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Bombay Chartered Accountants’ SocietyFire Side Chat on BEPS

19th October, 2016

Part – 3Explaining BEPS Action Reports

CA Rashmin Sanghvi chatting with

CA Sushil Lakhani

Mumbai

www.rashminsanghvi.com

Rashmin Sanghvi BEPS

Part - 3

BEPS Action Reports

1

Action Reports

Subject

1 E-Commerce Taxation, e.g. Google.

2 Hybrid Mismatch Arrangements.

3 CFC – Apple Computers.

4 Base Erosion via Payment of interest, etc.

5 Transparency & Substance.Vodafone. Cayman Island Company had no substance.

6 Treaty Abuse, Mauritius, UAE, etc.


Part - 3 2

BEPS Action Reports

Action Reports

Subject

7 Artificial Avoidance of PE

8 – 9 – 10 Transfer Pricing – Apple Computers

11 Measuring & Monitoring BEPS

12 Tax Payers to disclose Aggressive Tax Planning

13 Documentation

14 Dispute Resolution MAP

15 Multilateral Instrument - With one action, a few thousand treaties will be amended.


Part - 3

Proposals - to - Actions

All BEPS Action Reports are proposals. OECD ModelTreaty & its Commentary will be amended.

Then UN Model may be amended with or withoutmodifications.

Then if individual countries have to renegotiate theirtreaties (total over 3000 treaties); it may take time.

Hence a Multilateral Treaty is being drafted: Action 15.

Once a nation signs the Multilateral Treaty it will bedeemed that ALL its treaties have been amended withPost Facto effect.

3


Part - 3

We discuss only a few Subjects

Out of the 15 Action Reports - We will discuss briefly –

1. Action 1 – E-Commerce

2. Action 3 – CFC

3. Review Apple Computers

4. India – FII Tax Avoidance

5. Action 7 – Avoidance of PE

6. GAAR

7. Action 8-9-10 Transfer Pricing

8. EU & USA

9. Overall Impacts

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Part - 3E-Commerce

Action 1 – Vs. Action 3

5

Google USA / Ireland

Face BookUSA

40 Crore users in India.

Revenue Rs. 5,000 Cr.

16 Crores usersin India

Revenue Rs. 100 Cr.

Action 1 – No tax in India.Action 3 – All profits taxable in USA.


Part - 3

After implementing all 15 Action Reports, willIndia be able to tax these corporations?

Except for Equalisation Levy – No.

And some professionals claim that EL is not as perBEPS report.

So essence is BEPS actions do not protect Indiantax revenue.

Even EL, as legislated so far, only forces Indianpayer to pay the tax. There is no obligationwhatsoever on Google or Facebook.

6E-Commerce



Part - 3

Action 3 will support US taxing Google, Facebook,Apple etc. But these reports do not support Indiataxing all these Co.s despite the fact that they doearn billions of rupees from India.

OECD Model – Article 5 – Definition of PermanentEstablishment has 7 clauses.

We need to add 8th clause: Significant EconomicPresence.

Revenue exceeding a threshold: It can beRs. 10,00,000 or any other amount.

7E-Commerce



Part - 3 BEPS Action 1 ReportEqualisation Levy E-commerce Taxation

Some critics of Equalisation Levy say:

BEPS Action Reports state that -

Some E-Commerce MNCs pay no tax.

By amending TP & CFC provisions,

this situation will be corrected.

They will pay COR taxes.

That should be fine.

Why impose Equalisation Levy?

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Part - 3

Consider Apple & Google

Apple deals mainly in products/Goods

Google deals in services.

Both sell by E-commerce,

Both avoid – COR & COS taxes by basingoperations in Tax Havens. Apple - Ireland.

Google – Ireland, Netherlands & Bermuda.

Apple has accumulated more than $ 200 Bn.outside USA.

Google has accumulated $ 70 Bn. in Tax Havens.

Action 1 - Equalisation Levy9


Part - 3

Now BEPS proposes -

Amend TP so that more profits will beallotted to COR- USA.

No profits will be allotted to COS – India,UK, France & rest of the world other thanUSA.

Note: This is at the root of US - EU Tax War.

Action 1 - E-Commerce TaxProtect US Tax Revenue

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Part - 3BEPS Action 3

CFC Rules

11

US Holding Co

European SubBrazilSub

Indian Sub.

Tax Haven CFC

COR

COSAll profits shifted

to CFC

Action 3 will ensure that all these profits will be taxable in –COR.


Part - 3

CFC

Pre BEPS. US could not tax Apple Ireland.

Post BEPS –

Action 8-9-10 Attribute larger incomes to AU

Action 3 – Whole income of AI taxable in USA.

12

Apple USA (AU) US Holding Co.

Apple Ireland (AI)Corporate Structure

100% Sub.


