CA Padamchand Khincha, CA. P Shivanand Nayak, CA. Prem Raj Rathod and CA. Mohit A Parmar have conducted an expert analysis of the provisions in the Finance Bill 2016 relating to the imposition of Equalisation Levy, Place of Effective Management (POEM) and Base Erosion and Profit Shifting (BEPS) and explained all of its implications in a simple and easy-to-understand format
Finance Bill 2016 has recommended various amendments to the Income-tax statute. These amendments are spread over various facets of the Act right from definitions to penal provisions. Among these amendments, the Finance Ministry recommends some of the far reaching amendments in international tax space. We have deliberated on few of them crafted into three portions below:
Part A: Is Equalisation Levy a tax?
[By CA. P Shivanand Nayak]
The rise of machines is making a deep impact and inroads into the global economy. Business acumen is getting digitised. The dawn of digital age has transformed the experience of working or shopping. Software has replaced labour. Physical stores and exhibition is replaced by smart web-portals. Human interface is reduced to mouse clicks and key-tapping. The aura of digital economy has hijacked the business dynamics in a new direction. Innovation in the digital leads to mushrooming of niche and complex business models. Many such new business models are in vogue. E-commerce, app stores, online advertising, cloud computing, high speed trading, e-payments are today’s business necessity.
The physical gap between the vendor and consumer is no more a concern. The virtual proximity has narrowed the physical gap. In this e-age, the target customers are reached through internet. Online advertising is a manifestation of the transformation. Today advertising is not just information dissemination tool but has significant influence on consumer’s decision making. It is not just a medium of marketing, but provides precision in monitoring performance of ads, tracking consumer loyalty and analysing customer interests/preferences. Online advertising takes various forms. Some of them are display ads (wherein advertiser pays to display ads linked to particular content); search engine ads (advertiser pays to appear among internet search results); ads on social websites (such as facebook, twitter etc.).
Internet advertising is rapidly growing both in terms of revenue and share in the total advertising market. The volume of internet advertising reached USD 135.4 billion in 2014. The market for internet advertising is projected to grow at a rate of 12.1% per year during the period 2014 to 20192. As the stakes started rocketing, taxing such virtual transactions attained prominence. The existing provisions of the income-tax statute were unable to tie the noose around these transactions. Perhaps the reason is Indian income-tax legislation is still governed by Quill Rule3 (physical presence test). The search for new basis of taxation became inevitable. The question was whether the tax should be on consumption or income?
The first statutory initiative in this direction is now proposed. Finance Bill 2016 seeks to charge an Equalisation Levy of 6% on certain specified services. This levy is reflected in Chapter VIII of the Finance Bill. The objective was clearly to tax the online transactions which was nebulous and having no physical presence which made their taxation in the service country difficult.
The clarity in the objective has not correspondingly translated into the provisions of the Equalisation Levy. There appears to be a slip in the intent and literal translation of the provisions housed in Chapter VIII of Finance Bill. It is already hounded by varied issues which makes a levy of this nature unworkable (some of the issues pointed at the end of this write-up).
Before dwelling into the merits of a particular legislation, any provision has to pass the litmus test of constitutional validity. Legislative power in India is divided into three lists of the Constitution [Schedule VII read with Article 245 of the Indian Constitution]. In pith and substance it has to fall into one of the entries therein. Precise affirmation of whether the impost christened as Equalisation Levy would fall within Entry 82 of the Union list (as a variant of income-tax) or Entry 97 (under the residuary entry) is critical. Constitutionally, whether it has to be construed as a tax on income or levy on service? Reckoning the Constitutional validity is thus the starter. However, in this write-up, we have focused on a larger aspect of whether amounts paid as ‘Equalisation Levy’ can be construed to be a part of ‘income-tax’?
