BASE EROSION & PROFIT SHIFTING

BASE EROSION & PROFIT SHIFTING
Emerging trends and proposed Action Plans Shefali Goradia January 8, 2014

CONTENT Background BEPS Action Plans What is BEPS? BEPS Concerns
Formulation of Action Plans Timelines and Deliverables Objective Action Plans 2 | Base Erosion and Profit Shifting

BACKGROUND Globalization and technological advances have increased the pace of integration of national economies as well as evolved new business models in which Multinational Enterprise (MNEs) operate Shift from country specific business models to global models Domestic laws of countries do not consider tax systems of other countries. Further, gaps remain in international standards (say in bilateral agreements) Tax planners are continuously identifying and exploiting the legal arbitrage opportunities and boundaries of acceptable tax planning to minimize tax burden (say Double Irish Dutch Sandwich) In doing so, BEPS concern arises. BEPS relates chiefly to instances where the interaction of different tax rules leads to double non taxation or less than single taxation. It also relates to arrangements that achieve no or low taxation by shifting profits away from jurisdictions where the activities creating those profits take place. 3 | Base Erosion and Profit Shifting

WHAT IS BEPS? What is BEPS? BEPS – Causes
Shifting of profits /income to low-tax jurisdictions or other locations enabling a more favorable tax treatment Arrangements involving double non-taxation or less than single taxation Transfer of intangibles to favorable tax jurisdictions Stripping legal entities of business functions, assets and risks Use of “tax attributes” such as tax credits, loss-carry forwards, etc Use of intermediary companies/ jurisdictions in investment and financing structures Use of hybrid arrangements to exploit mismatches in tax treatment BEPS – Causes Existence of loopholes, gaps or mismatches in the interaction of domestic tax laws of countries Inadequacy of current treaty provisions to effectively deal with innovative business models Ineffectiveness or lack of anti-abuse measures in some tax jurisdictions 4 | Base Erosion and Profit Shifting

BEPS – CONCERNS Harm to Governments Harm to individual tax payers
Loss of substantial corporate tax revenues High cost of tax administration Undermines integrity of tax system Tax fairness issue Critical under-funding of public investment Harm to individual tax payers To bear a greater share of tax burden Harm to business Significant reputational risk for MNEs whose effective tax rate is low Competitive disadvantage for domestic businesses Risk of unilateral actions by certain tax jurisdictions 5 | Base Erosion and Profit Shifting | 5

BEPS ACTION PLANS

BEPS – FORMULATION OF ACTION PLANS
BEPS debate received political attention - G20 summits in 2012 and 2013 G20 countries realized the need of preventing BEPS and approached OECD to address the issue related to BEPS and incorporate a transparent and inclusive consultation process involving stakeholders On 19 July 2013, OECD released an Action Plan which was presented to the meeting of G20 Finance Ministers in Moscow The purpose of the Action Plan is “to prevent double non-taxation, as well as cases of no or low taxation associated with practices that artificially segregate taxable income from activities that generate it.” The report indicates that “no or low taxation is not per se a cause for concern, but it becomes so when it is associated with practices that artificially segregate taxable income from the activities that generate it.” The Action Plan covers 15 specific Actions which are broadly to be achieved within a two year time frame (ie by the end of 2015) 7 | Base Erosion and Profit Shifting

ACTION PLANS – TIMELINES 1/4
DELIVERABLES DEADLINE 1 – Address the tax challenges of the digital economy Report issued for identifying issues and possible actions to address the same. Supplementary report September 2014 December 2015 2 – Neutralize the effects of hybrid mismatch arrangements Report issued for recommendations regarding design of domestic rules and revise OECD model tax convention 3 – Strengthen CFC Rules Recommendations regarding design of domestic rules September 2015 4 – Limit base erosion via interest deductions and other financial payments Recommendations on design of domestic rules Changes to transfer pricing guidelines 8 | Base Erosion and Profit Shifting

DELIVERABLES DEADLINE 5 – Counter harmful tax practices more effectively, taking into account transparency and substance - Report issued on member country regimes Expand participation to non-member Revision of existing criteria for preferential regimes September 2014 September 2015 December 2015 6 – Prevent treaty abuse Report issued for changes to OECD model tax convention and recommendations regarding domestic rules 7 – Prevent the artificial avoidance of PE status Recommendations on changes to OECD model tax convention 8 – Assure that transfer pricing outcomes are in line with value creation- Intangibles Report issued for changes to the transfer pricing guidelines and possibly to the model tax convention Supplementary report 9 | Base Erosion and Profit Shifting

