Meaning and Challenges

Base Erosion and Profit Shifting (BEPS) refers to tax avoidance strategies that exploit gaps and mismatches in tax rules to artificialy shift profits to low or no-tax locations where there is little or no economic activity.

Addressing tax avoidance by multinational enterprises

Multinational Enterprises (MNEs) have historically used various strategies to reduce their overall tax liability. These strategies often involve structuring their operations and transactions in a way that allows them to book profits in jurisdictions with lower tax rates, even if the economic substance of those activities is located elsewhere. This practice can lead to a significant erosion of the tax base in countries where value is actually created.

The challenges posed by BEPS are multifaceted:

• Loss of Tax Revenue: Governments lose substantial amounts of tax revenue, which could otherwise be used for public services and infrastructure development.
• Unfair Competition: Companies that engage in BEPS practices gain an unfair advantage over smaller, local businesses that cannot utilize similar tax planning strategies.
• Distortion of Investment: Tax considerations can unduly influence investment decisions, leading to inefficient allocation of capital.
• Erosion of Tax Integrity: BEPS practices undermine the fairness and legitimacy of the tax system.

Recognizing these challenges, the Organisation for Economic Co-operation and Development (OECD) and the G20 developed a comprehensive Action Plan on Base Erosion and Profit Shifting in 2013. This plan outlines 15 actions designed to provide governments with domestic and international instruments to address tax avoidance.

BEPS Action Plans and India's Response

The OECD/G20 BEPS Project identified 15 Actions to address various aspects of BEPS. India has actively participated in the BEPS project and has been instrumental in shaping its outcomes. India has also implemented several of these actions through its domestic legislation and has entered into agreements like the Multilateral Instrument (MLI) to amend its bilateral tax treaties.

Key BEPS Actions and India's response include:

• Action 1: Digital Economy: This action addresses the tax challenges arising from the digitalization of the economy. India has been at the forefront of discussions and has introduced measures like the Equalisation Levy to tax digital services provided by non-residents.
• Action 2: Hybrid Mismatches: This action aims to neutralize hybrid mismatch arrangements that exploit differences in the tax treatment of an entity or instrument in two or more jurisdictions. India has incorporated rules to counter such mismatches.
• Action 3: Controlled Foreign Company (CFC) Rules: This action recommends rules to prevent MNEs from shifting profits to foreign subsidiaries that are subject to low taxation and are not engaged in substantial economic activities. India has strengthened its CFC rules.
• Action 4: Interest Deductibility: This action focuses on limiting the extent to which taxpayers can claim interest deductions for profits that are shifted out of the taxing jurisdiction. India has introduced thin capitalization rules and other measures to limit interest deductibility.
• Action 5: Harmful Tax Practices: This action aims to counter harmful tax practices, particularly those associated with intellectual property regimes, by ensuring substantial economic activities and substantial activities in low-tax jurisdictions.
• Action 6: Treaty Abuse: This action seeks to prevent the granting of treaty benefits in inappropriate circumstances, such as treaty shopping. India has implemented measures to counter treaty abuse.
• Action 7: Permanent Establishment (PE) Rules: This action addresses the ways in which MNEs artificially avoid the creation of a taxable presence (PE) in a jurisdiction. India has been revising its PE rules through various means, including the MLI.
• Action 8-10: Transfer Pricing: These actions focus on aligning transfer pricing outcomes with value creation, particularly for intangibles, risk, and capital. India's transfer pricing regulations are in line with these principles.
• Action 11: Measuring and Monitoring BEPS: This action focuses on data collection and analysis to assess the economic impact of BEPS.
• Action 12: Mandatory Disclosure Rules: This action requires taxpayers to disclose their aggressive tax planning arrangements.
• Action 13: Transfer Pricing Documentation: This action introduces a three-tiered approach to transfer pricing documentation: Country-by-Country Reporting (CbCR), Master File, and Local File. India has implemented CbCR.
• Action 14: Dispute Resolution: This action aims to improve the effectiveness of mutual agreement procedures (MAP) under tax treaties.
• Action 15: Multilateral Instrument (MLI): This action provides a framework for modifying tax treaties to implement BEPS measures in a more consistent and efficient manner. India has ratified the MLI.