Part - 3

CFC Apple

13

Apple USAHolding Co.

Apple Ireland100% Subsidiaries

Irish Tax Rate 12.5%Actual Tax paid 0.005%

The Credit that Apple USA will get for taxpaid in Ireland will be 0.005% & not 12.5%.


Part - 3

US has proposed to amend CFC provisionswith RETROSPECTIVE effect to tax all theprofits stored outside USA by US MNCs.

Action 3 BEPS Report on CFC recommendsthis.

Clearly, US will gain. India & rest of the worldwill continue to suffer.

And Indian tax consultants say –

“This is all fine. Let this continue”.

Action 3 - CFC Protect U.S. Tax14


Part - 3

1. Control over CFCLegal ControlEconomic ControlDe Facto ControlConsolidation of AccountsActing in Concert

2. CFC Income. Not just Passive income.Any Income.

3. Whole of CFC Profits to be taxed in the hands of Holding Co. – Proportionate to control.

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CFC Action 3

How are you going toprove that you doNOT control a foreignCo.?


Part - 3

US has proposed a law to change domestic CFCprovisions.

BEPS Action Report 3 should help USA. It permitsUSA to change law.

US is ready with draft law. US internal politics iswhat may prevent such rules.

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CFC


Part - 3

Understanding Jurisdiction to tax and attributionof profits by some illustrations.

1. Jurisdiction - Tata Group has the registeredoffices of most of the Tata Group Companies inBombay House. Hence it pays all its income-taxin Mumbai.

TELCO’s factories are in Pune etc.

TISCO’s mines & factories lie in Jamshedpur, etc.Similarly almost all Tata Companies have theirbusiness units outside Mumbai.

17Review Apple ComputersJurisdiction & Attribution


Part - 3

TCS has staff of more than 4,00,000 softwaredevelopers. Only a small number works inMumbai.

Mumbai boasts of contributing highest income-taxrevenue in the country.

Who should have jurisdiction to tax the profits –Pune / Jamshedpur or Mumbai? Where the profitsshould be attributed?



Part - 3

If we had detailed rules of Attribution of Profitsamongst – Head Office, mines, factories & salesoffices etc. then probably 90% of Tata Groupprofits would be attributed outside Mumbai.

You can select any illustration from a wide rangeof Indian MNCs.

State Bank of India, Infosys, Wipro, ONGC, IndianOil & so on.

Same issues of Jurisdiction & Attribution can beraised.



Part - 3

We never think of it. India is one country.Within India, Government has a fair system ofcollecting taxes & spending the revenue.

2. Imagine the huge amount of litigation that wehave avoided by having a system where –

(i) Throughout India – all income-tax is collectedby one Central Government.



Part - 3

Then

(ii) Allocation of the tax to various States &Union Territories is Government’s look out.Even if the State Governments have adispute with the Central Government – thetax payers is least bothered.



Part - 3

3. Supposing we had a single Global tax; andfurther supposing –the allocation of revenuecould be done fairly all over the world –

- How much litigation would be avoided?

It is an ideal dream.

People who see dreams –

are first ridiculed & ignored;

Then criticised; and then at some point oftime …. …… Dreams become realities.



Part - 3

4. Attribution of Profits

I am coming back to the illustration of BombayHouse. How much profits you would attributeto the following parts of Tata Group: Myestimates are given. You give your estimates.



Part - 3 24

Tata Group Organisation

Percentage of Value

Addition.

Hence Profit Attribution.

Hence Tax Collection.

Mining & Manufacturing operations

outside Mumbai.50%

Sales organisation outside Mumbai. 40%

Head office – ownership of all

finance, Intellectual Property, Risk

taking etc. etc.

10%

Total 100%

Review Apple ComputersJurisdiction & Attribution


Part - 3

Notes: There is no scientific attribution of profits inthe above table. I have no knowledge of real facts.You can have your own estimates. This is just anillustration.

The key issue in this illustration is – Not – howmuch profits to attribute to different functions,assets, risks & market. Issue is, profits can beattributed to all the functions / profit centers of anMNC and not just to Head office / COR.



Part - 3

In case of Apple Ireland the attribution of profits is as under:

And this is perfectly legal. Now consider this query:

5. Don’t you think OECD model of DTA; and severalOECD reports need significant changes?

26

Production 0%

Sales 0%

Irish Branch 0.005%

Non-Existent HO 99.995%

Total 100%

Review Apple ComputersJurisdiction & Attribution


Part - 3

FIIs avoid Indian Taxes

27

US FII

Singapore SPV

Funds from Foreign Investor

Rest of the World

India

Indian Black Money

Round Tripping

Invested in India


Part - 3 28

US FII

Singapore SPV

Funds from Foreign Investor

Rest of the World

India

Indian Black Money

Independent AgentsStock Exchange Brokers

Buys Securities within India. Sells securities within India

As per Actions 8-9-10;Probably No profits will be attributed to India.