DELIVERABLES DEADLINE 9 – Assure that transfer pricing outcomes are in line with value creation- Risks and capital Report on changes to the transfer pricing guidelines and possibly to the model tax convention September 2015 10 – Assure that transfer pricing outcomes are in line with value creation- Other high risk transactions 11 – Establish methodologies to collect and analyze data on BEPS and the actions to address it Recommendations on data to be collected and methodologies to analyse the same. 12 – Require taxpayers to disclose their aggressive tax planning arrangements Recommendations regarding design of domestic rules 10 | Base Erosion and Profit Shifting

DELIVERABLES DEADLINE 13 – Re-examine transfer pricing documentation Report issued on changes to transfer pricing guidelines and recommendations regarding design of domestic rules. September 2014 14 – Make dispute resolution mechanism more effective Recommendations for changes to model tax conventions September 2015 15 – Develop a multilateral instrument Report issued on identifying relevant public international law and tax issues Develop a multilateral instrument December 2015 11 | Base Erosion and Profit Shifting

ACTION 1 – DIGITAL ECONOMY
Challenges in the digital economy – Example Significant challenges: Nexus Characterization Value Attribution A Co. (outside India) Development of algorithms (IP) for targeted display of advertising through use of data Transfer of IP Data B Co. (outside India) Users of free online services Marketing Support Online Advertising Fees India Co Indian Advertisers Where is the value created? 12 | Base Erosion and Profit Shifting

Challenges posed by digital economy Digital economy raises 4 main tax challenges: Nexus- Reduced need for physical presence Characterisation- new digital products or means of delivery Data- Possibility to gather and use information from various sources is a primary input into process of value creation in digital economy. How to attribute value to such data? Collection of VAT- Exemption for imports of low value goods in countries and cross border B2C transactions Ring fencing the digital economy from rest of the economy would be difficult High mobility of intangibles, users, business functions – adds to the difficulty to identify the location of business Avoiding a taxable presence – increasing reliance on automated process (eg websites or fragmentation of activities to qualify for exemption from Permanent Establishment (‘PE’) status) Minimising functions, assets and risks in market jurisdictions – assets (particularly intangibles) and risks may be allocated to other group entities in low tax jurisdiction 13 | Base Erosion and Profit Shifting

Challenges posed by digital economy Maximising deductions in market jurisdictions – hence, camouflaging the taxable profits (eg use of intangibles) Profit extraction - Reduced or no withholding tax on royalties/ interest by locating entities in low tax jurisdiction Eliminating or reducing tax in intermediate country and/or in the country of residence of the ultimate parent Administrative challenges-Identification, determining extent of activities, etc 14 | Base Erosion and Profit Shifting

Potential Options Changes to the definition of PE Modification to the exemption of the PE status (eg eliminate the listed exemptions or making such exemptions subject to an overall condition of being preparatory or auxiliary in nature) New ‘nexus rule’ for enterprises engaged in ‘fully dematerialized digital activities’ based on significant digital presence. For instance, a significant digital presence be deemed to exist when: Significant number of contracts for provision of digital products are remotely signed Digital products are widely used or consumed in the country Substantial payments are received as part of enterprise’s core business or Existing branch in the country offering secondary functions (marketing, consulting functions etc) are strongly related to the core business of the enterprise Virtual PE (say websites-fixed place PE, online contracts-agency PE, etc) Imposing withholding tax at source on digital transactions Consumption tax options – Review threshold exemptions, simplified registrations, etc Coordination with work on other Action Plans 15 | Base Erosion and Profit Shifting

ICAI Recommendations Provide criteria to distinguish core and preparatory and auxiliary activities; withholding tax-beyond threshold and not to apply on ‘B2C’ transactions; presumptive tax regime; simplified single VAT registration in all states; defer VAT on B2C transaction till GST is introduced; etc Few Questions E-commerce business models likely to be subjected to increased scrutiny in India on withholding tax, attribution of value to data, characterization, etc? Is a final WHT an equitable solution? Practicality of registration for consumption tax? Tracking attribution of profits in highly mobile digital businesses-challenge the already challenge transfer pricing? Base Erosion and Profit Shifting

