<b>Parthasarathi Shome:</b> MNEs' tax avoidance & overdealt response

Has the OECD's BEPS proposals asked too much from MNEs to counter global tax avoidance?

The Group of 20 Nations (G20) asked the Organisation of Economic Cooperation and Development (OECD) based in Paris to suggest comprehensive measures to address egregious tax avoidance by multinational enterprises (MNEs) that the latter typically structure through a process of tax base erosion by shifting profits (BEPS) among their parent companies, branches and subsidiaries across national boundaries. Essentially they locate profits in low tax jurisdictions and successfully minimise their total tax contribution in terms of their global profits. Though their operations were legal, advanced country tax administrations began to perceive such practices as unreflective of the intention of the law.
 

Despite comprising a cluster of advanced economies, the OECD invited Brazil and India to participate in the BEPS steering group. Even a decade back India looked askance from the OECD as a rich country club and it required considerable effort to get India to participate in selected OECD deliberations. Subsequently, India's posture on international taxation was strongly and publicly criticised by tax authorities of advanced economies, compelling India to modify its position. In the end, India's role in BEPS has been commendable and it has made useful contributions to the 15 BEPS reports that were released by the OECD in Peru at a G20 Summit last month.

First, there is the matter of vindication. India steadfastly argued well before BEPS that tax revenue must justly accrue in source jurisdictions where value added is created in the international supply chain of a commodity or service. Advanced economies by and large ignored this stance, their position being, revenue should accrue where risk taking and management decisions are made and where capital resides. However, with the collapse in advanced economy revenue with the onset of the 2008 global crisis, they began to realise the potential revenue benefits of applying the source principle as India did. Recognising the validity of India's position, advanced economies pointed out, their disagreement lay less in India's philosophical positions than in the unpredictable implementation of Indian tax laws pertaining to international taxation as well as its practice of retrospective legislation that changed risk parameters of businesses ex-post.

Second, upon examination of the array of BEPS recommendations, one may assess that there are good possibilities they will be of benefit to India and other emerging economies. For example, Action 5 of BEPS highlights the so-called substance test, linking the accrual of intellectual property (IP) rights and associated income and the right of taxation thereof to where research and development (R&D) take place, making jurisdictional taxability a more transparent phenomenon than before. This supports India's viewpoint to the extent that India is host to R&D of MNEs. To achieve transparency, BEPS raises exchange of information among tax administrations to a high pedestal, a matter that has also been pushed for by India while advanced economies have been historically reticent about it. At the same time, the OECD tends to neutralise its position inasmuch as BEPS Actions 8 to 10 go deeper into the relationship between risk taking and intangibles such as IP to ensure that they are not dissociated from revenue rewards, thus tilting towards a position in favour of advanced economies.

Another area of clarity where the Indian view has been vindicated is BEPS Action 6 on limiting treaty abuse and controlling treaty shopping by specifying the principal purpose of an MNE operation in a taxing jurisdiction. This should assist India and emerging economies to receive a more rightful share of global MNE revenue.

Nevertheless there were limits to what India and similar emerging economies could achieve. BEPS Action 1 could be safely viewed as not having fully achieved adequacy in the taxation of the digital economy, a matter that has been of some concern to India where the digital economy has made a strong presence while escaping taxation and leading to intractable disputes. The BEPS' superficial assertion that already agreed upon taxation arrangements specified in the double taxation avoidance arrangements (DTAAs) should be adhered to, limits the ability to tax the digital economy since most DTAAs did not anticipate and do not address this issue. It also reveals the continuation of strong influences of advanced economies in what position the OECD may be finally able to take.

One area where India should have taken a different stand is Action 14 on dispute resolution. The quantum-generation, accumulation, management, resolution-of tax disputes in India far exceeds the rest of the world. India decided not to be a part of the mandatory arbitration process on sovereignty grounds, and missed an opportunity to rationalise disputes. What improvement will it bring in the Mutual Agreement Process (MAP) that addresses double taxation-a sore point with India's treaty partners? India's position would also continue to affect investment adversely. The Indian tax administration needs to rise above being a mere revenue collection agency shorn of and supra the growth context.

More fundamental than how the revenue pie is shared among tax administrations is how accountability and compliance cost would be dealt with between global tax authorities and MNEs. MNEs have been productive in technology, in supply, and in raising living standards globally. Their tax performance should be segmented into good and bad performers. There are likely to be good taxpayers even among those who fall above the high threshold that BEPS Action 13 has stipulated for the detailed 3-step-master file, country-by-country (CbC), local-reporting of their global operations. The authorities' expectation is that CbC coupled with information exchange would reduce disputes. Nevertheless, the importance of Advance Pricing Arrangements (APAs) whose speed is slow, cannot be minimised.

A heavy handed reporting system applied to all MNEs indiscriminately is detrimental to global productivity and growth. It is expectable that Action 13 would be scaled back in future deliberations reflecting that collapse in global growth was the motivator for the G20's BEPS initiative while revenue decline was only its outcome. Ultimately, revenue at the cost of growth is unlikely to receive sympathetic ears from global policymakers.