In the Addressing Base Erosion and Profit Shifting Report, there are certain key tax principles and opportunities for Base Erosion and Profit Shifting that have been analyzed, such as jurisdiction to tax, transfer pricing, leverage and anti-avoidance. Further in these key pressure areas of the Report have been discussed in detail as different chapters of this dissertation.
As the world becomes more globalized and resources become more internationally mobile, the issue related to international taxation is moving to the forefront of debates surrounding national tax system. The process of globalization has led to increased competition among businesses in the global market place. International taxation generally refers to the tax treatment of cross-national transactions. Since each nation has its own tax rules and the rules of one nation are rarely perfectly meshed with those of another, it is possible that income will be taxed more than once which is sometimes referred to as double taxation or that it will go untaxed by any jurisdiction. To prevent this, usually countries adopt different methods. In principal, two methods of taxation are there i.e. the territorial (or source) system of taxation and the worldwide (or residence) system.
Base Erosion and Profit Shifting by the multinational enterprises or by the individuals is one of the current problem by which the whole world suffering. To curb this problem Organisation for Economic Co-operation and Development (OECD) has unveiled its report on Base Erosion and Profit Shifting (BEPS) on 12 February, 2013. The Report has attempted to identify and tackle the global issue of tax base erosion, which in present time has achieved gigantic proportions.
There is a growing perception that Governments across world lose substantial revenue due to tax avoidance because of planning aimed at eroding the tax the taxable base or shifting profits to favorable tax jurisdiction. Keeping cognizance of this situation, the Organisation for Economic Co-operation and Development (OECD) recommends a holistic and planned approach to address the problem of Base Erosion and Profit Shifting (BEPS).
TABLE OF CONTENTS
LIST OF CASES
LIST OF ABBREVIATIONS
CHAPTER ONE INTRODUCTION
1.1 International Taxation
1.2 Base Erosion and Profit Shifting
1.3 Key Pressure Areas of the OECD Report
1.4 Purported Action of Organisation for Economic Co-operation and Development
1.5 Action Steps in OECD Action Plan
CHAPTER TWO TAX JURISDICTION AND TAXATION
2.1 Introductory
2.2 The Jurisdiction to Tax
2.3 Organisation for Economic Co-operation and Development Report Views
2.4 Conclusion
CHAPTER THREE TRANSFER PRICING
3.1 Introductory
3.2 Meaning of Transfer Pricing
3.3 Transfer Pricing in India
3.4 Scope of Transfer Pricing
3.5 Organisation for Economic Co-operation and Development Report Views regarding Transfer Pricing
3.6 Key Features of the Transfer Pricing Regulations
3.7 Section 92A - Meaning of Associated Enterprise
3.8 Meaning of International Transaction (Section 92B)
3.9 Extension to Domestic Transaction
3.10 Methods for arriving at Arm’s Length Price
3.11 Conclusion
CHAPTER FOUR TAX HAVENS & HARMFUL TAX COMPETITION
4.1 Introductory
4.2 The Concept of Tax Competition
4.3 Globalization and Harmful Tax Competition
4.4 Benefits of Tax Competition
4.5 The Organization for Economic Co-Operation and Development Report on Harmful Tax Competition
4.6 Tax Haven
4.7 Harmful Preferential Tax Regime
4.8 Conclusion
CHAPTER FIVE CORPORATE GOVERNACE AND TAXATION
5.1 Introductory
5.2 Meaning of Corporate Governance / Theoretical framework
5.3 Interaction between Taxation and Corporate Governance
5.4 Studies on Corporate Governance and Taxation
5.5 Conclusion
CHAPTER SIX TAX AVOIDANCE TECHNIQUES: GAAR & SAAR
6.1 Introductory
6.2 Meaning of Anti-Avoidance
6.3 Common Methods used by Taxpayers to Reduce Tax Liability
6.4 Sources of Anti-Avoidance Measures
6.5 Some Common Anti-Avoidance Measures
6.6 Conclusion
BIBLIOGRAPHY
PREFACE
As the world becomes more globalized and resources become more internationally mobile, the issue related to international taxation is moving to the forefront of debates surrounding national tax system. The process of globalization has led to increased competition among businesses in the global market place. International taxation generally refers to the tax treatment of cross-national transactions. Since each nation has its own tax rules and the rules of one nation are rarely perfectly meshed with those of another, it is possible that income will be taxed more than once which is sometimes referred to as double taxation or that it will go untaxed by any jurisdiction. To prevent this, usually countries adopt different methods. In principal, two methods of taxation are there i.e. the territorial (or source) system of taxation and the worldwide (or residence) system.