ACTION 2 – HYBRID MISMATCH ARRANGEMENTS
What is Hybrid Mismatch Arrangements? An arrangement that exploits the different tax treatment in two jurisdictions to produce a mismatch in tax outcomes Mismatch is either double deductions for the same payment or a deductible payment that is not included in income by the recipient What Action 2 is trying to achieve? Recommendations for changes to domestic law and OECD Model Convention to deal with hybrids ie to develop model treaty provisions and design domestic rules to neutralize the effect of hybrid instruments / entities by not permitting: Multiple deductions for a single expense Deduction in one country without corresponding taxation in another Generation of multiple foreign tax credits for one amount of foreign tax paid Clear, automatic and comprehensive rules that neutralize the tax mismatch without disturbing the commercial or regulatory consequences 17 | Base Erosion and Profit Shifting

ACTION 2 – HYBRID MISMATCH ARRANGEMENTS
Changes to Domestic tax rules: Specific changes: (i) Denial of dividend exemption (ii) proportionate limitation on withholding tax credits (iii) improvements to Controlled foreign corporations (‘CFC’) and other regimes; and imposition of information requirements and (iv) rules restricting tax transparency of reverse hybrids Hybrid Mismatch rules: To adjust the tax outcomes in one jurisdiction to align them with tax consequences in another through ‘primary rule’ and ‘defensive rule’. It targets 2 types of payments: Payments deductible under payer jurisdiction - Not includible in ordinary income of the payee Duplicate deductions for the same payment Further, to avoid risk of double taxation it calls for guidance on coordination or tie breaker rules, if more than one country seeks to apply the rules Changes to OECD model conventions: Examine issues of dual resident entities Examine issues related to transparent entities Interactions between recommendations in Part 1 and provisions of OECD model conventions Limited applications of situations covered in report in Indian context due to regulatory restrictions 18 | Base Erosion and Profit Shifting

ACTION 2 – Overview of proposed rules
Special rule on dividend exemption for instruments D/NI Instruments / entities General rule: deny deduction Linking rules Indirect D/NI Instruments / entities DD Entities only Rule order Primary rule & defensive rule Scope Controlled groups and structured arrangements Related parties for instruments 19 | Base Erosion and Profit Shifting

ACTION 2 – HYBRID MISMATCH ARRANGEMENTS (Example)
DEDUCTION IN ONE COUNTRY WITHOUT TAXATION IN ANOTHER: B Co issues a hybrid financial instrument to A Co, which shall be characterized as debt in Country B and as equity in Country A Country A treats the payment as ‘dividend’, which is entitled to participation exemption Country B allows deduction to B Co for interest payments made on the instrument BEPS Recommendations: Country B to deny deduction to Payer (B Co) Defensive rule: Country A to treat receipt as ordinary income of A Co A Co Interest Country A Country B Hybrid Financial instrument (ie equity injection for Country A and debt for Country B for tax purposes) B Co 20 | Base Erosion and Profit Shifting

ACTION 3 – CFC RULES Need for Action 3 Objective of Action 3
Creation of affiliated non-resident taxpayers and routing income of a resident enterprise through the non-resident affiliate Objective of Action 3 CFC rules already prevalent in many countries. Need to strengthen the same Develop recommendations regarding the design of CFC rules CFC rules lead to inclusions of passive undistributed income in the residence country of the ultimate parent A positive spillover effect in source countries as taxpayers have no (or much less) incentive to shift profits into a third, low-tax jurisdiction 21 | Base Erosion and Profit Shifting

ACTION 4 – LIMIT INTEREST DEDUCTIONS
Limit base erosion via interest deductions and other financial payments To address base erosion and profit shifting using deductible payments such as interest or such other equivalent payments that can give rise to double non-taxation From an inbound perspective, concern regarding interest expense deduction wrt lending from a related entity in a low-tax regime From an outbound perspective, a company may use debt to finance the production of exempt or deferred income while claiming a current deduction for interest expense Plan Develop recommendations regarding best practices to prevent base erosion through use of interest expense Transfer pricing guidance for pricing of related party financial transactions such as financial and performance guarantees, derivatives, and captive and other insurance arrangements 22 | Base Erosion and Profit Shifting

