best practices to prevent base erosion through use of

interest expense

Transfer pricing guidance for pricing of related party financial transactions such as financial and

performance guarantees, derivatives, and captive and other insurance arrangements

ACTION 4 – LIMIT INTEREST DEDUCTIONS


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Proposed Option - Group-wide test

A group-wide test would limit a company’s net interest deductions to a proportion of its group’s actual net third party interest expense, based on a measure of economic activity such as earnings or asset valueAims to allow groups to claim tax relief for their real cost of funds, while protecting countries from excessive deductionsGroups can continue to centralise third party borrowings in the entity/country which is most efficient for non-tax purposes, while tax relief for interest is matched with economic activityA best practice recommendation could include an agreed approach to be applied consistently by all countries or provide flexibility for a country to incorporate existing tax principles within its ruleNo country currently applies a group-wide test as a main rule

Proposed Option - Fixed ratio testA fixed ratio test operates by applying a fixed benchmark ratio to an entity’s earnings or asset valueRelatively inflexible, applying the same benchmark ratio to all entities irrespective of the level of third party gearing Difficult to establish the “correct” benchmark ratio, for example current fixed interest/EBITDA ratios are often in excess of groups’ actual ratiosMore straight-forward for groups and tax authorities to apply

A combined approach would allow lower risk companies to apply a simple fixed ratio test, while more highly geared companies could claim higher deductions by applying a group-wide test

ACTION 4 – LIMIT INTEREST DEDUCTIONS


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Counter harmful tax practices

Current concerns on a “race to the bottom” approach – Trend of across the board corporate tax rate

reductions on particular types of income (such as income from financial activities or from the

provision of intangibles)

Plans

ACTION 5 – HARMFUL TAX PRACTICES


PLANS

Revamp the work on harmful tax practices with a priority on improving transparency

Compulsory spontaneous exchange on rulings related to preferential regimes

Engage with non-OECD members to consider revisions or additions to the existing framework

Rules that require substantial activity for any preferential regime

Holistic approach to evaluate preferential tax regimes

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Forum on Harmful Tax Practices (‘FHTP’) to deliver 3 outputs:

Finalization of review of member country preferential regimes

Strategy to expand participation to non-OECD member countries and

Consideration of revisions or additions to the existing framework

For review of the existing preferential regimes, emphasis put on:

Elaborating a methodology to define the substantial activity requirement in the context of IP

regimes

Countries have agreed to strengthen the substantial activity requirement for realigning

taxation of profits with substantial activity - This will affect IP holding companies

Improving transparency through compulsory spontaneous exchange on rulings related to

preferential regimes

ACTION 5 – HARMFUL TAX PRACTICES


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Prevent treaty abuse

Treaty abuse, in particular treaty shopping, identified as one of the most important sources of BEPS

concerns

Issues identified

Use of low taxed branches of a foreign company

Use of conduit companies/ regimes to channel investments and for intra-group financing

Use of multiple layers of legal entities

Artificial shifting of income through transfer pricing arrangements

Plan

Recommendations regarding the design of domestic rules to prevent the granting of treaty

benefits in inappropriate circumstances

Clarify that tax treaties are not intended to be used to generate double non-taxation

Identify the tax policy considerations that countries should consider before deciding to enter into

a tax treaty with another country

ACTION 6 – TREATY ABUSE


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Design rules to prevent granting of treaty benefits in inappropriate circumstances

Cases where person tries to circumvent limitations provided by treaty Clear statement that treaties intend to avoid creating opportunities for non-taxation or

reduced taxation through tax evasion or avoidance (including treaty shopping)

Specific treaty anti-abuse rules (SAAR) which are:

• Limitation-on-benefits (LOB) rule to address a large number of treaty shopping situations based on the legal nature, ownership in, and general activities of, residents of a Contracting State

• Minimum shareholding period to prevent dividend transfer transactions

• Changes to Article to prevent transactions that circumvent the application of that rule dealing with capital gains on sale of shares of companies deriving value from immovable property

• Residence under tie-breaker rule determined through Mutual Agreement Procedure (‘MAP’) proceedings (having regard to factors such as place of effective management (‘POEM’), place of incorporation, etc)

• Anti-abuse rule for permanent establishments situated in third States

General treaty anti-abuse rule (GAAR) aimed at arrangements as one of the principal purposes of which is to obtain treaty benefits (conduit financial arrangements)

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Cases where person tries to abuse provisions of domestic law using treaty benefits

