BEPS empowers tax authorities to rewrite transactions

Once introduced, it will realign contemporary tax policies with the realities of today’s global economy

By EY
Updated: Aug 3, 2015 07:52:56 AM UTC
global_tax

Image: Shutterstock

Base Erosion and Profit Sharing (BEPS) is a concept where tax authorities will cut across geographies to understand ‘why’ and ‘how’ MNCs are reducing their ‘Global Effective Tax Rate’. Typically, this is a result of MNCs developing interplay of transactions between countries with low tax regimes and countries with a high-tax incidence. The BEPS concept is predominantly introduced to regulate the planned tax efficiencies in globalised business platforms.

Concept of BEPS: global_tax
An example, widespread among business houses – I Co is an Indian arm of an MNC headquartered in the US, paying S Co, a Singapore group company technical service fees and/or brand royalties. Thus, profits are lowered in high-tax jurisdiction: India, and reported (shifted) in low-tax jurisdiction: Singapore.

Such structures are rather common in business houses and would be legitimate if backed by strong commercial motives. However, an issue arises when MNCs, merely to claim a tax benefit, design their dealings through such tax havens.

BEPS in today’s M&A environment:
Could this be a matter of concern during an acquisition or a merger? The answer is yes. Read further to know the reasons.

When you plan an acquisition, BEPS could be a hidden risk that could open a box of litigation which, if not considered during acquisition, may lead to an unforeseen outflow of tax, time and efforts. Some of the possible ways in which BEPS could impact M&A are illustrated as under.

Inheritance of aggressive tax structures:
Situation: Acquisition of a large group having business presence in various countries
BEPS: Could compel business houses to undertake cross border tax due diligences to understand if any aggressive tax structure would be inherited as a part of the acquisition. Foresight of such aggressive tax structures and the knowledge of plausible consequences shall assist to factor the same in valuation.

Treaty abuse:
Situation: Typical M&A cross-border transaction where the seller, on transfer of an asset, is not liable to pay taxes due to a bilateral treaty protection.

BEPS: One of the core action points of BEPS is to address deals/transactions which are designed to enjoy economic advantage through treaty abuse.

Leveraged acquisitions:
Situation: Thinly capitalised companies are funded through debt arrangements.

BEPS: While interest/coupon payment on loans is typically tax deductible for the investee company (depending on local laws of the investee company), interest income earned could be tax exempt under bilateral treaty provisions for the investor company.

Economic advantage enjoyed here can be illustrated through the following example:

global_tax

BEPS seeks to deny interest deductibility to thinly capitalised companies.

Addressing BEPS risk in M&A environment:
So how can one identify such economic risks and address them. It can be done through diligence procedures which enable highlighting/identifying and accessing such risks pre-acquisition to avoid unpleasant discoveries post acquisition. A commercial and informed decision could then be taken post the assessment of potential risks.

Unconscious to hidden tax issues on aggressive structures, corporates may also inherit ‘reputational risks’ apart from economic risks. Recent times have witnessed multinationals being criticised by the media for adopting aggressive global tax structures, whereby profits are speculated to be shifted to jurisdictions having a lower tax rate. Such possibility of loss to reputation needs to be addressed ahead of actual acquisition.

Global efforts to address BEPS:
Globally, countries, recognising the concern, have come together to create a code to enable looking at transactions with a borderless lens for taxes. Once introduced, BEPS will realign contemporary tax policies with the realities of today’s global economy. It seeks to empower tax authorities across countries to rewrite transactions.

Is the concept of BEPS already embedded in the Indian domestic tax laws?
The Indian tax authority, in the Vodafone judgment for the first time in India, introduced the concept of “look-through approach”, thereby restrained tolerance against rigorous tax planning. With General Anti Avoidance Regulations (GAAR) proposed to be effective from April 1, 2017, in India, the tax authorities are empowered to identify the underlying intent of the companies and prevent granting of concessions to non-genuine transactions undertaken with a sole objective to exploit tax provisions.

Globally, countries are campaigning for watertight tax regimes and gradually but definitely towards commercially driven business practices, and BEPS seems to be the way to it!

- By Amrish R Shah, Partner & National Leader - Transaction Tax, EY; Deepa Dalal, Director, Transaction Tax, EY

The thoughts and opinions shared here are of the author.

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