India's commitment to tackling BEPS demonstrates its dedication to ensuring a fair and robust international tax system, protecting its tax base, and promoting a level playing field for businesses.

Taxation of Digital Economy

The rapid growth of the digital economy has presented significant challenges for traditional international tax rules, which were largely designed for a pre-digital era. These rules often rely on the concept of a "permanent establishment" (PE), which typically requires a physical presence in a country for taxability. Many digital businesses can generate substantial revenue in a country without having a physical presence, leading to a situation where they are not adequately taxed in the markets where their users are located.

Equalisation Levy

In response to these challenges, India introduced the Equalisation Levy. This is a withholding tax on specified digital services supplied by non-residents who do not have a significant economic presence in India. The levy aims to tax revenue generated from online advertising, sales of digital advertising space, or any other specified digital service, effectively bridging the gap in the taxation of digital transactions.

Key Features of the Equalisation Levy in India:

• Rate: The Equalisation Levy is charged at 6% of the gross amount of the specified services.
• Applicability: It applies to non-resident companies providing specified digital services to a resident in India, or to a permanent establishment of a non-resident in India, provided the aggregate value of these services exceeds a certain threshold (initially ₹1 lakh in a financial year).
• Services Covered: Initially, it covered online advertising services and any other services for the purpose of online advertising, including provision of digital advertising space or any facility or service for the purpose of placing advertisements. Subsequently, the scope was expanded to include other digital services.
• Collection Mechanism: The levy is collected by the resident payer or the branch in India.
• Deductibility: The Equalisation Levy paid is often allowed as a deductible expense for the non-resident service provider in their home country, subject to tax treaty provisions.

The Equalisation Levy has been a point of discussion internationally, with some countries expressing concerns about its potential impact on cross-border trade and potential for double taxation. However, India views it as a necessary interim measure until a global consensus on digital taxation is reached.

International Efforts for Digital Taxation

The international community has been actively engaged in finding solutions to tax the digital economy. The OECD/G20 BEPS Project identified the taxation of the digital economy as a priority area (Action 1). This led to extensive discussions and proposals aimed at reforming international tax rules.

Key International Developments:

• OECD/G20 BEPS Project (Action 1): The project explored various options, including new forms of digital presence and a digital services tax. It concluded that a comprehensive solution would require changes to both existing international tax rules and potentially new instruments.
• Two-Pillar Solution: In October 2021, the OECD/G20 Inclusive Framework on BEPS reached a landmark agreement on a two-pillar solution to address the tax challenges arising from the digitalisation of the economy.
• Pillar One: This pillar aims to re-allocate taxing rights over a portion of the profits of the largest and most profitable MNEs to the market jurisdictions where they operate and earn revenues, regardless of their physical presence. This is particularly relevant for MNEs that derive significant revenue from users in a jurisdiction.
• Pillar Two: This pillar introduces a global minimum corporate tax rate of 15% for MNEs with global revenues exceeding €750 million. This aims to ensure that large MNEs pay a minimum level of tax on their income, irrespective of where they are headquartered or where their profits are booked.
• Unilateral Digital Services Taxes (DSTs): In the absence of a swift global agreement, several countries, including India with its Equalisation Levy, introduced their own unilateral Digital Services Taxes. These measures have often led to international disputes and calls for a coordinated approach.

India continues to actively participate in the ongoing discussions at the OECD and other international forums to ensure that its interests are protected and that any global solution is fair and effective in taxing the digital economy.

Increasing volume of tax litigation

Tax litigation in India, as in many other countries, has seen a significant increase in both volume and complexity. This surge can be attributed to several factors:

• Evolving Tax Laws: Frequent amendments and new provisions introduced in tax legislation, often in response to economic changes or to address tax avoidance, can lead to interpretational ambiguities and disputes.
• Aggressive Tax Administration: Tax authorities may adopt more assertive stances in assessing taxes, leading to a higher number of cases being contested by taxpayers.
• Complex Transactions: The increasing complexity of business transactions, particularly with globalization and the rise of the digital economy, makes tax assessment and compliance more challenging, resulting in disputes over transfer pricing, characterization of income, and deductibility of expenses.
• Judicial Pronouncements: While court decisions clarify tax law, they can also create new areas of contention if their application is not universally understood or if they overturn previous established practices.
• Taxpayer Behavior: Some taxpayers may resort to litigation to challenge assessments they deem unfair or to delay payment of taxes, even when the chances of success are slim.

