India's forthcoming budget may draw from some of the recommendations, especially in the realm of transfer pricing, contained in the final package of 'Base Erosion and Profit Shifting' (BEPS) measures, rolled out in October.
Certain anti-abuse measures, such as thin capitalization, which for tax purposes disallows interest payments beyond certain limits in the hands of the corporate borrower, could also be introduced. Controlled Foreign Corporation (CFC) Regulations that were contained in the direct tax code may also be on the cards. As of now, discussions on these issues are at the drawing board stage.
Several BEPS measures (or action points), if introduced, would enable India to get a higher share of taxes from multinational companies (MNCs). The BEPS project, led by the Organisation for Economic Co-operation and Development (OECD), aims at closing loopholes that enable MNCs to shift profits to low or nil tax countries.
It is learnt that the ministry of finance (MoF) is drafting various policies relating to the BEPS action plan. While some aspects would be captured in the forthcoming budget, other policies may be rolled out at a later date. G20 countries, including India, are committed to the BEPS project - this was also affirmed by the country-leaders at the recently concluded summit in Turkey. Government officials are currently engaging with the industry, tax experts and other stakeholders, to make the process of BEPS implementation participative and collaborative.
High on the list of measures that could be introduced in the budget is the country-by-country reporting (CBCR) requirement for transfer pricing purposes. MNCs headquartered in OECD or G20 countries, with consolidated revenues of at least 750 million euros (Rs 5,000 crore approximately), will be required to maintain and furnish CBCRs to their tax authorities. CBCR requires details of the place of incorporation, tax residency, revenues, profits, taxes paid, capital, number of employees and details of activities on a country-by-country basis.
According to the BEPS action plan, this requirement is recommended for accounting years starting on or after January 1, 2016. MoF officials are having informal interactions with industry and experts on this point.
The tax authorities of a country where the MNC has its headquarters will automatically share the CBCR with other countries where the company operates, subject to the other countries having suitable confidentiality measures.
"India is committed to safeguarding the data it receives," say government sources. "CBCR will give tax authorities a global picture of the operations of an MNC; this will help them determine whether appropriate profits were apportioned to their country or whether there was revenue leakage. It is a crucial document for Indian transfer pricing authorities," explains Sudhir Kapadia, national tax leader at EY (India).
"India-headquartered companies meeting these financial criteria will have to get used to higher level of transparency. CBCR outcome will require companies to review their global supply chain for inter-company transactions and evaluate the effectiveness of existing transfer pricing policies. Documentation will be time consuming but much needed to demonstrate that the group is globally compliant with the new tax landscape," says Sanjay Tolia, transfer pricing leader, PwC (India).
Another aspect which is currently being discussed is the possible introduction of CFC rules. These were contained in the direct code and enabled India to tax passive income of overseas subsidiaries of Indian companies, even when profits had not been repatriated back to India. "Place of Effective Management (POEM) was introduced, last budget, as one of the criteria to determine tax residency of a company. It took care of any tax abuse by setting up of shell entities overseas. In general terms, if key decisions for the conduct of the business of such an overseas entity were made in India, India could treat such an entity as an Indian tax resident and subject it to tax on its worldwide income. In this context, the need for introduction of CFC rules is negated," explains Girish Vanvari, national head of tax, KPMG (India). CFC is also a complex piece of legislation; and with outbound investments from India in their infancy, India Inc is not in favour of its introduction.
India currently doesn't have thin-capitalization rules. In some countries, if a debtor company's total debt exceeds a certain proportion of its equity capital (debt:equity ratio), the interest on the excess loan component is disallowed as a deduction for tax purposes. BEPS action plan for thin-capitalization is wide, and limits a debtor company's deduction for interest to a percentage of its ebitda (earnings before interest, tax, depreciation and amortization).
"The Indian economy needs funding. Large projects, such as infra projects, cannot be funded entirely with equity. Banking regulations provide checks and balances for external borrowings. At best, thin-capitalization rules, if introduced, should be restricted to borrowings from related parties such as group companies," says Kapadia.
Of particular interest to India's revenue authorities is the BEPS action plan recommendation that an intangible should be taxed in the country where the IPR is created or exploited (used). Legal ownership will no longer be the determinant for tax purposes. Typically, MNCs house IPRs in companies situated in low tax countries. The operational activities are outsourced to another group company in another country - such as Indian subsidiaries for pharma R&D or software development. The Indian subsidiary earns only a small profit margin, resulting in lower tax outgo. With BEPS recommendation, a greater allocation of profits to India can be justified by tax authorities. "The substance test, viz: whether the profits in a particular country can measure up to the business operations in that country will need to be substantiated by companies - be it MNCs having subsidiaries in India or Indian headquartered global companies having overseas operations," says Vanvari.