As per plain logic, 90% profits should be attributed to India.

Research Analysts

Banks Custodian

FIIs avoid Indian Taxes


Part - 3

FIIs avoid Indian Income Tax

1. They fragment their activities amongstseveral players.

Will Action 7 on Artificial Avoidance ofPE help India?

If all Indian operators are independentthird parties; it will not help.

If Indian parties are “Controlled RelatedParties,” Action 8-9-10 will helppartially.

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No.


Part - 3

FIIs avoid Indian Income Tax

2. Since FIIs are doing their Indianbusiness on the internet, it is ElectronicCommerce.

Will Action 1 help?

Will Equalisation Levy help?

3. After all 15 Actions Reports areimplemented, will Round Tripping ofBlack Money Stop?

BEPS are not targeted against BlackMoney.

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No.No.

No.


Part - 3

BEPS Action 7 Avoidance of PE

31

Sale of Goods

Order concluded in USAMNC

Business with India.

Indian Importer Unrelated Party

MNC has No presence in India

MNC’s profits are not taxable in India. Article 7 of OECD Model.NO PE. No Tax.

Note 1 - If MNC sets up a PE in India for localmarketing & sales; the profits attributable to Indian PEwill be taxable in India.

Note 2 – Existing injustice of no profit attribution to theCountry of Sales continues even after BEPS.


Part - 3


32

Sale of Goods

Order concluded in USA

MNC

Indian Importer of goods

“Closely Related Parties”New Definition

Indenting Agent

Warehouse Service

Canvassing / Liaison office

Habitually plays principal role inconclusion of contract. Subjectivematter. Difficult to prove either way.

Pre BEPS Post BEPS

No PE in India A PE shall be deemed

No profits taxable in India Profits shall be attributed to

deemed PE & taxable in India.

Mere conclusion of orders

outside India won't help


Part - 3


1. Fragmentation of Activities - Several parties.

2. Splitting up of Contracts – To remain under the threshold of Period.

If these are artificial, they shall be ignored & PE shall be deemed to exist.

However all the amendments still require a“Place of Business” in India.

Hence E-Commerce Companies will still escape.FIIs – not having Closely Related Parties willalso escape.

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Part - 3

GAAR

34

1. Will any of the BEPS Action Reports prevent thisTax Avoidance? No.

2. Will the 2nd part of action – InformationExchange Agreements avoid this tax avoidance?No.

Hutchison Essar Indian Company

Hutchison of Hong Kong sold 67% shares in

To Vodafone UK

Sale price $ 11 BillionTax Payable Rs. 11 Billion.


Part - 3

The Anti – Tax Evasion measures - InformationExchange Agreements work if there is secrettax avoidance.

Hutchison & Vodafone did it openly.

India will have to rely on GAAR.

Explanations 4 & 5 added to S.9 (1) (i) still donot help as DTA overrides ITA.

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GAAR


Part - 3

BEPS 8-9-10 Transfer Pricing

TP 8-9-10 Reports – See Pages 22-24.

Emphasis is laid on several factors.

- Capacity to take decisions

SPV in Tax Haven – Directors won’t have capacityto take decisions.

- Actual Performance.

Assuming that the SPV director has the capacity.In reality he is not going to actually perform.

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Part - 3

If this is applied to POEM,

then most planning will fail.

That is the purpose of BEPS.

G20 wants Reality. No planning.

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Risk Taking, Holding meeting of executives, Maintaining Minutes Books & Setting up policy environment.Is this direct attack on Apple’s planning?

All these are not adequate for profit attribution .


Part - 3


Risk, Intellectual Property etc. were allocated tocompanies with zero economic activities but cashboxes.

Now these are to be connected to economicactivities. Indian CBDT has for long taken a stand–If foreign television companies broadcast theirprogrammes in India; If goodwill and intellectualproperties are used in India, the same are taxablein India. Now BEPS Reports accept this positionbut for COR.

38


Part - 3

Today tax practitioners are comfortable with alegal position that Written Documents – contractsetc. would prevail. “Form prevails uponSubstance”.

However BEPS Action Reports state that ActualConduct of the Controlled Relatives willsupplement or even replace contractualarrangements

We have huge litigation in EPC & FTS splitbetween supply of goods & FTS

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Part - 3

These action reports state that Post – BEPStax departments will look at actual conduct,real transactions.

If contracts are not in line with actualconduct, then the contracts will be ignored.See Executive Summary Page 10, ActionReports 8 to 10.

40



Part - 3

Written contracts may or may not mean much.Company will have to prove actual performances,capabilities etc.

When an MNC group has executed several contractsamongst several AEs, will they have to go on provingthe truth behind every contract?

