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Taxation | UPSC

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UPSC Syllabus: Mains – GS Paper III – Economy

A number of multinational companies shift their profits from high tax jurisdiction to tax haven countries such as Mauritius, Singapore, Hongkong, Cayman Islands, Panama, Bermuda etc. This is referred to as “Base Erosion profit Shifting” (BEPS). The BEPS takes place multiple routes such as:

  1. Misuse of DTAA
  2. Treaty Shopping
  3. Round Tripping
  4. Misuse of Patent box Regime etc.

This causes huge loss to the revenue of the Governments. According to research by the Tax Justice Network campaign group, total revenue lost at the global level on an annual basis due to BEPS is as high as $ 427bn.  India’s annual tax losses due to corporate tax abuse are estimated at over $10 billion. Almost $8.7 trillion of global wealth is stored in these low-tax jurisdictions (known to us more familiarly as tax havens).

Hence, in order to prevent these MNCs from shifting their profits to low tax jurisdictions, recently, the Joe Biden Administration in USA has unveiled a new plan known as “Made in America Tax Plan” in order to boost economic activity and create employment opportunities. One of the most important proposals put forward by US is with respect to adoption of Global Minimum Corporate tax.

What is Base Erosion and Profit shifting (BEPS)?

It refers to tax avoidance strategy wherein the companies take undue advantage of the tax exemptions in order to pay less tax. As part of tax avoidance strategy, the Multinational companies shift their profits from high tax jurisdictions to low tax jurisdictions (tax havens) in order to pay less tax. This leads to erosion of the tax base of the high tax jurisdictions. This causes significant revenue losses for the high tax jurisdictions.  A report published by OECD in 2017 has stated that BEPS is responsible for tax losses of around $200bn globally.

Some of the tools of the BEPS are misuse of DTAA, Round Tripping, Treaty Shopping.

DTAA

A DTAA is a tax treaty signed between two or more countries. Its key objective is that tax-payers in these countries can avoid being taxed twice for the same income. A DTAA applies in cases where a tax-payer resides in one country and earns income in another. DTAAs are intended to make a country an attractive investment destination by providing relief on dual taxation. Such relief is provided by exempting income earned abroad from tax in the resident country. India has signed DTAA with more than 80 countries.

Misuse of DTAA

India has signed DTAA with the tax havens such as Mauritius, Singapore, Cayman Islands etc. These DTAAs have been misused by the MNCs in order to reduce their tax liability in India. For example, If company (Shell Company) is registered in tax haven and carries out the operations through its subsidiary based in India. Under the provisions of DTAA, the company would be liable to pay tax only in the tax haven country, even for the profits which it makes in India. This causes significant revenue loss for India.

Note: There is no universally acceptable definition of a tax haven country. However, a Tax Haven Country has certain peculiar features such as:

  • Nil or Nominal Tax rates.
  • Does not share Tax related Information with other Countries
  • Presence of large number of Shell Firms. These Firms are legally registered in a tax haven countries, but do not have substantial presence there. Most of its activities are carried out through its subsidiaries based in other countries. This is mainly done because under the Terms of DTAA, the Firm would be required to pay tax only in a tax haven country and not in other countries. Since, the tax rates are either Nil or Nominal in a tax haven country, the shell firm significantly reduces its tax liability.

Treaty Shopping

Under Treaty Shopping, a foreign company routes its investment into India through a tax haven country i.e. it registers a company headquartered in tax haven and then establishes its Indian subsidiaries to carry out the operations. For example, Hutch’s investment into India was routed through Cayman Islands. Since, the company is based in tax haven, it would be liable to pay tax to the Tax haven country.

Round Tripping

Round tripping refers to the practice where, capital belonging to India goes out to tax haven country where it is used to set up Shell Company. The money is then, reinvested back in India in the form of FDI.

The profit out of such investment cannot be taxed in India as the capital  is coming from tax haven.

 

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