ACTION 4 – LIMIT INTEREST DEDUCTIONS
Proposed Option - Group-wide test A group-wide test would limit a company’s net interest deductions to a proportion of its group’s actual net third party interest expense, based on a measure of economic activity such as earnings or asset value Aims to allow groups to claim tax relief for their real cost of funds, while protecting countries from excessive deductions Groups can continue to centralise third party borrowings in the entity/country which is most efficient for non-tax purposes, while tax relief for interest is matched with economic activity A best practice recommendation could include an agreed approach to be applied consistently by all countries or provide flexibility for a country to incorporate existing tax principles within its rule No country currently applies a group-wide test as a main rule Proposed Option - Fixed ratio test A fixed ratio test operates by applying a fixed benchmark ratio to an entity’s earnings or asset value Relatively inflexible, applying the same benchmark ratio to all entities irrespective of the level of third party gearing Difficult to establish the “correct” benchmark ratio, for example current fixed interest/EBITDA ratios are often in excess of groups’ actual ratios More straight-forward for groups and tax authorities to apply A combined approach would allow lower risk companies to apply a simple fixed ratio test, while more highly geared companies could claim higher deductions by applying a group-wide test 23 | Base Erosion and Profit Shifting

ACTION 5 – HARMFUL TAX PRACTICES
Counter harmful tax practices Current concerns on a “race to the bottom” approach – Trend of across the board corporate tax rate reductions on particular types of income (such as income from financial activities or from the provision of intangibles) Plans PLANS Revamp the work on harmful tax practices with a priority on improving transparency Compulsory spontaneous exchange on rulings related to preferential regimes Rules that require substantial activity for any preferential regime Holistic approach to evaluate preferential tax regimes Engage with non-OECD members to consider revisions or additions to the existing framework 24 | Base Erosion and Profit Shifting

ACTION 5 – HARMFUL TAX PRACTICES
Forum on Harmful Tax Practices (‘FHTP’) to deliver 3 outputs: Finalization of review of member country preferential regimes Strategy to expand participation to non-OECD member countries and Consideration of revisions or additions to the existing framework For review of the existing preferential regimes, emphasis put on: Elaborating a methodology to define the substantial activity requirement in the context of IP regimes Countries have agreed to strengthen the substantial activity requirement for realigning taxation of profits with substantial activity - This will affect IP holding companies Improving transparency through compulsory spontaneous exchange on rulings related to preferential regimes 25 | Base Erosion and Profit Shifting

ACTION 6 – TREATY ABUSE Prevent treaty abuse Issues identified Plan
Treaty abuse, in particular treaty shopping, identified as one of the most important sources of BEPS concerns Issues identified Use of low taxed branches of a foreign company Use of conduit companies/ regimes to channel investments and for intra-group financing Use of multiple layers of legal entities Artificial shifting of income through transfer pricing arrangements Plan Recommendations regarding the design of domestic rules to prevent the granting of treaty benefits in inappropriate circumstances Clarify that tax treaties are not intended to be used to generate double non-taxation Identify the tax policy considerations that countries should consider before deciding to enter into a tax treaty with another country 26 | Base Erosion and Profit Shifting

ACTION 6 – TREATY ABUSE Design rules to prevent granting of treaty benefits in inappropriate circumstances Cases where person tries to circumvent limitations provided by treaty Clear statement that treaties intend to avoid creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance (including treaty shopping) Specific treaty anti-abuse rules (SAAR) which are: Limitation-on-benefits (LOB) rule to address a large number of treaty shopping situations based on the legal nature, ownership in, and general activities of, residents of a Contracting State Minimum shareholding period to prevent dividend transfer transactions Changes to Article to prevent transactions that circumvent the application of that rule dealing with capital gains on sale of shares of companies deriving value from immovable property Residence under tie-breaker rule determined through Mutual Agreement Procedure (‘MAP’) proceedings (having regard to factors such as place of effective management (‘POEM’), place of incorporation, etc) Anti-abuse rule for permanent establishments situated in third States General treaty anti-abuse rule (GAAR) aimed at arrangements as one of the principal purposes of which is to obtain treaty benefits (conduit financial arrangements) 27 | Base Erosion and Profit Shifting

ACTION 6 – TREATY ABUSE Cases where person tries to abuse provisions of domestic law using treaty benefits Savings Clause - Treaty does not restrict a right of contracting state to tax its own residents Departure or Exit Taxes - Liability to tax certain types of income accrued for the benefit of resident is triggered in the event resident of a particular country ceases to be resident of that country LOB Rule Residents entities to get benefit of treaty only if Qualified person (by reference to nature or attributes of various categories of persons) Active business connection tests Derivative benefits - Allow certain entities owned by resident of other states to obtain treaty benefits that these resident would have obtained, if directly invested Competent authority to grant treaty benefits, if other provisions deny the same 28 | Base Erosion and Profit Shifting