The term ‘Equalisation Levy’ has been defined in Section 161(d) of the Finance Bill to mean a tax leviable on consideration received or receivable for any specified service under the provisions of this Chapter. The definition defines Equalisation Levy to be a ‘tax’. The term ‘tax’ has not been defined in the Chapter. Clause (j) to Section 161 provides that words or expressions used but not defined in the said Chapter and which are specifically defined in the Income-tax Act; shall have the meanings respectively assigned to them in the Income-tax Act. In other words, terms which are undefined in Chapter VIII (to Finance Bill) have to mandatorily borrow their meaning from Income-tax Act. Section 2(43) of the Income-tax Act defines tax as under:
""Tax" in relation to the assessment year commencing on the 1st day of April, 1965, and any subsequent assessment year means income-tax chargeable under the provisions of this Act, and in relation to any other assessment year income-tax and super-tax chargeable under the provisions of this Act prior to the aforesaid date and in relation to the assessment year commencing on the 1st day of April, 2006, and any subsequent assessment year includes the fringe benefit tax payable under Section 115WA”
The section inter alia defines tax to mean ‘income-tax chargeable under the provisions of this Act’. From an Income-tax Act standpoint, tax means ‘income-tax’ (including other taxes mentioned in the definition which are not relevant in the present context). As mentioned earlier, Section 161(j) mandates that undefined words in the Chapter shall have meanings assigned to them in Income-tax Act. The impost is unqualified. Such meaning is not subject to any qualifications or caveats. Accordingly, the term ‘tax’ in Chapter VIII of the Finance Bill should mean ‘income-tax’. It cannot be restricted to mean a levy which is distinct from income-tax.
If the legislature wanted to give a different meaning to the term, it could have either defined it in Section 161. Alternatively, the closing portion of clause (j) could have been supplemented by the words “unless there is something in the subject or context inconsistent with such construction”. If these words were employed in clause (j) one could have argued that tax in Chapter VIII is not ‘income-tax’ having regard to the context of the charge. Nothing prevented the legislature from employing such language. The Chapter employs an unqualified language for an unrestricted import of words from Income-tax Act. Accordingly, going by the literal interpretation of the definition of Equalisation Levy, it should constitute income-tax.
The linkage of Equalisation Levy to Income-tax Act appears undisputable (apart from and in addition to the nexus already discussed above). Section 175 enlists various provisions of Income-tax Act which are applicable in relation to Equalisation Levy. The assessing and appellate authorities are the same for the two statutes. Thus, the two imposts are closely intertwined and operate in the same field.
It is interesting to note that the term ‘Equalisation Levy’ is proposed to be used twice in the Income-tax Act. The intent and placement of these sections appear to indicate that ‘Equalisation Levy’ is synonymous to ‘income-tax’.
Section 10(50): The section provides that any income from any specified services (as defined in Chapter VIII) and which is chargeable to Equalisation Levy is exempt from tax. Thus, if consideration received or receivable for specified services suffers Equalisation Levy, no income-tax would be charged on such income. Such exemption negates ‘double taxation’. The memorandum to Finance Bill reiterates this rationale in the following words –
“In order to avoid double taxation, it is proposed to provide exemption under Section 10 of the Act for any income arising from providing specified services on which Equalisation Levy is chargeable.”
Double taxation is generally a phenomenon when the same income is taxed twice under the same statute. Two different statutes levying taxes (even though on same income) cannot amount to double taxation. This is because, object of every legal framework is different. However, a reference to double taxation in the context of Section 10(50) indicates that Equalisation Levy and income-tax cannot be levied simultaneously. They are mutually exclusive. If the nature of charge is different, the plea of double taxation can never survive. By inference therefore, it is suggestive of the two (income-tax and Equalisation Levy) being the same.
Section 40(a)(ib): The section provides that the levy paid or payable by the assessee towards specified services (on which Equalisation Levy is chargeable) shall not be allowed as a deduction in case of failure of the assessee to deduct and deposit the Equalisation Levy to the credit of Central government.
It is pertinent to observe the placement of this section in Section 40(a). If Equalisation Levy was a tax other than income-tax, the same would have been covered within the provisions of Section 43B(a). Clause (a) to Section 43B provides deduction for any sum paid as tax, duty, cess or fee within the stipulated time provided therein. The payment of Equalisation Levy would have been thus an allowable expenditure on actual payment basis. There was therefore no necessity of a separate amendment in Section 40(a). The legislature has found it fit to place this in Section 40(a). This is possibly because, Section 40(a)(ii) provides that any sum paid on account of tax on profits or gains shall be disallowed. The new sub-clause (ib) seeks to create an exception to the Section 40(a)(ii). It therefore became necessary to insert the new provision within Section 40(a) itself. Consequently, the income-tax and Equalisation Levy do not appear to be different.