Base Erosion and Profit Shifting by the multinational enterprises or by the individuals is one of the current problem by which the whole world suffering. To curb this problem Organisation for Economic Co-operation and Development (OECD) has unveiled its report on Base Erosion and Profit Shifting (BEPS) on 12 February, 2013. The Report has attempted to identify and tackle the global issue of tax base erosion, which in present time has achieved gigantic proportions.
There is a growing perception that Governments across world lose substantial revenue due to tax avoidance because of planning aimed at eroding the tax the taxable base or shifting profits to favorable tax jurisdiction. Keeping cognizance of this situation, the Organisation for Economic Co-operation and Development (OECD) recommends a holistic and planned approach to address the problem of Base Erosion and Profit Shifting (BEPS).
In the Addressing Base Erosion and Profit Shifting Report, there are certain key tax principles and opportunities for Base Erosion and Profit Shifting have been analyzed, such as jurisdiction to tax, transfer pricing, leverage and anti-avoidance. Further in these key pressure areas of the Report have been discussed in detail as different chapters of this dissertation.
ABOUT THE AUTHORS
Abbildung in dieser Leseprobe nicht enthalten
Dr. Vivek Shukla
Dr. Vivek Shukla is an Assistant Professor of Commerce in an affiliated college of University of Lucknow. He is also a visiting faculty of Commerce in University of Lucknow. He has more than 10 years of teaching experience and 5 years of professional experience in the field of tax and accounts. He has to his credit publication of 3 books on International Taxation, Direct Tax and Tax planning, Financial Management and over 14 Research Papers in various journals of national and international repute. His expertise lies in simplifying technical issues related with taxation.
Abbildung in dieser Leseprobe nicht enthalten
Prof. (Dr.) Somesh Kumar Shukla
Prof. (Dr.) Somesh Kumar Shukla is Professor and Dean of the Department of Commerce, University of Lucknow. He is Nominee of Hon’ble President of India on the Executive Council, Allahabad Central University. He has over 35 years of teaching experience and has to his credit publication of 17 books on various subjects and more than 27 research papers publishes in various journals of national and international repute. He has been bestowed with various awards some of which are Direct Tax Literature Award in 1991 by Ministry of Finance, Government of India; Shishak Shri Sammaan 2014 by Government of Uttar Pradesh; Dewang Mehta National Education Award of Best Professor in Commerce, 2017; Best Citizen of India Award, 2017 by International Publishing House, New Delhi; Awards for Significant Contribution in Commerce in Hindi Language in 2012 by Hindi Sansthan, Government of Uttar Pradesh, etc. More than 38 degrees of PhD and 3 degrees of D.Litt have been awarded under his supervision.
LIST OF CASES
ACIT v. Chrys Investment Advisors India P. Ltd, IT appeal 3928 of 2009 dated 11-3-2010 (Delhi)
Altair Engineering India P. Ltd. v. DCIT, ITA No. 1184 of 2010, dated 14-3-2011(Bang.-ITAT)
Altama Delta Corporation v. Commissioner, 104 TC No. 22 (1995)
Amiantit International Holding Ltd., In re 2010 322 ITR 678 (AAR)
AricentTechologies (Holding) Limited v. DCIT, 2011 9 Taxmann.com 287 (Delhi-ITAT)
CIT v . GlaxoSmithkline Asia (P) Ltd., 8 Taxmann.com 5 (SC).
CIT v. Hart, (2004), 217 CLR 216.
CIT v. P.K.Abubucker, 2002 259 ITR 507 (Kerala)
CIT v. Walfort Share & Stock Brokers, 2010 326 ITR 1 (SC)
Clear Plus India (P) Ltd. v. DCIT, 10 Taxmann.com 249 (Delhi-ITAT)
Coca Cola India Inc. v. Asst. CIT, 2009 309 ITR 194 (P&H).
Craven v. White, (1988) 3 All ER 495.
Dana Corporation, In re, 2010 321 ITR 178 (AAR)
DCIT v. Cheil Communication India Private Limited, ITA No. 712 of 2010 (Delhi)
Deere and Company, In re, 2011 337 ITR 277(AAR)
Dy. CIT v. Quark System Pvt. Ltd., 2010 6 ITR (Trib.) 606 (Chandigarh) [SB]
EI Du Pont de Nemours, 1979 608 F2d 445
E-Gain Communication Pvt. Ltd., 2008 23 SOT 385 (Pune)
Goodyear Tire and Rubber, Company, In re, 2011 334 ITR 69 (AAR)
Hyatt Group Holdings v. Commissioner, Tax Code Memorandum Decision 1999-334
Intel Asia Electronis Inc. India v. ADIT, 2011 9 Taxmann.com 197 (Bang-ITAT)
IRC v. Dukeof Westminster, 1935 All ER 259 (H.L.).