ACTION 6 – TREATY ABUSE Identification of tax policy consideration – required before entering into a tax treaty Policy considerations would help countries to explain not to enter into tax treaties with certain no or low tax jurisdiction Modify a treaty previously concluded in event that change of circumstances raises BEPS concern related to that treaty Protect sovereign right of nations to enter into treaties considering other issues (taxation rights, foster economic ties, etc) besides potential BEPS risks Follow up Work Model provisions and related Commentary included in the report, in particular the LOB rule, are in draft form and need to be refined Further work is also needed with respect to: the implementation of the minimum standard adopted to address treaty shopping and the treaty entitlement of various investment funds 29 | Base Erosion and Profit Shifting

ACTION 6 – TREATY ABUSE ICAI recommendations Questions
LOB Rule - May lead to inappropriately restrictive outcome impacting genuine cases; TRC a prima facie evidence be acceptable Treaty Abuse provisions - No clarity in interplay with domestic GAAR. Further, if treaty GAAR introduced then domestic GAAR only for determination of income under the domestic law; grandfathering framework needs to be put in place; practical administration challenges Tie Breaker test- current rule based framework can continue; MAP resort anyways available Questions Is tax planning dead? Too much discretion left with competent authorities? 30 | Base Erosion and Profit Shifting

ACTION 7 – PE AVOIDANCE Objective of Action 7
Prevent the artificial avoidance of PE status by developing changes to the definition of PE: Use of commissionaire arrangements instead of traditional distributor models Use of preparatory and auxiliary exemptions - artificial fragmentation of operations among multiple group entities Splitting up of contracts Address related profit attribution issues Commissionaire arrangements A commissionaire arrangement may be loosely defined as an arrangement through which a person sells products in a given State in its own name but on behalf of a foreign enterprise that is the owner of these products. The debate has been focussed on legal interpretation of phrase ‘authority to conclude contracts in name of’ which is found in Article 5(5) Four alternative options to ensure that there will be a PE where the activities that an intermediary (other than independent agent) exercises in a country result in the regular conclusion of contracts to be performed by a foreign enterprise 31 | Base Erosion and Profit Shifting

ACTION 7 – PE AVOIDANCE Preparatory and Auxiliary activities exemption
Art 5(4) of the OECD Model deems a PE not to exist where a place of business is used solely for activities that are listed in that paragraph First option: only activities that are preparatory or auxiliary would be covered Second option: more targeted changes Removal of the reference to ‘delivery’ (which will catch situations where an enterprise maintains a warehouse, unless purely preparatory or auxiliary). Removal of the exception for ‘purchasing offices’ or for both ‘purchasing offices’ and ‘places maintained for the ‘collection of information’ Proposal to address the abuse of Art 5(4) through fragmentation of activities between related parties Art 5(4) will not apply with respect to a specific place of business if taxable activities that constitute “complementary functions that are part of a cohesive business operation” are carried on in the country by the same enterprise or by associated enterprises Splitting of contracts between related entities To be addressed by GAAR (PPT rule) or ‘Automatic Rule’ 32 | Base Erosion and Profit Shifting

ACTION 7 – PE AVOIDANCE Questions
How will jurisdictions overcome challenge of distinguishing genuine marketing support provider entities from those who tacitly negotiate and conclude contracts for MNEs? Will this lead to unreasonable attribution although the local subsidiary is adequately compensated? While the Action Plan 7 mentions subsidiaries and commissionaire arrangements, whether employee secondments or visits to customer premises / locations could be impacted? 33 | Base Erosion and Profit Shifting

ACTIONS 8, 9 AND 10 – TRANSFER PRICING
Assure that TP outcomes are in line with value creation Develop rules to prevent BEPS by moving intangibles among group members. This will: adopt a broad and clearly delineated definition of intangibles ensure that profits associated with the transfer and use of intangibles are appropriately allocated in accordance with (rather than divorced from) value creation develop TP rules or special measures for transfers of hard-to-value intangibles and update the guidance on Cost Compensation Agreements (CCAs) Develop rules to prevent BEPS by transferring risks among, or allocating excessive capital to group members. This will involve: Ensuring that inappropriate returns will not accrue to an entity solely because it has contractually assumed risks and has provided capital Alignment of returns with value creation 34 | Base Erosion and Profit Shifting