The legislative intention of the proposed Equalisation Levy can be gathered from the budget speech of the Hon’ble Finance Minister (while presenting Finance Bill 2016). At para 151 of his speech he said:
“151. In order to tap tax on income accruing to foreign e-commerce companies from India, it is proposed that a person making payment to a non-resident, who does not have a permanent establishment, exceeding in aggregate ` 1 lakh in a year, as consideration for online advertisement, will withhold tax at 6% of gross amount paid, as Equalisation Levy. The Levy will only apply to B2B transactions.”
The opening portion of the para amply clarifies the objective is to create a charge on income accruing to overseas e-commerce entities. The focus is thus to tax ‘income’. The proposed charge is on the income of non-residents engaged in the specified services. Equalisation levy is thus arguably a variant of income-tax.
However, this conclusion is not sacrosanct. A contrary view is also in evidence. Income-tax is argued to be distinct and separate from the Equalisation Levy. The following aspects draw a distinction between Equalisation Levy and Income-tax:
(a) Equalisation levy is proposed to be inserted into the statute vide a separate Chapter in the Finance Bill. If the Levy and Income-tax were the same, the provisions could have been introduced within the contours of the Income-tax itself (similar to fringe benefit tax). The proposal to introduce it as a separate chapter of Finance Bill is indicative of this intent to regard this levy as not the same as income-tax.
(b) Chapter VIII of the Finance Bill appears to be an attempt to create an independent code by itself. There is a separate charging section, scope, levy, collection and penal mechanisms. It borrows certain provisions from the Income-tax statute to further strengthen its machinery provisions. Section 175 states that several provisions of the Act shall apply to Equalisation Levy, as they apply to income-tax. Such clarification is not required if the two imposts were identical. Further, Chapter VIII extends to whole of India except Jammu & Kashmir. The scope is thus different from Income-tax Act (which is applicable pan India). These factors are therefore suggestive of the fact that the two are not the same.
(c) Chapter VIII of the Finance Bill fastens the liability of deduction and payment of Equalisation Levy on the payer. The onus is on the payer to ensure appropriate and timely collection of taxes on behalf of the exchequer. The assessment procedures and penal provisions are directed at the payer. The payee is only the stimulus. Income of such non-resident payee is the trigger for this Levy. However, he remains untouched by the tax collection and compliance mechanisms. Being the income earner, he is never the focus of tax collection. Such modus operandi is not evident in Income-tax statute which never absolves the income earner/ recipient from tax compliance. This is a stark difference in the two provisions which darken the line of separation between income-tax and Equalisation Levy.
(d) Equalisation levy has been defined to mean tax. In the absence of the definition in Chapter VIII, one would resort to Section 2(43). However, there are no corresponding provisions in the Income-tax Act to accommodate or house the Equalisation Levy within its ambit. There is not a single instance in the Income-tax Act which explicitly acknowledge Equalisation Levy to be income-tax.
(e) BEPS Action Plan 1 deliberated on four options to address the direct tax challenges raised by digital economy. They were: (i) modifications to the exceptions to Permanent Establishment; (ii) creation of new nexus through significant economic nexus; (iii) imposition of withholding tax on certain digital transactions; or (iv) introduction of excise tax or other levy. The Indian legislature seeks to implement the last option. It is thus not a withholding tax. This is suggestive of Equalisation Levy being different from income-tax.
Thus, contradictory views are in evidence. An answer to this through clarification or appropriate amendment is extremely critical. This ambiguity leaves many other associated questions unanswered. One among them is whether an Equalisation Levy can be claimed as a foreign tax credit while claiming relief under the Double taxation avoidance agreement? The answer would be obvious if the Equalisation Levy is confirmed to be a part of income-tax. If divorced from income-tax, such Equalisation Levy is a tax on the online transaction/ activity.
