The Finance Minster in the Budget for the year 2016-17 has initiated a process to incorporate, atleast partially, the recommendations /suggestions of Base Erosion and Profit Shifting (BEPS) Action Plans 1,5 &13. In July 2013, the Organisation for Economic Co-operation and Development (OECD) published its “Action Plan on BEPS”. This publication addressed the concerns of various stake holders against the growing tax planning by multinational enterprises (MNEs) that makes use of gaps in the interaction of different tax systems to artificially reduce taxable income or shift profits to low-tax jurisdictions in which little or no economic activity is performed. In its final report of October 2015, BEPS has identified 15 Action Plans addressed them in a comprehensive manner, and set deadlines to implement those actions.
India having been a keen participant in the recommendations/suggestions of the BEPS- Action Plans has acted promptly to implement some of the recommended measures. A new Chapter VIII is introduced in the Finance Bill, 2016 proposing an Equalisation Levy on transactions in digital economy. This is following the suggestions of the OECD in BEPS project under Action Plan 1. Secondly, a new Section 115BBF is introduced to address taxation of patent developed and registered in India following BEPS Action Plan 5. Thirdly, a new Section 286 is proposed to be inserted for adoption of standardised approach to transfer pricing documentation following the suggestions of BEPS Action Plan 13.
BEPS Action Plan–5 – Countering Harmful Tax Practices more Effectively, taking into account Transparency and Substance
In order to encourage indigenous research and development (R&D) activities and to make India a global R& D hub, the Finance Bill has proposed a concessional tax regime on any income by way of royalty in respect of a patent developed and registered in India. The aim of the concessional taxation regime is to provide an additional incentive for companies to preserve and promote existing patents and to develop new innovative patented products. This regime will motivate companies to establish high income jobs in relation to development, manufacture and exploitation of patents in India.
The concessional regime would align the taxation of patents with the recommendation of the OECD. BEPS Action Plan 5 suggests the nexus approach and prescribes that income arising from exploitation of Intellectual property (IP) should be attributed and taxed in the jurisdiction where substantial research & development (R&D) activities are undertaken rather than in the jurisdiction of legal ownership only.
The above stated reasons for the introduction of “Taxation of Income from Patents” are emanating from the memorandum explaining the provisions to Finance Bill 2016, the relevant extract of which is as reproduced below-
“In order to encourage indigenous research & development activities and to make India a global R&D hub, the Government has decided to put in place a concessional taxation regime for income from patents. The aim of the concessional taxation regime is to provide an additional incentive for companies to retain and commercialise existing patents and to develop new innovative patented products. This will encourage companies to locate the high-value jobs associated with the development, manufacture and exploitation of patents in India. The Organization for Economic Cooperation and Development (OECD) has recommended, in Base Erosion and Profit Shifting (BEPS) project under Action Plan 5, the nexus approach which prescribes that income arising from exploitation of Intellectual property (IP) should be attributed and taxed in the jurisdiction where substantial research & development (R&D) activities are undertaken rather than the jurisdiction of legal ownership only.”
To achieve the above, a new Section 115BBF is proposed to be inserted to provide that any income by way of royalty received in respect of a patent developed and registered in India shall be taxable at a concessional rate of ten per cent (plus applicable surcharge and cess).No expenditure or allowance in respect of such royalty income shall be allowed. The income would thus be taxable on a gross basis.
To be entitled to this concessional regime the taxpayer engaged in development of IP should be a resident in India and also a true and first inventor of the invention, whose name is entered on the patent register as the patentee in accordance with Patents Act, 1970. The amendment is to be applicable from 1st April, 2017 and shall apply for Assessment Year 2017-18 and onwards.
The concerns expressed in BEPS was regarding preferential regimes being used for artificial profit shifting and about a lack of transparency connected to certain rulings. To address these concerns the Forum on Harmful Tax Practices (FHTP) was committed to frame a methodology to define the substantial activity requirement to assess preferential regimes, looking first at intellectual property (IP) regimes and then other preferential regimes. The work of the FHTP was also to focus on improving transparency through the compulsory and spontaneous exchange of certain rulings that could give rise to BEPS concerns in the absence of such exchanges.
As per the recommendations of the BEPS- Action Plan 5, the substantial activity requirement to assess preferential regimes should be strengthened in order to realign taxation of profits with the substantial activities that generate them. The various approaches considered were :-
a) Value creation approach;
b) Transfer pricing approach;
c) Nexus approach.
The Indian Government has adopted the “nexus approach”. In order to avail benefit under this approach the taxpayer has to incur expenditure towards research and development that give rise to the IP income.
Under the nexus approach, ‘expenditure’ is used as factor for activity. This approach is built on the principle that the taxpayer who is benefitted should have carried out the research and development activity and has incurred actual expenditure on such activities. This ensures that tax payer satisfies the substantial activity requirement. These IP regimes are designed to encourage R&D activities and to foster growth and employment.
In the area of transparency, a framework covering all rulings that could give rise to BEPS concerns in the absence of compulsory spontaneous exchange has been agreed. The framework covers six categories of rulings: (i) rulings related to preferential regimes; (ii) cross-border unilateral advance pricing arrangements (APAs) or other unilateral transfer pricing rulings; (iii) rulings giving a downward adjustment to profits; (iv) permanent establishment (PE) rulings; (v) conduit rulings; and (vi) any other type of ruling.
