Anuprita Mehta, Vice President – Taxation,
Tax management is no longer restricted to compliance or reducing effective tax rate but is an important agenda in the corporate board rooms as well. With widespread globalization, MNCs realized existence of tax friendly jurisdictions, and structures were built to arrange taxes efficiently through these economies. The countries that were hitherto tourist destinations and small in size and trade, started to own high value intangibles, hosting financial centres and cash boxes and acting as a hub for global holding structures. Profits ‘disappeared’ for tax purposes or were shifted to locations where there is little or no real activity but the taxes are low, resulting in little or no payment of tax. This is called as ‘Base Erosion and Profit Shifting’ (BEPS). It is achieved by the mechanism of inter-company transactions between group entities through transfer pricing (TP). As an illustration, a US Information Technology MNC may develop an IT product in the US but register it and book sales in the name of a shell group entity in a low tax jurisdiction leading to shifting of profits and reduction of overall taxes.
Although these schemes could, in most cases be legal through domestic tax rules or application of bilateral tax treaties, they are still based on tax legislations created to tax local brick and mortar economy rather than today’s global environment which is mobile and intangibles driven. This gave birth to a debate on morality vs. legality in taxes, thereby Governments questioning the tax structures of MNC giants who pay negligible amount of taxes globally as compared to their global profits or turnover. When taxpayers (including ordinary individuals) see MNCs legally avoiding taxes, it discourages voluntary compliance by all taxpayers.
Simultaneously, countries are becoming more and more aggressive in protecting their own tax base resulting in the risk of double or multiple taxation. To counter attack such harmful international tax practices and plug the loopholes in a coordinated and comprehensive manner, the G20 (including India) and the OECD member countries joined hands and released a report '15 Action Plans on BEPS' on October 5, 2015. The key focus is that profits are taxed where economic activities take place and value is created. For transactions between related parties, the report focuses more on actual conduct rather than on internal legal arrangements or agreements between them.
Specifically, Action 13 recognises the need to improve transparency for tax administrations and increase certainty and predictability for taxpayers through improved TP documentation and a template for Country by Country Reporting (CbCR). The guidelines recommend that individual countries adopt a three-tiered approach to TP documentation:
• A master file with global information about the MNC group, including specific information on intangibles and financial activities;
• A local file with detailed information on all relevant material intercompany transactions of the particular group entity in each country; and
• The country-by-country report requires aggregate tax jurisdiction wide information as follows:
India has introduced the three tiered TP documentation requirements from Financial Year (FY) 2016-17 and the first filing will be due by November 30, 2017. CbCR will apply only to tax payers having an annual consolidated group turnover of Euro 750 million in the immediately preceding FY.
CbCR will provide the tax authorities across jurisdictions, through a mechanism for exchange of information, an organized picture of where an MNC creates value, earns income and pays taxes. MNCs should address any potential gaps or inconsistencies before they file their first CbCR. The analysis should focus on the location of the decision makers or value creators, location of unique, high value assets, including technical and marketing intangibles and whether commensurate taxes are paid where the business activities are performed and value is actually created and not merely where the legal ownership of the asset is held. While the primary purpose of the CbCR is to provide information to a tax authority to enable it to undertake a transfer pricing risk assessment, it is acknowledged that the data will be used to assess wider BEPS related risks.
Indian MNCs will need to gather and maintain data across operating units and locations and will require increased collaboration between businesses and geographies. They may have to introduce technology solutions to strengthen capability of financial systems for creation, analysis, maintenance, and retention of TP documentation. Articulation and implementation of consistent TP policy across the globe assumes importance than ever before!