The Mumbai Tribunal in the case of ADIT v. Chiron Behring GmbH & Co (2008) 24 SOT 278 (Mum) had an occasion to examine the applicability of India-Germany Double Taxation Avoidance Agreement. In the said case, the assessee was liable to pay ‘trade tax’ under the German domestic tax provisions. The Revenue authorities argued that such tax is not covered within the tax treaty. The Mumbai Tribunal rejected this argument by observing that Article 6 of the German Trade Tax Act states ‘The basis of taxation for Trade Tax is the income from the business’. From this finding, it concluded that the trade tax is not a turnover tax, but only is tax on the income from business. Such tax was thus held to be eligible for tax treaty purposes.
The basis for Equalisation Levy is also income from business. This cannot be disputed. The question is can one extend the dictum of Mumbai Tribunal in the present case? Possibly it can be applied only when the definition of Indian tax in the treaties are suitably widened to house Equalisation Levy. Some answer is also available in the roots of such levy. The BEPS Action Plan 1 dealing with Digital Economy appears to be the source for such proposed levy by the Indian legislature. At para 307 of the Action point, there is a discussion on relationship of Equalisation Levy with corporate income-tax which is as under:
“18.104.22.168. Relationship with corporate income tax
307. Imposing an Equalisation Levy raises risks that the same income would be subject to both corporate income tax and the levy. This could arise either in the situation in which a foreign entity is subject to the levy at source and to corporate income tax in its country of residence or in the situation in which an entity is subject to both corporate income tax and the levy in the country of source. In the case of a foreign entity, for example, if the income is subject to corporate income tax in the country of residence of the enterprise, the levy would be unlikely to be creditable against that tax. To address these potential concerns, it would be necessary to structure the levy to apply only to situations in which the income would otherwise be untaxed or subject only to a very low rate of tax.” (emphasis supplied)
Action Plan 1 thus expresses its doubts with regard to claim of such levy against corporate income-tax. BEPS Action Plan being the source of Equalisation Levy, the doubt in the action point can form the basis for denying foreign tax credit by the Indian legislature/ judiciary.
The focus of this write-up has only been to address the above discussed ‘uncertainty in characterization’ of this levy. The legislature has several other complex issues (in this levy) to cure. Some of them are as under:
(a) Can Equalisation Levy create a territorial nexus with India which Income-tax could not establish?
(b) Whether the threshold of ` 1lakh is a standard deduction or a threshold? Is it to be examined from vendor or consumer perspective?
(c) Is the present online payment system geared up to permit ‘deduction’ of levy on payment or ‘grossing up’ is the only recourse? Further, will grossing up shield the payer from penal consequences?
(d) Should such transactions pass through form 15CA and 15CB certification?
To conclude, it is of primary importance that the nature of this levy be abundantly clarified. There is presently an ambiguity in the legislative semantics. The memorandum to Finance Bill clarifies that Equalisation Levy owes its origin to BEPS Action Plan. Equalisation levy therein (in the Action Plan) was a suggested means of taxing economic nexus. Although the Levy was introduced, the Finance Bill does not explain the manner in which such Levy justifies ‘economic nexus’. Neither the budget speech nor the memorandum to Finance Bill clarifies why the option of Equalisation Levy was chosen as the most appropriate method of taxing online transactions. The rationale behind such levy is thus obscure. The Finance Bill seeks to arrest every online advertising transaction above rupees one lakh. Such low threshold seeks to capture even those transactions whose Indian nexus is fragile.
With the emergence of Digital India as the Indian household sermon, online and real time transactions are only on the rise. Online advertisement is the inseparable portion of these virtual transactions. They cannot be left grappling with uncertainty. The stakes are high. Clarity in this regard is inevitable to ensure the Government’s goal of ‘reducing litigation’. The ghost of uncertainty in taxation should not eclipse the digitization process.
Part B: Deferral of POEM
[By CA. Prem Raj Rathod]
The residential status of a company is determined by the tests enunciated in Section 6(3) of the Income-tax Act, 1961 (hereinafter referred as ‘Act’). Prior to Finance Act, 2015, a foreign company was held to be a resident in India if during that year, the control and management of its affairs was situated wholly in India. Finance Act, 2015 amended Section 6(3), to provide that a company would be resident in India in any previous year if it is an Indian company or its Place of Effective Management (POEM) in that year was in India.
The amended sub-section (3) to Section 6 read as under:
“(3) A company is said to be resident in India in any previous year, if—
(i) It is an Indian company ; or
(ii) Its place of effective management, in that year, is in India.
