BEPS and the Indian outbound investor: are we ready for CFC Rules?

5 October 2015 was a red-letter day for the global tax community. The OECD released final reports on all 15 Action Plans of the Base Erosion and Profit Shifting (BEPS) project, which was undertaken at the behest of the G20.

There was tremendous anticipation of these reports due to the amount of global attention and participation the BEPS project has received over the last two years. Now that the reports are out, governments stand at a critical juncture, as they consider an overhaul of their tax legislations.

India, too, is at a stage, where formulation of a clear direction for tax policy is essential with respect to taxation of cross-border transactions. Moreover, given the growing quantum of overseas investment from India, the outbound investor must figure prominently in Government of India’s plans.

One of the facets of BEPS, which may directly affect Indian headquartered groups, more than any other, is “Designing Effective Controlled Foreign Company Rules” (Action 3 of the BEPS project).

CFCs and the OECD stance
CFC rules are generally enforced to discourage tax deferral and tax avoidance by residents in the home country, through methods such as setting up entities in low tax jurisdictions that earn passive incomes such as dividend. In most cases, income that is not earned through active business by an overseas CFC is attributed to the parent company in the home country and taxed therein.

Therefore, though tax on CFC income is extra-territorial in a sense, it is currently employed by more than 30 countries. Nevertheless, it may be borne in mind that each country is likely to have distinct economic and policy considerations while determining whether to enforce CFC rules or not.

In essence, this is the stand of the OECD as well. The OECD report on designing effective CFC Rules sets out clearly that the recommendations are not “minimum standards” (i.e., partner countries are not under an obligation to adopt these measures). However, their approach is to suggest building blocks for an effective CFC legislation along with alternate approaches that may be followed for each such block. The six building blocks given in the report are:

  • Definition of CFC
  • CFC exemptions and threshold requirements
  • Definition of CFC income
  • Computation of CFC income
  • Attribution of CFC income
  • Prevention and elimination of double taxation

The systematic break-down of an effective CFC regime by OECD notwithstanding, the vital question is whether India is in a position and place to introduce such legislation.

Indian perspective
India does not have full capital account convertibility currently. Regulations under the Foreign Exchange Management Act, 1999 (FEMA) impose various restrictions on overseas investment from India. Therefore, certain aggressive structuring strategies are not permissible under FEMA itself.

As an economy, we are at a stage where there is great vigor and enthusiasm to go global. It is imperative that home-grown businesses, established houses and start-ups alike, are given the impetus to compete effectively in overseas markets.

While from the Government’s perspective, erosion of tax base is a legitimate concern, improving international competitiveness of the Indian economy is equally important. No tax measure should have the effect of stifling genuine business activity.

We have, in the past, been witness to the impact that investor sentiment can have on our economy. The trust of the Indian entrepreneur is important for the tax administration, and to have another GAAR-like situation at hand would be rather undesirable.

Therefore, it may be worthwhile to make a thorough policy assessment along with stakeholder participation prior to deciding the fate of introduction of CFC provisions in India. This is a key aspect, especially when we consider the presence of exchange controls as well as robust transfer pricing rules in India.

As we mentioned earlier, the OECD recommendations on CFC are not a minimum standard; therefore there is hardly any political pressure in that respect. Being aligned and consistent with global practices is indeed an ideal situation, but such steps should not be parallel to a country’s own policy goals.

Concluding thoughts
Most will recall that CFC regulations were first introduced in the Direct Taxes Code Bill, 2010 (DTC). Therefore, the concept of CFCs is not alien to legislators. However, the technical nitty-gritty and merits of what was proposed in the DTC will warrant another discussion altogether.

We must not conclude at this point in time, without a rounded view, as to whether CFC regulations may be justifiably enforced in India or not. With that being said, the concerns and apprehensions of businesses eyeing the global pie are real too.

India is a key member of the G20 and there is no doubt that each action plan of the BEPS project will come up for discussion within the Government. However, with specific regard to CFCs, answering the fundamental question of its place in context of the Indian economy, without any haste or global political influence, will be crucial.

Contributor: Raju Kumar, Tax Partner, EY India
The article includes contribution from Amish Behl, Sr. Tax Professional, EY India.

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