India has traditionally been known for its imports in the area of technology or intellectual property rights. Our service sector is largely engaged in the research and development activities on behalf of the foreign principals. The efforts in the development of patent happen in India, but the registrations are made outside India. In order to encourage more Indian companies to develop and register these patents in India the aforesaid amendments are proposed. As a result of this amendment, we could see more research and development activities being conducted and more inventors and patentee holders emerging in our country. However the success of this change would to a large extent depend upon the IP protection norms in India.
BEPS – Action plan 13 – Transfer Pricing Documentation and Country-by – Country Reporting
BEPS -Action Plan 13 report contains revised standards for transfer pricing documentation and a template for Country-by-Country Reporting of income, taxes paid and certain measures of economic activity. In this report, a three-tiered standardised approach to transfer pricing documentation has been developed and suggested. Firstly, multinational enterprises (MNEs) are to provide tax administrations with high-level information regarding their global business operations and transfer pricing policies in a “master file” that is to be available to all relevant tax administrations. Secondly, transactional details are to be provided in a “local file” specific to each country, identifying material related party transactions, the amounts involved in those transactions, and the company’s analysis of the transfer pricing determinations made with regard to those transactions. Thirdly, large MNEs are required to file a Country-by-Country Report that will provide annually and for each tax jurisdiction in which they do business the amount of revenue, profit before income tax and income tax paid and accrued. This is driven by the need to have transparency on the part of taxpayers in sharing all facts relevant to international transactions. In all interactions Indian tax authorities have been indicating that they are serious about implementing the suggestions by the OECD to the extent possible.
In line with the above recommendations, a new Section 286 is proposed to be inserted requiring maintenance and furnishing of the CbC report by multinational enterprises (MNE’s) having prescribed annual consolidated revenues. The salient features of Section 286 are as follows:
i. The CbC reporting requirement would mandatorily apply to multinational enterprise (‘MNE’) Group having annual consolidated revenues exceeding INR 5,395 crore (equivalent to € 750 million) in the previous year 2015-16
ii. The resident parent entity of an MNE Group, would be required to furnish the CbC report to the prescribed authority, on or before the due date of furnishing the return of income.
iii. Every constituent entity of an MNE Group having a non-resident parent entity, would provide information regarding the country or territory of residence of the parent entity
iv. The Indian constituent would be required to furnish the CbC report to the prescribed authority, if the parent entity is resident:
– in a country with which India does not have an arrangement for exchange of the CbC report; or
– in a country which is not exchanging information with India even though there is an agreement and this fact has been intimated to the entity by the prescribed authority
v. In case an MNE Group having a non-resident parent entity has designated an alternate entity for filing the CbC report with the tax jurisdiction in which the alternate entity is a resident, then the Indian constituent entities, would not be under an obligation to furnish the CbC report, if the same can be obtained under the agreement for exchange of such reports by the Indian tax authorities
vi. In case there is more than one entity of the MNE Group in India (having a non-resident parent entity), then the MNE Group can nominate in writing the entity which would furnish the report on behalf of the MNE Group.
vii. The CbC report would be required to be furnished in a prescribed manner and in the prescribed form and would be based on the template provided in the OECD BEPS report on Action Plan 13
viii. The prescribed authority may also call for such document and information from the entity furnishing the CbC report, for the purpose of verifying the accuracy, as it may specify in the notice. In such cases, the entity would be under an obligation to make the required submission within a period of thirty days from the date of receipt of notice, which could be further extended by a period not beyond thirty days.
The report mentions that taken together, these three documents (country-by-country report, master file and local file) will require taxpayers to articulate consistent transfer pricing positions and will provide tax administrations with useful information to assess transfer pricing risks. It will facilitate tax administrations to make determinations about where the resources were effectively deployed, whether the profits are consistent with the deployment of resources, and, in the event audits are called for, provide information to commence and target audit enquiries.
To ensure proper reporting of the international group in compliance with Section 286, a new Section 271GB is proposed to be inserted for levy of penalty where there is failure in furnishing of such report. The quantum of penalty is ` 5,000 per day when the failure does not exceed one month and the quantum would be ` 15,000 per day when the failure continues beyond a period of one month.
Where the reporting entity fails to produce information and documents sought by the prescribed authority within the time allowed under Section 286, the penalty under Section 271GB could be levied at ` 5,000 to ` 50,000 for every day of such failure. For inaccurate information in the report furnished under Section 286(2) and if the entity fails to inform the incorrectness and furnish correct report within a period of 15 days of such discovery, the prescribed authority may impose a penalty of ` 5 lakhs.
BEPS Implementation: The CbC reporting requirement Action 13 of BEPS Action Plan entails easy availability of information to tax authorities and helps them to identify the risk areas in transfer pricing cases and get an overview of the operations of multi-national groups. For this reasons, the CbC reporting has been widely implemented by various jurisdictions across the world. The amendments proposed in the Finance Bill, 2016 are to the ease the work of tax authorities in the area of transfer pricing. Requirement of furnishing this requisite information and reports before the due date of filing return of income is likely to be an onerous compliance burden. The burden of the penalties is also significant, especially considering that for multinational groups having hundreds of group entities, the available information may not technically meet the requirements of law.
The rules or forms in regard the transfer pricing law are awaited. This Cbc reporting requirement apart from increasing the compliance burden on the tax-payer; will add to increased costs. To expect fair appreciation of such information from the tax department is to belie the current reality and experience. There could be many reasons for an entity to have a non-uniform transfer pricing practice across regions. This could be for example the uniqueness of the business; diversified costs involved in a transaction; differences in the volume of the transactions; and ease of doing business among various jurisdictions. These unique features mandate a studied approach by the revenue authorities. In India at least, from the current experience whether this would happen is unlikely. Government is likely to use information that is favourable to them and ignore the rest.
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