CII - Tax Conference 2021 (Western Region) | Day 2

This webinar covers recent developments in cross-border taxation, digital taxation, and international tax and how these changes will impact business activities across the globe.

Recent developments in Digital Taxation and OIDAR

Basic Erosion Profit Sharing (BEPS) is an initiative by the G20 countries and OCED to combat tax evasion efforts by defaulters due to rising competition and depletion in tax gains.

Using the loopholes in international tax rules, MNCs can shift profits to a jurisdiction where they pay low or no tax. This happens mainly via methods explained:

• Hybrid mismatch: using instruments that are treated as shares in some countries, while in source country it would be debt, leading to tax savings. One can also use methods like hybrid entity for treaty benefits, where the profits are not taxed in the source country.
• Special purpose entity/vehicle: involves setting up an entity in another jurisdiction to save on tax, without any real business interest.
• Transfer pricing: major economic activity lies in the source country, but the entity is set up as a cost-plus entity with no visibility of activities of the parent or holding company.

Laying our Plan of Action

If we look at BEPS project holistically, it is quite effective to prevent treaty shopping, introduced principal purpose test, limitation of benefits - these itself has a huge impact on International Tax avoidance. Coupled with domestic law changes, BEPS can curb profit shifting. - Nilesh Patel, Former ‘IRS India’ Officer, Global Tax Expert

Fifteen action plans were laid down, out of which the session focused on Action 1: Address the tax challenges of the digital economy.

With the submission of plans in 2013, today in 2021, a two-pillar solution is framed that would be implemented by 2023 as follows:

• France and Spain introduced a 3% tax on social networks, search engines, eCommerce, etc. by 2020
• UK and Italy introduced 2% and 3% taxes respectively for digital platforms in 2020 with worldwide revenues exceeding GBP 500 Mn and EUR 750 Mn
• Austria and Turkey introduced 5% and 7.5% tax rates respectively for digital platforms with worldwide revenues exceeding EUR 750 Mn

India started with an Equalization levy in 2016 at 6% for online advertisement, which was later expanded across various transactions. This was a separate levy and not a part of a direct or indirect taxation regime. These taxes do not apply to SMEs with transactions less than INR 20 Mn.

Reallocation of Taxing Rights for Digital Businesses

OECD Pillar-1:

Pillar 1 deals with fair distribution of profits among Home v/s Market country under which

• The residual profits are to be provided to market jurisdiction (Amount A)
• For entities doing sales and marketing activity, a standardized remuneration of residual profits is to be provided to other countries (Amount B)

The scope of Amount ‘A’ is based on the business activity one is performing in that particular jurisdiction.

OECD Pillar-2:

Pillar 2 aims to keep track of competition for corporate income tax via a global minimum corporate tax rate that countries can implement to protect one’s tax base.

Recent Developments in Free Trade Agreements

During the second world war, certain countries formed groups and traded within themselves, which resulted in the war. Hence, a need for threshold or level playing field was required to ensure history did not repeat itself, which led to the following developments:

• With India being a founding contracting party to General Agreement on Tariffs and Trade (GATT), replaced by World Trade Center (WTO), is committed to Most Favoured Nation (MFN) concept under which a country has to grant the same privileges in a trade agreement to member nations.
• An exclusion is permitted for forming Free Trade Areas under specific conditions between countries to drop customs tariffs and non-tariff barriers on valuable trade between them.

Types of Trade Agreements:

Based on recognition, access, and trade type, we have the following types of trade agreements:

• Preferential Trade Agreement (PTA): restrictive agreements where reduction of tariffs based on the mutually agreed number of tariff lines is made for specific trades only
• Free Trade Agreement (FTA): except for a few particular items, all other trades have tax exemptions available
• Comprehensive Economic Cooperation Agreement (CECA), Comprehensive Economic Partnership Agreement (CEPA), Comprehensive Economic Cooperation and Partnership Agreement (CECPA): for increased cordial relationships, ambitious partnerships, and developmental support respectively between countries across services, investments, disputes, etc. Ex - India-Mauritius (CECPA)
• Others: This includes the formation of a customs union, custom markets for the labor movement, or economic unions like the European Union.