The growing volume of tax litigation places a considerable burden on the judicial system, leading to delays in the resolution of disputes and impacting business predictability. It also consumes significant resources for both the government and the taxpayers.

Settlement of Tax Disputes

Recognizing the strain that tax litigation puts on the system and the need for a more efficient resolution mechanism, the Indian government has periodically introduced schemes for the settlement of tax disputes. These schemes aim to provide a one-time opportunity for taxpayers to resolve long-standing disputes, clear the backlog of cases, and foster a more cooperative relationship between taxpayers and tax administration.

Vivad se Vishwas Scheme

The 'Vivad se Vishwas' Scheme (Direct Tax Vivad se Vishwas Act, 2020) was a significant initiative launched by the Indian government to reduce tax litigation. The scheme provided a direct path for taxpayers to settle their pending direct tax disputes.

Key Features of the Vivad se Vishwas Scheme:

• Objective: To reduce the number of pending tax disputes and provide an opportunity for taxpayers to settle their cases without further litigation.
• Eligibility: The scheme was applicable to appeals pending before various appellate authorities (CIT(A), ITAT, High Courts, Supreme Court) or those where assessments, re-assessments, or revisions were made by the tax authorities.
• Settlement Amount: The amount payable by the declarant was based on the tax arrears, and the penalty or interest related to those arrears. For most cases, it was a percentage of the disputed tax amount, with a reduced percentage for cases pending before higher forums.
• Benefits to Taxpayers:
  • Waiver of Interest and Penalty: Full waiver of interest and penalty in respect of the tax arrears being settled.
  • Finality of Dispute: Once the declaration was accepted and the payment was made, the dispute was considered settled, and no further proceedings could be initiated for that tax period concerning the settled dispute.
  • No Adverse Precedent: The scheme ensured that the settlement did not create any adverse precedent for future tax assessments.
• Mechanism: Taxpayers had to file a declaration in a prescribed format, stating the details of the disputed tax and the amount they proposed to pay for settlement. Upon acceptance of the declaration, the taxpayer was required to pay the determined amount within a specified period.

The Vivad se Vishwas scheme was a welcome move by the government, offering substantial relief to taxpayers and significantly reducing the number of pending tax disputes.

Role of Tax Tribunals

Tax tribunals play a crucial role in the Indian tax dispute resolution ecosystem. They function as quasi-judicial bodies that hear appeals against orders passed by lower tax authorities, such as the Commissioner of Income Tax (Appeals) and the Income Tax Officer. The primary tax tribunal for direct taxes in India is the Income Tax Appellate Tribunal (ITAT).

Key Functions and Importance of Tax Tribunals:

• Specialized Expertise: Tax tribunals comprise members who are well-versed in tax laws, accounting principles, and financial matters. This specialized knowledge allows for a deeper and more accurate understanding of complex tax issues compared to general courts.
• Speedy Resolution: Tribunals are intended to provide a faster resolution of tax disputes compared to civil courts. While the volume of cases can lead to delays, they generally offer a more streamlined process.
• Reducing Burden on Courts: By handling a significant volume of tax appeals, tribunals help to decongest the regular court system, allowing civil courts to focus on other types of litigation.
• Fact-Finding and Law Interpretation: Tribunals often act as the final fact-finding authorities in tax matters. They interpret tax laws and apply them to the specific facts of each case.
• Appeals to Higher Forums: Orders passed by the ITAT can be appealed to the High Courts on questions of law, and subsequently to the Supreme Court.

The effectiveness of tax tribunals is vital for ensuring fairness, predictability, and efficiency in the tax system. Streamlining their processes and ensuring adequate resources are essential for managing the ever-increasing volume of tax litigation.