Explanation – For the purposes of this clause “place of effective management” means the place where key management and commercial decisions that are necessary for the conduct of the business of an entity as a whole are, in substance made.”
The amended provisions of Section 6(3) were to come into effect from Assessment Year 2016-17. The Finance Bill, 2016 proposes to defer the implementation of POEM as test of residency by one year to apply from Assessment Year 2017-18 onwards. The Finance Minister in his speech stated that “The determination of residency of foreign company on the basis of Place of Effective Management (POEM) is proposed to be deferred by one year.” This is to be achieved by omitting clause (ii) of Section 4 of the Finance Act 2015 with effect from
1-4-2016. The amendment to Finance Act 2015 is to be carried out vide Part XV of the Finance Bill 2016. Thus, for assessment year 2016-17, the test of residency for foreign companies continues to be on the touch stone of “control and management’’ of its affairs.
The concept of POEM as introduced by Finance Act 2015 had given rise to certain issues, to a company incorporated outside India which had not earlier been assessed to tax in India. The issues related to:
1. Applicability of advance tax provisions;
2. Applicability of withholding provisions;
3. Computation of total income;
4. Computation of depreciation when in earlier years foreign company has not been subject to computation under the Act;
5. Treatment of unabsorbed depreciation;
6. Set off or carried forward of losses;
7. Collection and recovery of taxes;
8. Special provisions relating to avoidance of tax;
9. Applicability of Transfer Pricing provisions.
The Memorandum explaining the provisions in the Finance Bill, 2015 had stated that, a set of guiding principles to be followed in determination of POEM would be issued for the benefit of the taxpayers as well as, tax administration. The Government released draft guidelines on December 23, 2015 providing various factors /principles which would be considered in determining the POEM of a company. The response to the guidelines by the stakeholders were to be received by a set date, which was thereafter extended. The guidelines incorporating the responses are not notified by the CBDT till date.
The Finance Act, 2015 received the assent of the President on 14-05-2015. In effect, the amended Section 6(3) had become applicable to the foreign companies for the financial year 2015-16. If the revenue had to give effect to the amended law, it was imperative that the guidelines spoken of in the memorandum were in place.
A foreign company, satisfying the test of residency on the basis of POEM for the assessment year 2016-17, would have been required to comply with various provisions of the Act attaching the subject listed above. Non- compliance would have invited adverse consequences. Problems would have aggravated if the company was held to be a resident under the POEM test during the course of assessment. Such determination would have been after the closure of the previous year inviting a non compliance of many procedural
requirements. Representations were made before the Central Board of Taxes to address the above issues.
The Government’s stated goal is to create a stable and consistence tax environment so as to give taxpayers confidence in the tax regime. The Finance Minster on various occasions has reiterated that the Government will not venture into retrospective taxation.
Adhering to the above principles and in order to address the concerns raised, the Finance Minister in his Budget 2016-17 speech said that the determination of residency of foreign company on the basis of Place of Effective Management (POEM) is proposed to be deferred by one year i.e. to financial year starting from April 1, 2016. A transition mechanism for a foreign company which is considered, for the first time, as a resident in India under the POEM test is envisaged. The Memorandum to the Finance Bill outlines the contours of the transitionary provisions.
Section 115JH is proposed to be introduced to provide immunity to foreign companies from certain compliances if such companies are held to be resident in India for the first time. Sub-Section (1) of Section 115JH provides that the provisions relating to computation of income, treatment of unabsorbed depreciation, set off or carry forward of losses, collection and recovery and special provisions relating to avoidance of tax shall apply with such modifications and exceptions as may be notified by the Government. The modified/transitional provisions would also apply to all the intervening years upto the date of determination of POEM in assessment proceedings. The
same has been explained through an illustration below:
Assessment proceedings for AY 18-19 commences by issue of notice under Section 143(2)
Order under Section 143(3) is passed concluding that POEM of the company is in India.
Consequence: Transitional provisions would apply for AY 18-19, 19-20, 20-21 (For AY 2021-22, the transitional provisions would not apply despite the assessment being completed during the course of the assessment year – Proviso to Section 115JH(1).