Trade Agreement is implemented as per the following three steps:

• Ministry of Commerce (Department of Commerce) negotiates the relevant terms of the agreement and finalizes
• CBIC, who are involved in the operations and implementation of these mandates on the ground, negotiates trade across tariff concessions, rules of origin, custom facilitation, etc.
• Official release by Central Government regarding the decided tariff concessions and rules of origin

Understanding Originating Criteria:

An originating criterion was set up to ensure non-compliant nations do not misuse the Trade Agreement by dumping their good with the partnered country to avail benefits. It is divided into two categories:

• Wholly obtained goods: these goods are obtained without any non-originating materials as inputs, for example - natural goods
• Not wholly obtained goods: these goods undergo considerable processing in the country. They are required to meet criteria like mandatory 30%-50% Domestic Value Addition and Change in Tariff heading to be eligible

A Certificate of Origin (COO) is issued by the designated Government authority of exporting nation that needs to be submitted before the customs take forward the trade.

Under CAROTAR 2020, the customs can ask importers for additional information apart from COO like declarations about the origin of goods, allowing due diligence, periodical reviews, etc. to avoid any hindrance to avail exemption benefits.

Transfer Pricing Year-End Compliance - Intricacies and Safeguards

The current transfer pricing is getting impacted due to COVID-19, BEPS, increased scrutiny for cross-border taxations, and changing global Transfer Pricing landscape. Mr. Abhay Saboo discussed the issues cropping up due to the impact:

Free of Cost Goods and Services:

Free of Cost Goods and Services is business or commercial activities that do not amount to supply; such as, ESOPs, software, use of trademark, management services, interest-free loans, etc. Since the implementation of GST, it has become necessary to identify Free of Cost Goods/Services.

In certain cases, these goods and services are not charged, maybe due to shareholder benefits, for which one has to provide a commercial explanation.

In the case of Free of Cost Services, one has to issue a self-declaration on the invoice for GST payment based on the reverse charge mechanism to get the input tax credit.

Interest on Overdue Receivables:

Supply chain disruptions due to COVID has led to delays in receivables across industries, this section discusses if interest is required to be charged on Overdue Receivables:

• One can use the TNMM method or industrial benchmark to determine interest costs
• Working capital adjustment is an apt method to be applied in the case of cost plus scenarios since it will take into account the receivable period
• Negative working capital adjustment is not needed in a cost-plus case due to no risk involved. It is compensated on a total cost-plus basis.
• In the case of a debt-free company, if it is not paying any interest to any banks, international transactions, or anyone, notional interest is not applied
• In case of a mix of overdue and on-time receivables, one should consider the holistic picture
• Reporting in Form No. 3CEB is mandatory

Potential issues with distributors and how it can be tackled:

• For normal risk distributors, one uses the resale price method benchmarking the gross level of the tested party, while for limited risk distributors, TNMM works.
• The distribution entity is considered the ‘Tested Party’, but if the overseas manufacturing entity is a low-risk manufacturer, ideally, it should be taken as a ‘Tested Party.’
• Customs TP harmonization - the person responsible for TP and customs are different within Corporate, leading to following two different approaches when dealing with an issue, especially due to increased collaboration between income tax and customs. One can use deductive value to determine import price in a manner that satisfies customs and TP requirements.
• Documentation is important in case of initial losses and projections of potential breakeven where re-validation of TP should be done accordingly.
• To ensure that the distributor meets arms-length profit, credit notes for import price adjustment could be issued.
• Pay attention to budgeting in terms of import pricing.

True Up and True Down Adjustments:

This approach is used to balance out when the year-end results are not aligned with the pre-determined budgeted margins. For such cases, the difference between budgeted and actual costs is adjusted by True Up and True Down adjustment approach. This could include offering credit notes, subventions to meet arms-length pricing.

In the end, for the absolute success of the amendments being made for International taxation and curbing loophole abuses, everyone within an organization should collaborate, analyze and document as one navigates these developments.