Union Budget 2016-17: decoding the Government’s stand on cross-border taxes

The NDA Government’s second Union Budget is coming at rather interesting crossroads, from the point of view of international taxation. On one hand, there is persistent reinstatement of efforts toward having a non-adversarial tax regime; while on the other, legislative enforcement of the OECD Base Erosion and Profit Shifting (BEPS) recommendations, which have changed the cross-border tax landscape so significantly, is set to commence.

At the very outset, this is not to say that the implementation of BEPS recommendations will be adversarial per se. The relevance of BEPS to countries and governments is real and definitely needs to be addressed. However, being the first Union Budget after release of the final BEPS reports by the OECD, the manner in which the Government chooses to bring about legislative amendment in this area and the tone it sets for its implementation will be crucial.

Implementation of BEPS actions

Of the 15 BEPS action plans, the one that is most likely to make it into Income-tax Act first is Country by Country Reporting (CbCR), i.e., Action 13. There is a strong signal from the Government that CbCR will be introduced in India through this year’s Budget. This reporting requirement is going to affect India-outbound MNE groups the most, as they will be required to provide a breakdown of financial and economic information for each country in which they operate, and will be in addition to the master file and local file to be furnished as part of transfer pricing documentation.

This three-tiered approach of Action 13 (i.e., master file, local file and country-by-country report) will necessitate revisiting group structures and reviewing key related party transactions, in addition to collecting, collating and reporting a large volume of data on an annual basis. Since CbCR is to be used as a risk assessment tool by tax authorities, ensuring correctness and consistency will be of paramount importance.

Base erosion through excessive interest deductions (Action 4) is a common approach that participant countries of the BEPS project may need to implement in local laws, by capping interest deductions based on percentage of EBITDA. Although the Government may choose to toe a cautious line in this regard in the immediate term, due to potential fallouts, its introduction may be imminent, sooner or later.

Two other key priority actions, namely prevention of treaty abuse (Action 6) and avoidance of permanent establishment (PE) status (Action 7) may remain outside the legislative boundaries of the Finance Act. On this front, we would need to wait for treaty amendments that may be brought about through use of a multilateral instrument, which is currently being developed by a group of approximately 90 countries, including non-OECD and G20 members.

Guidance on existing provisions

Implementation of General Anti-Avoidance Rules (GAAR) was deferred by two years in the last Budget, with an intent to review certain aspects and implement it comprehensively with anti-BEPS measures. Now, with the plethora of OECD recommendations and potential introduction of various specific measures, the design of GAAR may need a re-think. And if they are to be introduced starting next year, it is hoped that guidance on their implementation and interplay with other specific anti-avoidance rules will be clearly provided well in advance of the cut-off date of 1 April 2017.

Recently, the release of draft guidelines to determine the Place of Effective Management (PoEM) at the end of December stirred a few emotions in the industry. The foremost was calling out the delay in issuance of the guidelines for a law that had taken effect in April. And the second was the introduction of the “active business” criterion in aiding PoEM determination, in what may be regarded as a not-so-oblique reference to Controlled Foreign Corporation (CFC) rules, which were also one of the BEPS actions. Although these were draft guidelines, with comments asked from all stakeholders, it is entirely possible that the Government may be looking at PoEM to perform dual-duty, without expressly introducing CFC rules. Given both these factors, the industry wishes that implementation of PoEM provisions is also deferred by one year, so that businesses can adequately prepare themselves to be compliant and not be adversely affected.

Apart from its obvious consequences to outbound investors, these PoEM regulations, or introduction of CFC rules themselves, may also importantly impact the sentiment of large MNE groups that are increasingly viewing India as a regional hub for their operations.

Another area where clarity is expected is foreign tax credit (FTC). In the previous Budget, an enabling provision was introduced to notify rules in respect of granting FTC. However, no rules have been made in this regard. Certainty on these aspects, in order to avoid double taxation of income, is critical for taxpayers.

Concluding words

Lately a few themes have become evident from the Government’s side in the context of tax legislation and administration, which is indeed commendable. These are stakeholder engagement, an attempt at simplification of laws, readiness to issue clarifications, and facilitating innovation and ease of doing business.
It is hoped that these themes will apply equally when the international tax proposals are put forth in the upcoming Budget. India currently holds an important position in the global economy and history will tell us that fiscal measures have the ability to play make-or-break!

Article includes contribution from Amish Behl, Senior Tax Professional from EY.

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