Base Erosion and Profit Shifting

Relevance: GS-III: Effects of liberalization on the economy, changes in industrial policy, and their effects on industrial growth.

Base erosion and profit shifting (BEPS) refers to tax avoidance strategies that exploit gaps and mismatches in tax rules to artificially shift profits to low or no-tax locations. This undermines the fairness and integrity of tax systems because businesses that operate across borders can use BEPS to gain a competitive advantage over enterprises that operate at a domestic level.

• BEPS practice is a major problem since nations have lost tax revenues to the tune of $ 100 billion to $ 240 billion annually, as per statistics put out by the Organisation for Economic Cooperation and Development (OECD). The above revenue which is lost is equivalent to 4 % to 10 % of the total income tax revenue at a global level.
• The BEPS project is a joint initiative between G20 countries and the OECD works towards the development of a coherent global taxation system that addresses BEPS concerns.
• A project headed by the OECD's Centre for Tax Policy and Administration to deal with the tax avoidance strategy used by multinational companies was commissioned.
• The main purpose of such an initiative is to address the gaps in the current international tax rules relating to arrangements that achieve no or low taxation by shifting profits away from the jurisdictions where the activities creating profits take place. 
• The OECD, under the authority of the Group of 20 countries, has considered ways to revise tax treaties, tighten rules, and share more government tax information under the BEPS project, and had issued action plans in 2015.

The BEPS project would:

• Increase tax revenues which were earlier lost due to BEPS.
• BEPS is of major significance for developing countries due to their heavy reliance on corporate income tax, particularly from multinational enterprises.
• Give a level playing field for both and domestic and global companies by allowing them to conduct businesses under similar circumstances.
• Tax savings from BEPS give multinational companies an edge over domestic companies, which may lack the wherewithal to employ such strategies. prevent double taxation

How Does BEPS Work?

• Tax is levied on the multinational company by the Government as a percentage of the profit or income of the multinational company. 
• Using the loopholes, the multinational company shifts its income or profit to another country which could be a tax haven.
• As a result, the country which helps the multinational company generate its revenues does not get any tax or there is tax erosion due to the shifting of income or profits by the company. 

How is India Solving the Problem of BEPS?

At International Level:

• India has signed the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (“Multilateral Instrument” or “MLI”) to swiftly implement a series of tax treaty measures to update international tax rules and lessen the opportunity for tax avoidance by multinational enterprises. The MLI entered into force on 1st July 2018.
• The convention will modify India’s treaties to curb revenue loss through treaty abuse and BEPS strategies by ensuring that profits are taxed where substantive economic activities generating the profits are carried out.
• India has also signed the Inter-Government Agreement (IGA) on Foreign Account Tax Compliance Act (FATCA) with the United States.
• India also has become a signatory of the Multilateral Competent Authority Agreement on Automatic Exchange of Financial Account Information in 2015.

At National level

• In Union Budget 2016 an ‘equalization levy’ of 6% on payments exceeding over Rs 1 lakh to online ad services from non-resident entities was introduced. Prominent companies affected would be new economy multinationals with Indian subsidiaries, like Facebook and Google.

• India is the first country to impose such a levy, post the OECD action plans.
• A tax panel has recommended expanding the ambit of this levy to cover a wide gamut of transactions including online marketing, cloud computing, website designing, hosting and maintenance, platforms for the sale of goods and services, and online use of or download of software and applications.
• India has already implemented some of the important recommendations of the BEPS project through amendments in its domestic tax laws such as:
  1. Country-by-Country Reporting (CbCR) – It is part of the Organization of Economic Cooperation and Development’s Base Erosion and Profit Shifting Action Plan 13. As per the Indian Income Tax Act, Section 286(2), the CbCR is required to be submitted by an Indian affiliate of a foreign-parented group or Indian parent company.
  2. Thin capitalization – Thin Capitalisation refers to a condition where a company is financed with a high level of debt compared to the equity (highly leveraged).
  3. Patent Box tax regime – It was introduced in India by enacting new Section 115BBF as per Finance Act, 2016.

Conclusion

BEPS is of major significance for developing countries due to their heavy reliance on corporate income tax, particularly from multinational enterprises.