A Guide to India’s Transfer Pricing Law, Part 2: Should BEPS be on India’s Radar?
In the first of this two part article, we outlined what businesses must do to comply with India’s transfer pricing laws, while stressing the key reforms introduced by the new government to bring certainty to the domestic tax system. Here, we discuss if and how India should respond to the Group of Twenty (G-20) nations’ ongoing work on base erosion and profit shifting (BEPS).
In July 2013, at the behest of the G-20 Finance Ministers, the Organization for Economic Co-operation and Development kicked off the BEPS project to address the erosion of tax bases by large groups. The BEPS project, which comprises 15 Action Items, calls upon world governments to implement change in domestic tax policies to prevent artificial segregation of taxable income from business activities that generate it. The BEPS project inter alia focuses on:
- Tax challenges of the digital economy;
- Effects of hybrid mismatch arrangements;
- Controlled foreign corporation rules;
- Interest payments and financial payments;
- Avoidance of permanent establishment status;
- Transfer pricing documentation; and
- Dispute resolution.
The chief objective of the BEPS project is to provide countries with “domestic and international instruments that will better align rights to tax with economic activity.” As an active member of the G-20, India should certainly drive forward this objective and support the OECD’s efforts in redesigning the international tax landscape. This is not to suggest that the government be abrupt, unclear, and inconsistent in implementing BEPS measures. Action 6 of the BEPS project, perceived by some as “overly restrictive”, is a classic example which may lead to denial of treaty benefits in genuine commercial transactions.
While the government has generally welcomed the BEPS project, it has expressed reservations about introducing a mandatory arbitration clause in the mutual agreement procedure, which is outlined in tax treaties to resolve tax disputes. Nirmala Sitharaman, Minister of State for Finance, told the G-20 Finance Ministers in their September 2014 Cairns meet that such a clause “not only impinges on the sovereign rights of developing countries in taxation, but will also limit the ability of the developing countries to apply their domestic laws for taxing non-residents and foreign companies.”
The government’s reservation against mandatory arbitration, which is seemingly informed by lessons learnt from high-profile transfer pricing disputes concerning Vodafone and Nokia, is unjustified. With the BEPS project gathering momentum, mandatory arbitration is the only possible way to ensure that taxpayers do not get entangled in expensive, lengthy litigation. It is vital that the government commit to a hassle-free tax administration – a pre-requisite for voluntary tax compliance leading to greater revenue collection.
To achieve this, India’s overall strategy in implementing BEPS must be three-fold. Any BEPS-related measure must align with, and not be disproportional to, India’s domestic tax policies; the measures must not jeopardize India’s obligations with its double tax avoidance agreements; the measures adopted must not only strengthen the integrity of the tax system, but also attract foreign investment. Hasty implementation of BEPS measures would undermine India’s tax competitiveness compared to other emerging economies.
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