Develop rules to prevent BEPS from other high risk transactions - transactions which would not, or very rarely, occur between 3rd parties: clarify the circumstances in which transactions can be re-characterized clarify the application of TP methods, in particular profit splits, in the context of global value chains and provide protection against common types of base eroding payments, such as management fees and head office expenses The Action Plans would consider the application of both the principles (i) Arm’s Length Price (ALP) principle and (ii) Potential special measures required to address concerns identified in Action Plan. Guidance for Applying ALP Principle Identifying the commercial and financial relations (Contractual terms; FAR analysis of the transaction, {if activities fragmented, determine the interdependency and how commercial activity is coordinated}; Characteristics of property transferred or services provided; economic circumstances of parties and market in which parties operate; and Business strategies pursued by parties) 35 | Base Erosion and Profit Shifting

Identifying risks in commercial and financial relations (nature and sources of risks, allocation of risks in contract, how risks assumed, potential impact of risks (value created), risks management, actual conduct, transfer pricing consequences) Interpretation- Determine pricing for the actual transaction as accurately delineated under the ALP principle Non recognition- If transaction does not have the economic attributes of arrangements between unrelated parties, the same would be disregarded for transfer pricing purposes. Accordingly, each party to have a reasonable expectation to enhance or protect commercial or financial relations on risk adjusted basis compared to other opportunities realistically available to them at the time arrangement was entered into Specific considerations like losses, effect of government policies, use of custom valuations Locations savings and other local market features Assembled work force MNE’s group synergies 36 | Base Erosion and Profit Shifting

Potential Special Measures -To address the residual risks unidentified by ALP principle. They mainly relate to information asymmetries between tax payers and tax administrations and relative ease with which MNE group can allocate capital to lowly taxed Minimal functional entities (MFE) Hard to value intangibles - Concerns- (i) potential for systematic mispricing, if no comparable exists (ii) assumptions used are speculative (fixed price agreed years before intangibles generates income) (iii) information asymmetries between taxpayer & tax administration are acute Action- Target circumstances where (i) taxpayer fixes price on basis of projections without any further contingent payment mechanism (ii) does not contemporaneously document projections and make them available to tax administration Tax administrations may rebase calculations based on actual outcome, imputing a contingent payment mechanism Independent investor - Circumstances where capital rich-asset owning company depends on another group company to generate a return from asset Thick Capitalization - to determine the amount of capital in excess of pre-determined capital ratio and then to deem interest deductions which would reduce the profitability of capital rich company and produce deemed interest income in the company providing excess capital Constraint - determining level of thick capitalization ratio a challenge? 37 | Base Erosion and Profit Shifting

MFE- Transactions between related parties, especially transactions transferring key business risks or intangibles, that one of the parties has minimal functions. The action plan would determine thresholds of functionality based on qualitative or quantitative attributes The effect of falling beneath threshold would require entity’s profit to be reallocated based on profit split, reallocate to ultimate parent (not a MFE), relocate to company providing functional capacity Ensuring appropriate taxation of excess returns- This option entails application of primary rule in form of CFC and a secondary rule to prevent non taxation. Under this, if CFC earns excess return and average tax rate is below threshold percentage, the excess returns subjected to tax at that rate under primary rule. A secondary rule would apply, if primary rule not applied. Locations Savings Cost savings applicable on account of operating in a particular market. Actions include (i) determining whether location savings exist, (ii) amount, (iii) extent to which savings are retained or passed by MNE (iv) if not passed then manner of allocation Challenge- Quantifying benefit derived from location savings Questions- Approach to be adopted for quantifying location savings? Approach to be adopted for allocated retained savings amongst various group companies? Does use of local comparable factor return for location savings? 38 | Base Erosion and Profit Shifting

Cross Border Commodity Transactions Transfer pricing issues- (i) Use of pricing date conventions which enable tax payer to adopt advantageous quoted price (ii) significant adjustments/ charging significant fees in supply chain (processing, transportation, etc) (iii) involvement of MFE located in low tax jurisdictions Options The use of the CUP method for pricing commodity transactions and use of quoted prices in applying CUP method Deemed pricing date for commodity transactions (Firstly, use specified date selected by parties. If pricing date is inconsistent with other facts, tax administrations impute pricing date based on evidence provided by facts of case. If no evidence- date of shipment) Potential additional guidance on comparability adjustments 39 | Base Erosion and Profit Shifting