Savings Clause - Treaty does not restrict a right of contracting state to tax its own residents

Departure or Exit Taxes - Liability to tax certain types of income accrued for the benefit of

resident is triggered in the event resident of a particular country ceases to be resident of that

country

LOB Rule

Residents entities to get benefit of treaty only if Qualified person (by reference to nature or

attributes of various categories of persons)

Active business connection tests

Derivative benefits - Allow certain entities owned by resident of other states to obtain treaty

benefits that these resident would have obtained, if directly invested

Competent authority to grant treaty benefits, if other provisions deny the same



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Identification of tax policy consideration – required before entering into a tax treaty

Policy considerations would help countries to explain not to enter into tax treaties with certain no

or low tax jurisdiction

Modify a treaty previously concluded in event that change of circumstances raises BEPS

concern related to that treaty

Protect sovereign right of nations to enter into treaties considering other issues (taxation rights,

foster economic ties, etc) besides potential BEPS risks

Follow up Work

Model provisions and related Commentary included in the report, in particular the LOB rule, are

in draft form and need to be refined

Further work is also needed with respect to:

the implementation of the minimum standard adopted to address treaty shopping and

the treaty entitlement of various investment funds



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ICAI recommendations

LOB Rule - May lead to inappropriately restrictive outcome impacting genuine cases; TRC a

prima facie evidence be acceptable

Treaty Abuse provisions - No clarity in interplay with domestic GAAR. Further, if treaty GAAR

introduced then domestic GAAR only for determination of income under the domestic law;

grandfathering framework needs to be put in place; practical administration challenges

Tie Breaker test- current rule based framework can continue; MAP resort anyways available

Questions

Is tax planning dead?

Too much discretion left with competent authorities?



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ACTION 7 – PE AVOIDANCE



Prevent the artificial avoidance of PE status by developing changes to the definition of PE:

Use of commissionaire arrangements instead of traditional distributor models

Use of preparatory and auxiliary exemptions - artificial fragmentation of operations among multiple group entities

Splitting up of contracts

Address related profit attribution issues

Commissionaire arrangements

A commissionaire arrangement may be loosely defined as an arrangement through which a

person sells products in a given State in its own name but on behalf of a foreign enterprise that

is the owner of these products. The debate has been focussed on legal interpretation of phrase

‘authority to conclude contracts in name of’ which is found in Article 5(5)

Four alternative options to ensure that there will be a PE where the activities that an intermediary

(other than independent agent) exercises in a country result in the regular conclusion of

contracts to be performed by a foreign enterprise

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Preparatory and Auxiliary activities exemption

Art 5(4) of the OECD Model deems a PE not to exist where a place of business is used solely for

activities that are listed in that paragraph

First option: only activities that are preparatory or auxiliary would be covered

Second option: more targeted changes Removal of the reference to ‘delivery’ (which will catch situations where an enterprise

maintains a warehouse, unless purely preparatory or auxiliary). Removal of the exception for ‘purchasing offices’ or for both ‘purchasing offices’ and ‘places

maintained for the ‘collection of information’

Proposal to address the abuse of Art 5(4) through fragmentation of activities between related

parties

Art 5(4) will not apply with respect to a specific place of business if taxable activities that

constitute “complementary functions that are part of a cohesive business operation” are

carried on in the country by the same enterprise or by associated enterprises

Splitting of contracts between related entities

To be addressed by GAAR (PPT rule) or ‘Automatic Rule’

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Questions

How will jurisdictions overcome challenge of distinguishing genuine marketing support provider

entities from those who tacitly negotiate and conclude contracts for MNEs?

Will this lead to unreasonable attribution although the local subsidiary is adequately

compensated?

While the Action Plan 7 mentions subsidiaries and commissionaire arrangements, whether

employee secondments or visits to customer premises / locations could be impacted?

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Assure that TP outcomes are in line with value creation

Develop rules to prevent BEPS by moving intangibles among group members. This will:

adopt a broad and clearly delineated definition of intangibles

ensure that profits associated with the transfer and use of intangibles are appropriately allocated in accordance with (rather than divorced from) value creation

develop TP rules or special measures for transfers of hard-to-value intangibles and

update the guidance on Cost Compensation Agreements (CCAs)

Develop rules to prevent BEPS by transferring risks among, or allocating excessive capital to group members. This will involve:

Ensuring that inappropriate returns will not accrue to an entity solely because it has contractually assumed risks and has provided capital

Alignment of returns with value creation

ACTIONS 8, 9 AND 10 – TRANSFER PRICING


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Develop rules to prevent BEPS from other high risk transactions - transactions which would not,

or very rarely, occur between 3rd parties:

clarify the circumstances in which transactions can be re-characterized

clarify the application of TP methods, in particular profit splits, in the context of global value chains and

provide protection against common types of base eroding payments, such as management fees and head office expenses

The Action Plans would consider the application of both the principles (i) Arm’s Length Price (ALP) principle and (ii) Potential special measures required to address concerns identified in Action Plan.

