Base erosion and profit shifting (BEPS) refers to corporate tax planning strategies used by multinationals to “shift” profits from higher-tax jurisdictions to lower-tax jurisdictions, thus “eroding” the “tax-base” of the higher-tax jurisdictions. In layman’s language BEPS translates into one of the different ways MNCs find loopholes in governments tax systems and how they employ these so as to pay less taxes and increase their revenue.
For the government, the tax base is the income or profit earned by companies. Tax is levied as a percentage on this income/profit. Once this income/profit shifts to another country or tax haven (s), the tax base is eroded, and no tax gets paid by the company to the country that generates the revenue. As a result of this, the government finds itself in a fix as its revenues from taxes get reduced.
There is a growing concern with respect to the serious losses of tax revenues due to BEPS.
So the question arises how do MNCs actually do it?
The idea is simple. Firms make profits in one jurisdiction, and shift them across borders by exploiting gaps and mismatches in tax rules, to take advantage of lower tax rates and, thus, not paying taxes to in the country where the profit is made. Illegal practices exploit ambiguity from the interaction of different tax rules and Double Tax Treaties (DTTs). These Base Erosion and Profit Shifting (BEPS) avoidance strategies enable MNEs to minimize their tax burden, eroding government revenue bases by strategically transfering profits.
BEPS schemes lead to “double nontaxation” outcomes when income is not taxed at all or at minimal rates failing to reflect the firm’s economic reality at the jurisdictional site of created value.
SO HOW DOES GOVERNMENT TACKLE THIS PROBLEM?
These hurdles resulted in the launch of the BEPS project by the Organisation for Economic Co-operation and Development (OECD). OECD has designed a 15 point action plan for tackling this problem of shifting profits.
All concerned nations could join G-20 and the OECD member countries on an equal footing to implement the BEPS package. It could assist:
1. Nations facing fiscal deficits
Every country may tax the supply chain differently. However, despite the increasing digital business environment globally, the recommendations by OECD highlight the significance of allocating the profits to the location where you have real substance, including both the tangible assets as well as people actively performing the business operations. This change in the approach can cause a shift in how and where the income is taxed. It will reduce the overall fiscal deficit a country faces due to the loopholes in its tax structure.
2. A strict environment and improved focus on involvement from the businesses
Business information would be disclosed and accessible through automatic information exchanges. This information will be made available to tax authorities wherever a company has a presence. Companies would have to explain to the authorities clearly the need their operational purpose of the business arrangements which might include tax advantages.
3. Reporting requirements
The new reporting requirements for large companies would make a detailed Country-by-Country (CBC) financial and tax information visible, to various eyes and possibly not just to the tax authorities. Additionally, the amount of data disclosed would be much higher than what companies are reporting presently. So, the compliance burden would grow substantially.
CHALLENGES FOR BUSINESS?
1. Tax administrations now won’t just introduce stricter measures and look for restricting tax treaty benefits, but would also test arrangements which in their view, lack substance or has a real commercial principal purpose. Business groups would have to reshape the business models and might have to adopt the practices for evaluating their position in the new environment.
2. Enhanced transparency is one of the key objectives of the BEPS framework. This brings new reporting obligations such as Country-by-Country Reporting (CbCR). Transparency would also mean to anticipate outcomes of extra disclosures that are required to be made. Such requirements could lead to additional transfer pricing challenges or might even cause adverse publicity.
3. As the implementation of BEPS quickens, businesses increasingly would require track how changes to transfer pricing practices and domestic laws, and the revised double tax treaties would affect them.
All of these changes would need allocation of more resources for tax function.
WHAT HAS INDIA DONE TO TACKLE THE SAME?
The involvement of India in the BEPS initiative has been intensive. India has been part of the forum in devising action plans, and also part of various working groups, committees and task forces that were set up for examining different aspects of these action plans. After the publication of the final BEPS deliverables, several Indian Government officials have taken active participation in addressing various public forums and gave statements to press on views of the Indian Government.
Response to BEPS needs to be managed in an orderly and phased manner and would need timely and proactive planning. Companies would need building consideration of possible BEPS impact into their current tax planning and arrange for different scenarios for its application.