Low value adding intra-group services (Action Plan 10) Services performed by one member or more than one member of MNE group on behalf of one or more members of MNE group which (i) are of a supportive nature (ii) not a part of core business activities (iii) do not require use of or lead to creation of unique or valuable intangibles (iv) do not involve assumption or control or (creation) of (to) substantial or significant risks Examples of Services that would qualify as low value added intra-group services: Accounting and auditing; Processing and management of accounts receivable and accounts payable; Human Resources activities, General services of an administrative or clerical nature,etc Simplified Method for determination of Arm’s Length charges in case of low value added services Determination of cost pools Identify and remove those costs that are attributable to the services performed by one group member solely on behalf of another group member Allocation of low value added service costs to group members based on some allocation key (depending on nature of services) Profit mark up- Same mark up for all the low value added intra group services (range of 2 to 5 percent) 40 | Base Erosion and Profit Shifting

Low value adding intra-group services (Action Plan 10) Charge of low value added services - this would be sum of specific cost plus profit mark up (step 2) & pooled cost plus profit mark up Application of the benefits tests to the low value adding intra group services Documentation and reporting Documents to be maintained: description of the categories of low value adding services provided, reasons justifying the same, rationale for provision of such services, benefits or expected benefits, etc Written contracts or agreements for provision of services Calculation showing determination of cost pool and costs solely to one group member Calculations showing application of specified allocation keys Questions Tax authorities could challenge characterization and mark up of 2 to 5 percent for such services? 41 | Base Erosion and Profit Shifting

ACTION 11 – MONITORING BEPS
Establish methodologies to collect and analyze data on BEPS and the actions to address it Several studies undertaken and data available identifying disconnect between location of value creating activities and reporting of profits for tax purposes. Further, work to be done to evaluate such studies Develop outcome based techniques which seeks to allocate income across jurisdictions relative to value creating activities Develop recommendations regarding indicators of the scale and economic impact of BEPS Ensure that tools are available to monitor and evaluate the effectiveness and economic impact of the actions taken to address BEPS on an ongoing basis Assess a range of existing data sources, identifying new types of data that should be collected by tax administrators and developing methodologies to analyse the same-based on both aggregate (eg FDI and balance of payments) and micro-level data (eg financial statements and tax returns) Balance the above objectives with taxpayer confidentiality and administrative costs 42 | Base Erosion and Profit Shifting

ACTION 12 – ENHANCED DISCLOSURE
Need for Action Plan 12 Comprehensive and relevant information on tax planning strategies often unavailable Audit suffers from number of constraints as tool for early detection of aggressive tax planning techniques Objective of Action Plan 12 Develop recommendations regarding the design of mandatory disclosure rules for aggressive or abusive transactions, considering administrative costs, current experiences in different countries, country specific needs and risks, etc Focus will be international tax schemes - explore a wide definition of “tax benefit” in order to capture such transactions Design and put in place enhanced models of information sharing for international tax schemes between tax administrations 43 | Base Erosion and Profit Shifting

ACTION 13 – TP DOCUMENTATION
Re-examine TP documentation Develop rules regarding TP documentation to enhance transparency for tax administration, by providing them with adequate information and also considering the compliance costs for business The rules to be developed will include a requirement that MNE’s provide all relevant governments with needed information on their global allocation of the income, economic activity and taxes paid or accrued among countries according to a common country by country template Objectives Provide tax administration information to conduct informed TP risks assessment and thorough TP Audit Tax payers assessment of its compliance with ALP principle The information will make it easier for tax administrators to identify whether companies have engaged in transfer pricing and other practices that have effect of artificially shifting substantial amounts of income into tax advantaged environments 44 | Base Erosion and Profit Shifting

A three tiered approach to TP Documentation Master File- Aimed at providing a clear understanding of MNE’s global operations. Organizational Structure of MNE Description of MNE’s major business lines Intangibles- Strategy for development, ownership, important related party agreements Intercompany financial transactions Financial and tax positions-MNE’s consolidated accounts; APA’s and Advance rulings, etc CBC Reporting Template- Information required country wise in draft template. Following are the major heads of CBC:- Constituent entities organized in country POEM Important business activities along with revenue and EBIT Tax paid on cash and accrued basis Stated capital and accumulated earnings No of employees Tangible assets Royalties/service fees/ interest paid or received to/from constituent entities Local File-Aimed at providing local country transactional information Local entity- Management structure, effective place of operations, business restructuring of intangible transfer in 2 years Details of controlled transactions- identification, description and value, FAR of entities; transfer pricing methods Financial information- Audited financial accounts and allocation schedule 45 | Base Erosion and Profit Shifting

Significant criticism and recommendations received by OECD Approach and objective only suits the tax administration Compliance cost and burden Confidentiality concerns Mechanism for sharing of information All information vs Need based information Flexibility in reporting – entity-wise or business wise Need for materiality and de minimis thresholds Exemption/simplification for SMEs 46 | Base Erosion and Profit Shifting