Guidance for Applying ALP Principle

Identifying the commercial and financial relations

(Contractual terms; FAR analysis of the transaction, {if activities fragmented, determine the interdependency and how commercial activity is coordinated}; Characteristics of property transferred or services provided; economic circumstances of parties and market in which parties operate; and Business strategies pursued by parties)



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Identifying risks in commercial and financial relations (nature and sources of risks, allocation of risks in contract, how risks assumed, potential impact of risks (value created), risks management, actual conduct, transfer pricing consequences)

Interpretation- Determine pricing for the actual transaction as accurately delineated under the ALP principle

Non recognition- If transaction does not have the economic attributes of arrangements between unrelated parties, the same would be disregarded for transfer pricing purposes. Accordingly, each party to have a reasonable expectation to enhance or protect commercial or financial relations on risk adjusted basis compared to other opportunities realistically available to them at the time arrangement was entered into

Specific considerations like losses, effect of government policies, use of custom valuations

Locations savings and other local market features

Assembled work force

MNE’s group synergies



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Potential Special Measures -To address the residual risks unidentified by ALP principle. They

mainly relate to information asymmetries between tax payers and tax administrations and relative

ease with which MNE group can allocate capital to lowly taxed Minimal functional entities (MFE)

Hard to value intangibles - Concerns- (i) potential for systematic mispricing, if no comparable exists (ii) assumptions used are speculative (fixed price agreed years before intangibles generates income) (iii) information asymmetries between taxpayer & tax administration are acute

Action- Target circumstances where (i) taxpayer fixes price on basis of projections without any further contingent payment mechanism (ii) does not contemporaneously document projections and make them available to tax administration

Tax administrations may rebase calculations based on actual outcome, imputing a contingent payment mechanism

Independent investor - Circumstances where capital rich-asset owning company depends on another group company to generate a return from asset

Thick Capitalization - to determine the amount of capital in excess of pre-determined capital ratio and then to deem interest deductions which would reduce the profitability of capital rich company and produce deemed interest income in the company providing excess capital

Constraint - determining level of thick capitalization ratio a challenge?37 |



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MFE- Transactions between related parties, especially transactions transferring key business risks or intangibles, that one of the parties has minimal functions. The action plan would determine thresholds of functionality based on qualitative or quantitative attributes

The effect of falling beneath threshold would require entity’s profit to be reallocated based on profit split, reallocate to ultimate parent (not a MFE), relocate to company providing functional capacity

Ensuring appropriate taxation of excess returns- This option entails application of primary rule in form of CFC and a secondary rule to prevent non taxation. Under this, if CFC earns excess return and average tax rate is below threshold percentage, the excess returns subjected to tax at that rate under primary rule. A secondary rule would apply, if primary rule not applied.

Locations Savings

Cost savings applicable on account of operating in a particular market. Actions include (i) determining whether location savings exist, (ii) amount, (iii) extent to which savings are retained or passed by MNE (iv) if not passed then manner of allocation

Challenge- Quantifying benefit derived from location savings

Questions- Approach to be adopted for quantifying location savings? Approach to be adopted for allocated retained savings amongst various group companies? Does use of local comparable factor return for location savings?



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Cross Border Commodity Transactions

Transfer pricing issues- (i) Use of pricing date conventions which enable tax payer to adopt

advantageous quoted price (ii) significant adjustments/ charging significant fees in supply chain

(processing, transportation, etc) (iii) involvement of MFE located in low tax jurisdictions

Options

The use of the CUP method for pricing commodity transactions and use of quoted prices in applying CUP method

Deemed pricing date for commodity transactions (Firstly, use specified date selected by parties. If pricing date is inconsistent with other facts, tax administrations impute pricing date based on evidence provided by facts of case. If no evidence- date of shipment)

Potential additional guidance on comparability adjustments



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Low value adding intra-group services (Action Plan 10)

