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India examining how to tax in a digital ECO
December, 09th 2015

Akhilesh Ranjan, joint secretary (foreign tax), who led India's initiative in the BEPS project, candidly shared his views on India's plans for its implementation and what lies in the future. The fundamental principle of the BEPS project, is that income of MNCs should be taxed in that country where economic activities are performed and where value is created. India, as a major outsourcing hub, may stand to garner higher share of taxes, as countries transition towards a BEPS-compliant regime. Looking ahead, taxation in a digital economy has its challenges, but India with a large consumer base (eg: 108 million Facebook users, second only to US) needs to find fair tax solutions.

Here are excerpts of Ranjan's views on key BEPS action plans, with explanatory notes (ENs) added by TOI.

Taxation In Digital Economy

"There is a concern that business operations, in a digital economy, can be run in another country without a physical business presence. The value of digital companies is skyrocketing, often with no rational basis. Such value is created largely by the market. We believe that value is created not merely by the production of goods and services, but also by the purchasing power of the market where the goods and services are consumed. "Even as no consensus emerged on this issue among countries, BEPS Action Plan-1 Report provides for options to deal with the broader tax challenges in the digital economy. India takes credit for incorporating into the action plan various tax options - this was a huge effort. (The options recognize the concept of a significant digital presence for corporate tax purpose, other tax options include withholding tax and an equalization levy in the nature of an excise tax). We even had to take cudgels against countries like the US.

"A committee has been set up to examine various facets of taxation in a digital economy. Suggestions within the framework of India's tax treaty obligations will be given by this committee in its report, which will be submitted in a time-bound manner."

Basic BEPS Framework

"BEPS action plan reports contain certain 'minimum standards' which OECD, G20 countries (including India) have committed to implement. These cover preventing treaty shopping, country-by-country reporting, fighting harmful tax practices and improving dispute resolution. Treaty-related measures will be implemented by the multilateral instrument. India is part of the drafting group and the instrument will be ready by end 2016. "Other minimum standards, will need to be implemented via domestic legislative changes. India is also examining the 'best practice' and 'common approach' BEPS recommendations such as on interest deductibility and CFC regulations."

Country-By-Country Reporting

"This requirement will be introduced in the tax legislation via the Finance Bill, 2016."

EN: Indian companies, with consolidated global revenues of Rs 5,000 crore approximately, will be required to maintain and furnish CBCRs to the Indian tax authorities by the specified date, in respect of FY16-17 onwards. This report will outline functions (activities), income, profits and other details relating to business activities carried out by the company in various countries. BEPS action plan calls for sharing of CBCRs between tax authorities of participating countries and at the same time, maintaining a high degree of confidentiality.

Treaty Renegotiation

"Actions relating to treaty shopping will be implemented via the multilateral instrument. However, as of now the ongoing discussions with countries like Mauritius and Cyprus for tax treaty renegotiation will continue. There is no conflict between the multilateral instrument being drafted and bilateral discussions between countries."

Artificial Avoidance of Permanent Establishment

"By fragmenting their business operations in India, MNCs should not be allowed to escape tax on the ground that their activities or some of their activities fall under the exempt 'preparatory and auxiliary clause'. We are moving quickly, through active participation in the drafting of the multilateral instrument to ensure that profits will be fairly attributed by MNCs to their business in India." EN: Under the tax treaty provisions, a country can tax business profits of a foreign enterprise, only if its business operations are carried out through a permanent establishment - PE (which is a fixed place of business). However, certain activities, though carried out from a fixed place of business, are treated as preparatory and auxiliary and do not create a PE, hence no taxing rights arise. BEPS aims at plugging artificial avoidance of tax.

Transfer Pricing

"We are very happy with the BEPS action plan in the arena of transfer pricing. It recognizes that income should be allocated to a country keeping in view the actual functions carried out in that country and not based on mere legal ownership of intangibles (IPRs) or formal contractual obligations between related parties. We believe more income should be allocated in India to the Indian entity (which carries out outsourcing) if there is concrete value addition."

Controlled Foreign Company (CFC) Norms

"The issue is not whether to introduce CFC regulations, but when to introduce them. We need to analyse how Indian companies are operating globally, as it must not dampen outbound investments and global business aspirations."

EN: CFC regulations enable a country to tax passive income (such as interest, dividend income) of overseas subsidiaries of Indian companies, even when profits are not repatriated back to India.

Interest Deductibility

"We realize that interest deductibility is a very sensitive subject in India, yet interest is a major source of base erosion even in case of ECBs (as it is allowed as a deduction from business income of the debtor company) and hybrid financial instruments are a cause of concern. We need to examine various issues, including the impact of the arbitrage between dividend distribution tax and withholding tax on interest payments, in the context of debt from related and unrelated parties. We will move cautiously on this issue."

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