International taxation

Is global reaction to the OECD's base erosion and profit shifting actions drifting?

October 2016 witnessed the release of 15 actions recommended by the Organisation for Economic Co-operation and Development (OECD) to contain tax base erosion through global profit shifting (BEPS). During 2017, these actions were discussed in international policy and academic circles and I, too, participated in conferences at Maastricht University in Amsterdam, Taxand in Frankfurt, Foundation for International Taxation (FIT) in Mumbai, and others. There was an approach of bracing the Actions with a certain adulation. Of course, there were some questions raised on what remained to be improved, for example, Action 1 on the taxation of the digital economy.

In 2018, the mood appears to have changed in the environment of international taxation. My participation in recent conferences of the International Fiscal Association (IFA) in Taipei, the International Bureau of Fiscal Documentation (IBFD) in Mombasa, and Institute of Advanced Legal Studies (IALS) in London, which was organised by Brazilians with overwhelming participation from South America, gave me a global view of the most recent and evolving thinking.

The discussion usually takes place in the context of Action 15 —  termed the Multilateral Instrument (MLI), which is a composite of Actions 1-14. Parties to the MLI are required to submit an MLI position document containing “Covered Tax Agreements” (CTAs)—or their double taxation avoidance agreements—together with a list of elements in the MLI that are not suitable to the country.

One fault line that has emerged reflects the fact that few countries have ratified the MLI fully and, even with ratifying the MLI, any country can put up “reservations” against most of its elements provided it agrees to a prior ”minimum standard”. Conference discussions veered on the lack of uniformity in the elements different countries have signed on to, the most visible non-signatory being the United States. Thus, discussions have pointed to the lack of certainty of purpose when the economically most advanced economy has refused to sign on.

The scepticism has been exacerbated with unilateral decisions by the US to impose high customs duties on the G7, its strategic political partner and the European Union, largest trade partner. Thus, the model of multilateralism in trade and tax that was close to being achieved in the coat-tails of globalisation has cracked. When one extends this analogy to BRICS, G20 and non-G20 countries, the MLI, resultant of the BEPS project, appears to be farther away, and the OECD’s success, achieved through successful persuasion and pressure, has receded.

I will take up selected Actions, namely, taxation of digital economy (Action 1), treaty abuse (Action 6), hybrid mismatch (Action 2), dispute resolution (Action 14), permanent establishment (Action 7) and country by country reporting (Action 13)  to show how a country could vary in its views across Actions. The OECD has provided little guidance in the MLI on Action 1 on the digital economy reflecting US reticence. As a result, countries such as India, UK and others have unilaterally imposed taxes and charges on the digital economy that possess little uniformity or comparability. Yet, one of the major, if not the most, tax avoiding sectors globally is the digital sector, taxing which has become a forbidding challenge for country authorities.  

A minimum standard under the MLI as mentioned above, attempts to obviate treaty abuse (Action 6), a significant BEPS concern. Essentially, unless a country already has a provision against treaty abuse in a CTA with another country, it has to incorporate a statement on the matter as stipulated in Action 6. India is silent, which implies that it has no reservation against it. On the other hand, India has reserved the rights in its entirety on “hybrid mismatch” (Action 2), which attempts to prevent a taxpayer from taking advantage of loopholes in any CTA to minimise its global tax burden by creating hybrid inter-country business structures.

The MLI stipulates that, if the income derived from a business arrangement among partners is considered fiscally transparent by either party (country) to a CTA, then it shall be considered income in the country where the business is resident, but only to the extent that the party treats such income as the income of a resident. India possibly was suspicious of this limitation, hence reserved its right against it. It is not India alone, the all-round selective approach to the MLI is found in many, if not most, signatory parties. This selective approach by country authorities is coming under the critical eye of technical and policy analysts in 2018. Thus, was the OECD correct in its judgement in accommodating widely variable positions in crucial elements of the MLI?

Dispute resolution (Action 14) is an aspect designed to ensure certainty and predictability for business. It identifies a mutual agreement procedure (MAP) as an essential complement to containing BEPS in the form of removal of uncertainty for business, and makes it another minimum standard. Initiated by a multinational corporation (MNC), a MAP is a prior agreement between country authorities delineating the division of tax revenue from future revenue streams of an MNC operating in both countries.

Thus, as per the MLI, a business aggrieved by taxation in any of the two countries could approach the competent tax authority of either country. If such objection appears justified and the affected country is unable to provide a satisfactory solution, then the two competent authorities must aim, through mutual agreement, to resolve the case. Agreements reached are to be implemented notwithstanding any time limit in domestic law.

Here too India has reserved its right, thereby disallowing aggrieved businesses to approach the competent authority of the other country on the basis (as permitted by the MLI) that it intends to meet the minimum standard by allowing its aggrieved resident business, to approach its own competent authority but not that of the other country. India’s position apparently reflects high costs of dealing with aggrieved businesses in a foreign jurisdiction. It is a fact that the Indian tax administration is poorly financed by global standards; but the solution should be to allocate adequate funds rather than to adopt a policy stance detrimental to business and growth.

Areas where I perceived great discomfort among businesses were the criteria for the definition of permanent establishments and their taxation (Action 7), as well as the demanding reporting requirements (Action 13) being imposed on them even though, in their view, the vast majority of MNCs were paying tax with minimal tax avoidance. They viewed the MLI provisions to be biased in favour of country tax authorities despite marked MNC contribution to global economic activity and growth.