Ever since 2013, the Organisation for Economic Co-operation and Development (OECD) has been proactively trying to address issues surrounding tax base erosion and profit shifting by multinational organisations. This started with the publication of its report titled ‘Action Plan on Base Erosion and Profit Shifting’ in July 2013.
The report had 15 action plans to address each of the elements of base erosion.
The introduction of pillar one and pillar two concepts by the OECD in 2021 is being seen as a watershed event in the OECD’s efforts towards better allocation of taxing rights and preventing base erosion.
In this regard, India has taken a proactive approach in implementing and suggesting policy and legislative changes within its domestic tax regime, while also setting examples for other countries to follow.
This article highlights the measures taken by the Indian government to align with these principles and set the benchmarks to prevent the erosion of the tax base.
Taxation of the digital economy
In 2015, an OECD task force unveiled the Action Plan 1 Report on the tax challenges of the digital economy. The report proposed three alternatives to address the issues around the digital economy:
An equalisation levy (EL);
A new nexus based on the concept of significant economic presence (SEP); and
Withholding tax on the digital economy.
India introduced an EL in 2016 and widened it in 2020 to tax highly digitalised businesses such as Google, Facebook, and LinkedIn, which earn revenue from India without having any physical presence. The salient features of the EL are:
An online advertisement EL – an EL at the rate of 6% is applicable on specified services (such as online advertisement) received by a resident from a non-resident (not having a presence in India). The amount of income subjected to the EL is exempt from the levy of income tax. The resident is liable to deduct the EL; failing which, the expenses incurred would be disallowed.
An e-commerce EL – a charge of 2% is applicable on the consideration received by non-resident e-commerce operators from the online sale of goods, the provision of services, and facilitation. The obligation to pay the EL is on the non-resident.
Both the above measures clarify the intent of the Indian government to put pressure on other governments to act on the OECD recommendations.
Furthermore, the Indian government is viewing the EL as a temporary measure and the same is exemplified by the agreement between India and the USA to have a transitional approach to withdrawing the EL. According to the agreement signed, the EL would be withdrawn from the date of implementation of pillar one or March 31 2024, whichever is earlier. Other countries such as Austria, France, Italy, Spain, and the UK have also entered into similar agreements.
In anticipation of the above change, India has introduced SEP provisions in its statute book from FY 2018–19 (however, it was made effective from FY 2021–22). A non-resident would have business connection by virtue of a SEP in India where it:
Undertakes transactions in goods, services, or property with persons in India exceeding INR 20 million ($251,000) in a financial year; or
Undertakes systematic and continuous soliciting of business activities or engages in interaction with 300,000 or more users in India.
India is closely watching, and actively participating in, developments on pillar one and will curtail any abuse or misuse of treaty protection that may be available against SEP provisions.
As things stand, SEP provisions apply where an EL does not apply.
GAAR and the principal purpose test and simplified limitation of benefit clause
Throughout the years, there have been varying opinions on the legality of tax planning. India’s judiciary has had the chance to review this issue multiple times in the following cases:
McDowell & Co. v. CTO  154 ITR 148;
Vodafone International Holdings v. Union of India (2012) 341 ITR 1;
Union of India v. Azadi Bachao Andolan  132 Taxman 373; and
Tiger Global International II Holdings  116 taxmann.com 878.
The takeaways from these judgments have been that:
Tax planning is permissible; however, colourable devices (methods that unfairly reduce tax liability) cannot be used;
The entire transaction should be examined holistically; and
Treaty benefits cannot be denied in the absence of the specific mention of anti-abuse rules.
In order to tighten the tax grip on tax avoidance structures, the Indian government introduced general anti-avoidance rules (GAAR) effective from FY 2017–18. These rules emphasise substance over form and, accordingly, arrangements that have their as main purpose obtaining tax benefits and that lack commercial substance or do not satisfy the arm’s-length principle, or are not bona fide, are considered as impermissible avoidance arrangements.
When an arrangement is declared impermissible, the tax benefits claimed can be denied by applying the GAAR. The GAAR apply only where the amount of tax benefit exceeds INR 30 million.
With regard to Action 6 and the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent BEPS (the Multilateral Instrument, or MLI), the OECD has also brought in measures to counter tax avoidance arrangements by making amendments to tax treaties, primarily around the principal purpose test (PPT) and the limitation on benefits (LOB) clause.
Given that the PPT is a minimum standard, India’s treaties with jurisdictions that have signed the MLI stand automatically amended (except with jurisdictions where the treaty already contains a similar clause).
Furthermore, India has opted for the simplified LOB clause as per Article 7 of the MLI. However, the simplified LOB clause is not a minimum standard and the countries may bilaterally opt not to apply the above provisions.
All the above changes reflect the sense of urgency of the Indian government to bring up to speed its income tax laws and maximise revenue for India.
As a country that depends on tax revenue for meeting its diverse growth and security demands, it is obvious that India would take a lead in implementing these changes and proposals. India’s position on various developments in international taxation is being closely observed and appreciated by the world.
There is hope that a balance will be struck between maximising revenue and ease of doing business and economic activity.
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