The relief or the modified provisions shall be applicable to the foreign company subject to compliance of the conditions as may be notified. The conditions could be one time or could be recurring. Default in compliance with conditions of the notification shall result in re-computation of income as if the modified provisions/transitional provisions did not apply to these companies. The Assessing Officer is empowered to invoke powers under Section 154. The period of four years for such rectification shall be computed from the end of the previous year in which the failure to comply with the notified conditions takes place.
The deferral of the POEM will give the Government time to finalise the guidelines pursuant to further consultation with stakeholders. The draft guidelines issued lack objectivity although the stated attempt is to impart so. The guidelines leave a lot of scope for mischief. Guidelines would now additionally have to cover the various topics outlined. It is only after the final guidelines are in place that one may have to determine whether they impart clarity or the cobwebs continue. The persistence of rooms for doubt is likely to dampen the “Ease of doing business” that the Government professes to accomplish. Such doubts are likely to discourage people to wholeheartedly look to India as an investment destination.
PART C: Introduction of BEPS into Indian domestic law
[By: CA. Mohit A Parmar]
The Finance Minster in the Budget for the year 2016-17 has initiated a process to incorporate, atleast partially, the recommendations /suggestions of Base Erosion and Profit Shifting (BEPS) Action Plans 1,5 &13. In July 2013, the Organisation for Economic Co-operation and Development (OECD) published its "Action Plan on BEPS". This publication addressed the concerns of various stake holders against the growing tax planning by multinational enterprises (MNEs) that makes use of gaps in the interaction of different tax systems to artificially reduce taxable income or shift profits to low-tax jurisdictions in which little or no economic activity is performed. In its final report of October 2015, BEPS has identified 15 Action Plans addressed them in a comprehensive manner, and set deadlines to implement those actions.
India having been a keen participant in the recommendations/suggestions of the BEPS- Action Plans has acted promptly to implement some of the recommended measures. A new Chapter VIII is introduced in the Finance Bill, 2016 proposing an Equalisation Levy on transactions in digital economy. This is following the suggestions of the OECD in BEPS project under Action Plan 1. Secondly, a new Section 115BBF is introduced to address taxation of patent developed and registered in India following BEPS Action Plan 5. Thirdly, a new Section 286 is proposed to be inserted for adoption of standardised approach to transfer pricing documentation following the suggestions of BEPS Action Plan 13.
BEPS Action Plan–5 – Countering Harmful Tax Practices more Effectively, taking into account Transparency and Substance
In order to encourage indigenous research and development (R&D) activities and to make India a global R& D hub, the Finance Bill has proposed a concessional tax regime on any income by way of royalty in respect of a patent developed and registered in India. The aim of the concessional taxation regime is to provide an additional incentive for companies to preserve and promote existing patents and to develop new innovative patented products. This regime will motivate companies to establish high income jobs in relation to development, manufacture and exploitation of patents in India.
The concessional regime would align the taxation of patents with the recommendation of the OECD. BEPS Action Plan 5 suggests the nexus approach and prescribes that income arising from exploitation of Intellectual property (IP) should be attributed and taxed in the jurisdiction where substantial research & development (R&D) activities are undertaken rather than in the jurisdiction of legal ownership only.
The above stated reasons for the introduction of "Taxation of Income from Patents" are emanating from the memorandum explaining the provisions to Finance Bill 2016, the relevant extract of which is as reproduced below-
"In order to encourage indigenous research & development activities and to make India a global R&D hub, the Government has decided to put in place a concessional taxation regime for income from patents. The aim of the concessional taxation regime is to provide an additional incentive for companies to retain and commercialise existing patents and to develop new innovative patented products. This will encourage companies to locate the high-value jobs associated with the development, manufacture and exploitation of patents in India. The Organization for Economic Cooperation and Development (OECD) has recommended, in Base Erosion and Profit Shifting (BEPS) project under Action Plan 5, the nexus approach which prescribes that income arising from exploitation of Intellectual property (IP) should be attributed and taxed in the jurisdiction where substantial research & development (R&D) activities are undertaken rather than the jurisdiction of legal ownership only."
To achieve the above, a new Section 115BBF is proposed to be inserted to provide that any income by way of royalty received in respect of a patent developed and registered in India shall be taxable at a concessional rate of ten per cent (plus applicable surcharge and cess).No expenditure or allowance in respect of such royalty income shall be allowed. The income would thus be taxable on a gross basis.