ICAI Recommendations ICAI Recommendations – TP Documentation
India should engage with OECD and the other countries for improving, standardizing and simplifying TP documentation requirements and converge TP documentation in line with international standards Taxpayers should be given sufficient time to understand and obtain clarity in respect of the proposed documentation requirements and develop systems Specific guidance to be provided for standard forms developed for risk assessment, sharing of ‘general risk assessment policies’, releasing of FAQ’s by tax administrator Safe harbour rules, exemption from TP documentation, etc CBC reporting template is to be used by tax authorities for purposes of initial high level risk assessment only aimed at determining whether and where to devote resources to conduct a detailed examination. In this regard, necessary training to be imparted to the tax authorities to facilitate the process of implementation. It should be clarified that CBC Reporting template should not be considered as evidence at all Information that is only relevant for ‘single’ or ‘group’ of entities can be included in Local file or can be shared through treaty mechanism to maintain confidentiality and prevent ‘fishing’ inquiries. Eg: APAs / MAPs between 2 countries Further, one tax administration should be responsible for enforcing compliance with respect to Master file/CBC reporting, in particular the country of ultimate parent company 47 | Base Erosion and Profit Shifting

ACTION 14 – DISPUTE RESOLUTION
Make dispute resolution mechanisms more effective Actions to counter BEPS must be complemented with actions that ensure certainty and predictability for the business Develop solutions to address obstacles that prevent countries from solving treaty-related disputes under MAP Consideration for supplementing MAP with mandatory and binding arbitration provisions Three pronged approach Consist in political commitments to effectively eliminate taxation not in accordance with the Convention Provide new measures to improve access to the MAP and improved procedures Establish a monitoring mechanism to check the proper implementation of the political commitment 48 | Base Erosion and Profit Shifting

4 principles shall guide the political commitments and the measures To ensure that treaty obligations related to the MAP are fully implemented in good faith To ensure that administrative process promotes the prevention and resolution of treaty related disputes To ensure that taxpayers can access the MAP when eligible To ensure that cases are resolved once they are in mutual agreement procedure Options proposed Put an obligation to resolve cases (not endeavor) Ensure independence of a competent authority Provide sufficient resources and performance indicators to a competent authority To ensure that audit settlements (eg no penalties, if MAP right waived) do not block access to the MAP To implement bilateral APA programme and recurring (multiple year issues) and roll back provisions 49 | Base Erosion and Profit Shifting

To provide additional guidance on the minimum contents of a request for MAP assistance (avoid onerous documentation) and improve transparency and simplicity of procedures To clarify the availability of MAP access where an anti-abuse provision is applied To ensure the taxpayer’s objection is justified and evaluated prima facie by both competent authorities and not unilaterally To clarify the relationship between MAP and domestic law remedies To clarify issues connected with collection of taxes, time limits to access MAP and self-initiated foreign adjustments in MAP To ensure principled approach to MAP resolution, improve competent authority co-operation, transparency and working relationships To increase transparency with respect to MAP arbitration To clarify the co-ordination of MAP arbitration and domestic legal remedies To provide guidance on consideration of interest and penalties in MAP 50 | Base Erosion and Profit Shifting

ACTION 15 – MULTILATERAL INSTRUMENT
Need for Multilateral instrument Updating of the current tax treaty network highly burdensome, time consuming and will require substantial resources due to multiple number of bilateral treaties Without mechanism to swiftly implement them, changes to model only makes gap between content of model and content of actual tax treaties wider. This contradicts the political objective Develop a Multilateral Instrument To ensure effective and innovative implementation of measures resulting from the BEPS Action Plan Objective of Action 15 Analyze the tax and international law issues for development of a multilateral instrument to enable jurisdictions (that wish to) to implement measures and provide a foundation for amendment of bilateral tax treaties Develop a multilateral instrument to provide an innovative approach to international tax matters-reflecting rapidly evolving nature of global economy and adapt quickly to it Streamline the implementation of tax treaty related BEPS measure 51 | Base Erosion and Profit Shifting

ACTION 15 – MULTILATERAL INSTRUMENT
Key Conclusions Multilateral instrument is desirable and feasible Innovative approach with no exact precedent in tax world Drawing on the expertise in other areas of public international law (other than tax) and tax experts 52 | Base Erosion and Profit Shifting

Thank you 53 | Base Erosion and Profit Shifting

BASE EROSION & PROFIT SHIFTING

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