India, 67 nations sign agreement to check loopholes in tax laws as companies evade taxes by artificially shifting business place

In a bid to bring tax evaders in government’s net, India and 67 countries have put in place an agreement to plug loopholes in existing laws that allowed companies to evade taxes by artificially shifting their place of business.

Finance Minister Arun Jaitley signed the multilateral convention, an outcome of the OECD/G20 Project to tackle base erosion and profit shifting. BEPS is resorted to by MNCs through tax planning strategies by exploiting gaps and mismatches in tax rules.

“The convention will modify India’s treaties in order to curb revenue loss through treaty abuse and base erosion and profit shifting strategies by ensuring profits are taxed where substantive economic activities generating the profits are carried out and where value is created,” a finance ministry statement had said.

Experts said MNCs doing businesses in India going forward will find it difficult to evade taxes by artificially shifting their place of business.

Artificial avoidance of permanent establishment (PE) by MNCs is the key concern of each signatory country since this is the main source of base erosion. MNCs often resort to artificial shifting of profits to low or no-tax locations, resulting in little or no overall corporate tax being paid.

In future, corporates will have to ensure the treaty provisions are not read on a stand-alone basis, but with the corresponding provisions of the convention.

“Governments worldwide have been patient with cross-border aggressive tax planning till now, but by signing this unique multi-lateral instrument (MLI), corporates have been given the final call that their game of funnelling income to low tax or no tax jurisdiction is up,” said Rakesh Nangia, Managing Partner, Nangia and Co.

According to EY International Tax Services Partner Rajendra Nayak, 1,100 tax treaties would be modified worldwide as a result of 68 jurisdictions signing the MLI.

In the convention, India has chosen a more stringent option to limit the specific activity exemptions from definition of PE, which is defined as a fixed place of business that gives rise to income.

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This would mean that corporates conducting certain level of business activities through India will constitute PE in India. Earlier, these businesses could claim exemption from the definition of a PE.

“India along with most of the countries of the world are now jointly fighting to crack down on tax evasion around the world. Though the implementation by each country would be subject of its reservations, but the message is clear that the treaty abuse shall not be acceptable and dispute resolution would become faster in the near future,” Nangia said.

Foreign companies usually claim tax concession under bilateral tax treaties and pay taxes in their home countries.  However, if it is established that a company has a PE in India, it has to pay taxes in India for the income generated in the country.

India has recently amended treaties with countries such as Singapore, Cyprus and Mauritius, providing for levy of taxes in the country where income is generated rather than the country of residence of the company.

Karishma R Phatarphekar, BMR and Associates Partner, said signing of the MLI is a continuation of the efforts of the government to plug treaty abuse and deal with artificial avoidance of permanent establishment.

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“The provisions of the MLI would apply to tax treaties between two countries only if both parties agree to it. The Indian businesses should continue to be extra-cautious of any kind of transactions that could be construed to be primarily entered for tax avoidance reasons,” Phatarphekar said.

Kunj Viadya, Price Waterhouse Leader Transfer Pricing, said it would make available dispute resolution mechanism for transfer pricing disputes. “This signing should allow for resolution through bilateral advance pricing agreement (BAPA) and mutual agreement procedures (MAPs) with a number of countries, which was not possible earlier.”