To be entitled to this concessional regime the taxpayer engaged in development of IP should be a resident in India and also a true and first inventor of the invention, whose name is entered on the patent register as the patentee in accordance with Patents Act, 1970. The amendment is to be applicable from 1st April, 2017 and shall apply for Assessment Year 2017-18 and onwards.
The concerns expressed in BEPS was regarding preferential regimes being used for artificial profit shifting and about a lack of transparency connected to certain rulings. To address these concerns the Forum on Harmful Tax Practices (FHTP) was committed to frame a methodology to define the substantial activity requirement to assess preferential regimes, looking first at intellectual property (IP) regimes and then other preferential regimes. The work of the FHTP was also to focus on improving transparency through the compulsory and spontaneous exchange of certain rulings that could give rise to BEPS concerns in the absence of such exchanges.
As per the recommendations of the BEPS- Action Plan 5, the substantial activity requirement to assess preferential regimes should be strengthened in order to realign taxation of profits with the substantial activities that generate them. The various approaches considered were :-
a) Value creation approach;
b) Transfer pricing approach;
c) Nexus approach.
The Indian Government has adopted the “nexus approach”. In order to avail benefit under this approach the taxpayer has to incur expenditure towards research and development that give rise to the IP income.
Under the nexus approach, ‘expenditure’ is used as factor for activity. This approach is built on the principle that the taxpayer who is benefitted should have carried out the research and development activity and has incurred actual expenditure on such activities. This ensures that tax payer satisfies the substantial activity requirement. These IP regimes are designed to encourage R&D activities and to foster growth and employment.
In the area of transparency, a framework covering all rulings that could give rise to BEPS concerns in the absence of compulsory spontaneous exchange has been agreed. The framework covers six categories of rulings: (i) rulings related to preferential regimes; (ii) cross-border unilateral advance pricing arrangements (APAs) or other unilateral transfer pricing rulings; (iii) rulings giving a downward adjustment to profits; (iv) permanent establishment (PE) rulings; (v) conduit rulings; and (vi) any other type of ruling.
India has traditionally been known for its imports in the area of technology or intellectual property rights. Our service sector is largely engaged in the research and development activities on behalf of the foreign principals. The efforts in the development of patent happen in India, but the registrations are made outside India. In order to encourage more Indian companies to develop and register these patents in India the aforesaid amendments are proposed. As a result of this amendment, we could see more research and development activities being conducted and more inventors and patentee holders emerging in our country. However the success of this change would to a large extent depend upon the IP protection norms in India.
BEPS – Action plan 13 – Transfer Pricing Documentation and Country-by – Country Reporting
BEPS -Action Plan 13 report contains revised standards for transfer pricing documentation and a template for Country-by-Country Reporting of income, taxes paid and certain measures of economic activity. In this report, a three-tiered standardised approach to transfer pricing documentation has been developed and suggested. Firstly, multinational enterprises (MNEs) are to provide tax administrations with high-level information regarding their global business operations and transfer pricing policies in a “master file” that is to be available to all relevant tax administrations. Secondly, transactional details are to be provided in a “local file” specific to each country, identifying material related party transactions, the amounts involved in those transactions, and the company’s analysis of the transfer pricing determinations made with regard to those transactions. Thirdly, large MNEs are required to file a Country-by-Country Report that will provide annually and for each tax jurisdiction in which they do business the amount of revenue, profit before income tax and income tax paid and accrued. This is driven by the need to have transparency on the part of taxpayers in sharing all facts relevant to international transactions. In all interactions Indian tax authorities have been indicating that they are serious about implementing the suggestions by the OECD to the extent possible.