Services performed by one member or more than one member of MNE group on behalf of one or

more members of MNE group which (i) are of a supportive nature (ii) not a part of core business

activities (iii) do not require use of or lead to creation of unique or valuable intangibles (iv) do not

involve assumption or control or (creation) of (to) substantial or significant risks

Examples of Services that would qualify as low value added intra-group services:

Accounting and auditing; Processing and management of accounts receivable and accounts

payable; Human Resources activities, General services of an administrative or clerical

nature,etc

Simplified Method for determination of Arm’s Length charges in case of low value added services Determination of cost pools Identify and remove those costs that are attributable to the services performed by one group

member solely on behalf of another group member Allocation of low value added service costs to group members based on some allocation key

(depending on nature of services) Profit mark up- Same mark up for all the low value added intra group services (range of 2 to 5

percent)

40 |Base Erosion and Profit Shifting


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Low value adding intra-group services (Action Plan 10)

Charge of low value added services - this would be sum of specific cost plus profit mark up

(step 2) & pooled cost plus profit mark up

Application of the benefits tests to the low value adding intra group services

Documentation and reporting

Documents to be maintained: description of the categories of low value adding services provided, reasons justifying the same, rationale for provision of such services, benefits or expected benefits, etc

Written contracts or agreements for provision of services

Calculation showing determination of cost pool and costs solely to one group member

Calculations showing application of specified allocation keys

Questions

Tax authorities could challenge characterization and mark up of 2 to 5 percent for such services?



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Establish methodologies to collect and analyze data on BEPS and the actions to address it

Several studies undertaken and data available identifying disconnect between location of value

creating activities and reporting of profits for tax purposes. Further, work to be done to evaluate

such studies

Develop outcome based techniques which seeks to allocate income across jurisdictions relative

to value creating activities

Develop recommendations regarding indicators of the scale and economic impact of BEPS

Ensure that tools are available to monitor and evaluate the effectiveness and economic impact of

the actions taken to address BEPS on an ongoing basis

Assess a range of existing data sources, identifying new types of data that should be collected

by tax administrators and developing methodologies to analyse the same-based on both

aggregate (eg FDI and balance of payments) and micro-level data (eg financial statements and

tax returns)

Balance the above objectives with taxpayer confidentiality and administrative costs

ACTION 11 – MONITORING BEPS


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Need for Action Plan 12

Comprehensive and relevant information on tax planning strategies often unavailable

Audit suffers from number of constraints as tool for early detection of aggressive tax planning

techniques

Objective of Action Plan 12

Develop recommendations regarding the design of mandatory disclosure rules for aggressive or

abusive transactions, considering administrative costs, current experiences in different countries,

country specific needs and risks, etc

Focus will be international tax schemes - explore a wide definition of “tax benefit” in order to

capture such transactions

Design and put in place enhanced models of information sharing for international tax schemes

between tax administrations

ACTION 12 – ENHANCED DISCLOSURE


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Re-examine TP documentation

Develop rules regarding TP documentation to enhance transparency for tax administration, by

providing them with adequate information and also considering 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 or accrued among countries according to a common country by country template

Objectives

Provide tax administration information to conduct informed TP risks assessment and thorough

TP Audit

Tax payers assessment of its compliance with ALP principle

The information will make it easier for tax administrators to identify whether companies have

engaged in transfer pricing and other practices that have effect of artificially shifting substantial

amounts of income into tax advantaged environments

ACTION 13 – TP DOCUMENTATION


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Master File- Aimed at providing a clear understanding of MNE’s global operations.

Organizational Structure of MNE

Description of MNE’s major business lines

Intangibles- Strategy for development, ownership, important related party agreements

Intercompany financial transactions

Financial and tax positions-MNE’s consolidated accounts; APA’s and Advance rulings, etc

CBC Reporting Template- Information required country wise in draft template.