41



Part - 3

Every sales & purchase invoice is a contract.

Every year assessment will take 10 years.

So far, the emphasis was – on Tax Compliance.Meaning paying taxes & complying with legalrequirements.

Now every assessment can be a massive job.

How Indian CBDT actually administers BEPS is animportant matter to observe.

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Part - 3

OECD is known for drafting theoretical reports.One can write fine reports on attribution of profitsbased on FAR analysis. But all that is subjective &theoretical. Making the law impractical.

After Action Reports 8, 9 & 10 it will be even moreimpractical.

All of the following - Tax Payer, Tax Administrator& Judiciary - can have different opinions on thesame set of accounts.

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Part - 3

Substance Over Form

Let me submitGolden Rules of Taxation.

There can be no conflict between Form & Substance.Form must always represent substance.If form does not represent substance –

the form has to be rejected.The Tax Payer who submitted incorrect form – corporate

structure etc. - is liable to action for telling lies on verification in his tax returns.

Whether you like my theory or reject it, please note that tax laws & Treaties are changing.

Be prepared.

44


Part - 3

There is an analogy.

A King is always expected to act right. King is anauthority – acting for the benefit of the people. Just& Fair.

Hence it is said: “King Can do No Wrong”.

Now this is no licence for Kings & Governments todo anything & then claim that “whatever I did hasto be right”.

45Substance to be disclosed in Tax Returns

by Assessee


Part - 3Substance to be disclosed in Tax Returns

by Assessee

Correct – King must do only right.

Wrong – Whatever King does is right.

Correct – Similarly, the tax return & auditedaccounts & all attachments must tell true & fairtaxable profits.

Wrong – Whatever papers are presented by taxpayer are right.

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Part - 3

Substance shall prevail over Form

All Treaty shopping;

All Use of Tax Havens is Wrong.

They spoil the True & Fair view.

Assessees are liable to action under

existing law. Now BEPS will make it clear in Domestic Law & Treaty Models

47


Part - 3

Since 1987 we (BCAS + ICAI + others) havepopularised FEMA & International Taxation. At thattime I used to say – “International Taxation is easy.Understand the concepts & any CA can practise it”.

Now I say:

“International Taxation has become too complex.

After implementation of BEPS it will be Complex & Complicated.”

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International Tax After BEPS


Part - 3

Reasons:

Every Regulator – be it RBI + DOE, ROC, SEBIconsiders that-

“His Regulation is most important.

All businessmen are out to violate the regulations.

Because of loopholes in the regulations, the rich &powerful people escape the regulations.”

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Part - 3

So Each Regulator demands extensive powers to deemviolation - where none may exist + very highpunishment provisions.

Parliament at highest levels is passing these laws.

What PM & others at highest levels ignore are thesefacts:

Corruption exists at all levels – business & industry,bureaucracy & politics. Corruption is not eliminated &cannot be eliminated. And to such a system you aregiving very wide discretionary powers.

50



Part - 3

The corrupt businessman will escape the rigours of regulations.

Honest businessman cannot afford to do business.

Business Friendly Environment

goes for a Toss.

GDP can’t grow. It can fall.

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Part - 3

European Union is acting

European Commission is taking action/ has taken action against:

Countries Companies

Ireland Apple Computers Inc.Belgium 35 MNCsLuxembourg FiatNetherlands StarbucksLuxembourg Amazon

There are two root issues/ Systemic Weaknesses:

1. Why don’t you isolate Tax Havens? When they are part of the system, whole system gets complicated.

52


Part - 3

European Union is acting

2. Apple, Amazon, Google etc. sell billions of dollarsworth of goods & services into Europe. And theydon’t pay any income-tax in Europe. What needsto be changed is – fundamental basis of currentInternational Tax system.

European Commission ignores both root causes &fights at a different level.

53


Part - 3

Coming back to BEPS

1. Some nations, are only looking at theirrevenue losses. Not concerned with lossessuffered by others.

Remember Vested Interest Lobbies ScuttlingGATT talks & delaying WTO agreements.

Same story for Nuclear Non-Proliferation;and Environment Control.

European Union Vs. US

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Part - 3

Similar vested interest actions can be seen in BEPSAction Reports.

2. Now a Tax War is emerging between US &European Union.

If US is loosing tax revenue, Amend the OECDDTA model & change domestic law.

If India is losing tax revenue, ignore it.(E-commerce Action 1)

And if US MNCs are avoiding taxes of rest of theworld, don’t allow any changes in DTA & domesticlaw.

EU & US - Tax War ?55


Part - 3

Consequences of BEPS

Consequences have been stated in Part 1 itself.

Tax Compliance & Tax Administration will beimpossible. Corruption will increase.

There can be a break down of the system.

Taxation will hurt Global GDP.

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