In line with the above recommendations, a new Section 286 is proposed to be inserted requiring maintenance and furnishing of the CbC report by multinational enterprises (MNE’s) having prescribed annual consolidated revenues. The salient features of Section 286 are as follows:
i. The CbC reporting requirement would mandatorily apply to multinational enterprise (‘MNE’) Group having annual consolidated revenues exceeding INR 5,395 crore (equivalent to € 750 million) in the previous year 2015-16
ii. The resident parent entity of an MNE Group, would be required to furnish the CbC report to the prescribed authority, on or before the due date of furnishing the return of income.
iii. Every constituent entity of an MNE Group having a non-resident parent entity, would provide information regarding the country or territory of residence of the parent entity
iv. The Indian constituent would be required to furnish the CbC report to the prescribed authority, if the parent entity is resident:
– in a country with which India does not have an arrangement for exchange of the CbC report; or
– in a country which is not exchanging information with India even though there is an agreement and this fact has been intimated to the entity by the prescribed authority
v. In case an MNE Group having a non-resident parent entity has designated an alternate entity for filing the CbC report with the tax jurisdiction in which the alternate entity is a resident, then the Indian constituent entities, would not be under an obligation to furnish the CbC report, if the same can be obtained under the agreement for exchange of such reports by the Indian tax authorities
vi. In case there is more than one entity of the MNE Group in India (having a non-resident parent entity), then the MNE Group can nominate in writing the entity which would furnish the report on behalf of the MNE Group.
vii. The CbC report would be required to be furnished in a prescribed manner and in the prescribed form and would be based on the template provided in the OECD BEPS report on Action Plan 13
viii. The prescribed authority may also call for such document and information from the entity furnishing the CbC report, for the purpose of verifying the accuracy, as it may specify in the notice. In such cases, the entity would be under an obligation to make the required submission within a period of thirty days from the date of receipt of notice, which could be further extended by a period not beyond thirty days.
The report mentions that taken together, these three documents (country-by-country report, master file and local file) will require taxpayers to articulate consistent transfer pricing positions and will provide tax administrations with useful information to assess transfer pricing risks. It will facilitate tax administrations to make determinations about where the resources were effectively deployed, whether the profits are consistent with the deployment of resources, and, in the event audits are called for, provide information to commence and target audit enquiries.
To ensure proper reporting of the international group in compliance with Section 286, a new Section 271GB is proposed to be inserted for levy of penalty where there is failure in furnishing of such report. The quantum of penalty is ` 5,000 per day when the failure does not exceed one month and the quantum would be ` 15,000 per day when the failure continues beyond a period of one month.
Where the reporting entity fails to produce information and documents sought by the prescribed authority within the time allowed under Section 286, the penalty under Section 271GB could be levied at ` 5,000 to ` 50,000 for every day of such failure. For inaccurate information in the report furnished under Section 286(2) and if the entity fails to inform the incorrectness and furnish correct report within a period of 15 days of such discovery, the prescribed authority may impose a penalty of ` 5 lakhs.
BEPS Implementation: The CbC reporting requirement Action 13 of BEPS Action Plan entails easy availability of information to tax authorities and helps them to identify the risk areas in transfer pricing cases and get an overview of the operations of multi-national groups. For this reasons, the CbC reporting has been widely implemented by various jurisdictions across the world. The amendments proposed in the Finance Bill, 2016 are to the ease the work of tax authorities in the area of transfer pricing. Requirement of furnishing this requisite information and reports before the due date of filing return of income is likely to be an onerous compliance burden. The burden of the penalties is also significant, especially considering that for multinational groups having hundreds of group entities, the available information may not technically meet the requirements of law.
The rules or forms in regard the transfer pricing law are awaited. This Cbc reporting requirement apart from increasing the compliance burden on the tax-payer; will add to increased costs. To expect fair appreciation of such information from the tax department is to belie the current reality and experience. There could be many reasons for an entity to have a non-uniform transfer pricing practice across regions. This could be for example the uniqueness of the business; diversified costs involved in a transaction; differences in the volume of the transactions; and ease of doing business among various jurisdictions. These unique features mandate a studied approach by the revenue authorities. In India at least, from the current experience whether this would happen is unlikely. Government is likely to use information that is favourable to them and ignore the rest.
1. The author is a member of the Institute of Chartered Accountants of India. The author acknowledges the contribution rendered by his co-authors mentioned in the respective segments of this write-up.
2. Source: OECD/G20 Base Erosion and Profit Shifting Project – 2015 Final Reports
3. In Quill Corp. v. North Dakota 504 U.S. 298 (1992), the Supreme Court of USA ruled that a business must have a physical presence in a state for that state to require it to collect sales taxes.
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