Following are the major heads of CBC:- Constituent entities

organized in country

POEM

Important business activities along with revenue and EBIT

Tax paid on cash and accrued basis

Stated capital and accumulated earnings

No of employees

Tangible assets

Royalties/service fees/ interest paid or received to/from constituent entities

Local File-Aimed at providing local country transactional information

Local entity-Management structure, effective place of operations, business restructuring of intangible transfer in 2 years

Details of controlled transactions- identification, description and value, FAR of entities; transfer pricing methods

Financial information- Audited financial accounts and allocation schedule

A three tiered approach to TP Documentation

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Significant criticism and recommendations received by OECD

Approach and objective only suits the tax administration

Compliance cost and burden

Confidentiality concerns

Mechanism for sharing of information

All information vs Need based information

Flexibility in reporting – entity-wise or business wise

Need for materiality and de minimis thresholds

Exemption/simplification for SMEs


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ICAI Recommendations

ICAI Recommendations – TP Documentation

India should engage with OECD and the other countries for improving, standardizing and simplifying TP documentation requirements and converge TP documentation in line with international standards

Taxpayers should be given sufficient time to understand and obtain clarity in respect of the proposed documentation requirements and develop systems

Specific guidance to be provided for standard forms developed for risk assessment, sharing of ‘general risk assessment policies’, releasing of FAQ’s by tax administrator

Safe harbour rules, exemption from TP documentation, etc

CBC reporting template is to be used by tax authorities for purposes of initial high level risk assessment only aimed at determining whether and where to devote resources to conduct a detailed examination. In this regard, necessary training to be imparted to the tax authorities to facilitate the process of implementation. It should be clarified that CBC Reporting template should not be considered as evidence at all

Information that is only relevant for ‘single’ or ‘group’ of entities can be included in Local file or can be shared through treaty mechanism to maintain confidentiality and prevent ‘fishing’ inquiries. Eg: APAs / MAPs between 2 countries

Further, one tax administration should be responsible for enforcing compliance with respect to Master file/CBC reporting, in particular the country of ultimate parent company


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Make dispute resolution mechanisms more effective

Actions to counter BEPS must be complemented with actions that ensure certainty and

predictability for the business

Develop solutions to address obstacles that prevent countries from solving treaty-related

disputes under MAP

Consideration for supplementing MAP with mandatory and binding arbitration provisions

Three pronged approach

Consist in political commitments to effectively eliminate taxation not in accordance with the

Convention

Provide new measures to improve access to the MAP and improved procedures

Establish a monitoring mechanism to check the proper implementation of the political

commitment

ACTION 14 – DISPUTE RESOLUTION


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4 principles shall guide the political commitments and the measures

To ensure that treaty obligations related to the MAP are fully implemented in good faith

To ensure that administrative process promotes the prevention and resolution of treaty related

disputes

To ensure that taxpayers can access the MAP when eligible

To ensure that cases are resolved once they are in mutual agreement procedure

Options proposed

Put an obligation to resolve cases (not endeavor)

Ensure independence of a competent authority

Provide sufficient resources and performance indicators to a competent authority

To ensure that audit settlements (eg no penalties, if MAP right waived) do not block access to the

MAP

To implement bilateral APA programme and recurring (multiple year issues) and roll back

provisions



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To provide additional guidance on the minimum contents of a request for MAP assistance (avoid

onerous documentation) and improve transparency and simplicity of procedures

To clarify the availability of MAP access where an anti-abuse provision is applied

To ensure the taxpayer’s objection is justified and evaluated prima facie by both competent

authorities and not unilaterally

To clarify the relationship between MAP and domestic law remedies

To clarify issues connected with collection of taxes, time limits to access MAP and self-initiated

foreign adjustments in MAP

To ensure principled approach to MAP resolution, improve competent authority co-operation,

transparency and working relationships

To increase transparency with respect to MAP arbitration

To clarify the co-ordination of MAP arbitration and domestic legal remedies

To provide guidance on consideration of interest and penalties in MAP



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Need for Multilateral instrument

Updating of the current tax treaty network highly burdensome, time consuming and will require

substantial resources due to multiple number of bilateral treaties

Without mechanism to swiftly implement them, changes to model only makes gap between

content of model and content of actual tax treaties wider. This contradicts the political objective

Develop a Multilateral Instrument

To ensure effective and innovative implementation of measures resulting from the BEPS Action

Plan


Analyze the tax and international law issues for development of a multilateral instrument to

enable jurisdictions (that wish to) to implement measures and provide a foundation for

amendment of bilateral tax treaties

Develop a multilateral instrument to provide an innovative approach to international tax matters-

reflecting rapidly evolving nature of global economy and adapt quickly to it

Streamline the implementation of tax treaty related BEPS measure

ACTION 15 – MULTILATERAL INSTRUMENT


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Key Conclusions

Multilateral instrument is desirable and feasible

Innovative approach with no exact precedent in tax world

Drawing on the expertise in other areas of public international law (other than tax) and tax

experts

ACTION 15 – MULTILATERAL INSTRUMENT


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Thank you