Marubeni India Pvt. Ltd. v. ACIT, ITA No. 919 of 2009
McDowell v. Commercial Tax Officer, (1985) 154 ITR
McDowell & Company v. C.T.O, 1985, SC 426.
Om Sindhoori Capital Investment Ltd. v. JCIT, 2002 82 ITD 514 (Chennai)
Perot Systems TSI (India) Ltd. v. DCIT, 2010 37 SOT 358 (Del); 130 TTJ 685;[2010-TIOL-51-ITAT-DEL]
Philips Software Centre (P) Ltd. v. ACIT, 2008 26 SOT 226 (Bang.),
Praxair Pacific Ltd.., In re, 2010 326 ITR 276 (AAR)
Richter Holding v. ADIT, 2011, 199 TAXMANN 70 (Kar).
Sap Labs India Pvt. Ltd. v. Asst. CIT, 2010 6 ITR (Trib.) 81 (Banglore)
Serdis Pharmaceuticals (I) Pvt. Ltd. v. ACIT, 2011 44 SOT 391 (Mum),
Sunstrand Corporation v. CIR, 2011 1991 96TC 226
United States Steel Corporation v. CIR, 1980 617 F2d 942
Vanenburg Group B.V., In re, 2007 289 ITR 464 (AAR)
VNU International B.V., In re, 2011 334 ITR 56 (AAR)
Vodafone International Holdings B.V. v. Union of India, (2012), 1 CompLJ 225 (SC).
VVF Ltd. v. DCIT, [2010-TIOL-55-ITAT-MUM]
W. T. Ramsay v. Inland Revenue Commissioner, (1982) AC 300.
LIST OF ABBREVIATIONS
ACIT Assistant Commissioner of Income Tax
ALP Arm's Length Price
AO Assessing Officer
BEPS Base Erosion and Profit Shifting
CBDT Central Board of Direct Taxes
CEO Chief Executive Officer
CFC Controlled Foreign Company
CIT Commissioner of Income Tax
CPM Cost Plus Method
CUP Comparable Uncontrolled Price
DCIT Deputy Commissioner of Income Tax
DTAA Double Taxation Avoidance Agreements
DTC Direct Tax Code
DTTs Double Tax Treaties
EC European Commission
ECJ European Court of Justice
EU European Union
GAAR General Anti-Avoidance Rule
GDP Gross Domestic Product
GNP Gross National Product
IIAs International Investment Agreements
IMF International Monetary Fund
IRS Indian Revenue Service
IT Income Tax
MNC Multi-National Companies
MNEs Multi National Enterprises
NGOs Non-Governmental Organizations
OECD Organisation for Economic Co-operation and
Development
PSM Profit Split Method
RPM Resale Price Method
SAAR Specific Anti-Avoidance Rules
SDTs Specified Domestic Transactions
SEZ Special Economic Zone
TNMM Transactional Net Margin Method
TP Transfer Pricing
TPR Transfer Pricing Regulations
UK United Kingdom
UN United Nations
US United States
USA United States of America
VAT Value Added Tax
CHAPTER ONE
INTRODUCTION
Tax is unique contribution to building more effective, accountable government (state) and public institutions. The importance of taxation has been increased by its years, not reduced, when countries receive large volumes of external assistance. The term “Tax” and “Taxes” have been defined as a rate or sum of money assessed on the person or property of a citizen by government for the use of the nation or state; burdens or charges imposed by the legislative power upon persons or property to raise money for public purposes, and the enforced proportional contribution of persons and property levied by authority of the state for the support of government and for all public needs and social developments.1
The purpose of taxation is to provide funds for government expenditure. One of the most important uses of taxes is to finance public goods and services, such as street lighting and street cleaning. Since public goods and services do not allow a non-payer to be excluded, or allow exclusion by a consumer, there cannot be a market in the good or service, and so they need to be provided by the government or a quasi-government agency, which tend to finance themselves largely through taxes. If tax is levied directly on personal income and corporate income, then it is a direct tax. If tax is levied on the price of a good and service, that is collected under indirect tax system.
Taxation refers to the practice of government collecting money from its citizens to pay for public services. Without taxation, there would be no public libraries or parks. Governments use taxation to encourage or discourage certain economic decisions.
One of the most frequently debated political topics is taxation. Therefore tax is a compulsory contribution to the government’s (state's) revenue, assessed and imposed by a government on the activities, enjoyment, expenditure, income, occupation, privilege, property, etc., of individuals and organizations. The money raised from taxation supports the government and allows it to fund police and courts, have a military, build and maintain roads, along with many other services.2
According to Adam Smith’s3 “Canons of Taxation” are:
i) Equality – Tax payments should be proportional to income.
ii) Certainty – Tax liabilities should be clear and certain.
iii) Convenience of payment – Taxes should not be collected at a time and in a manner convenient for taxpayer.
iv) Economy of collection – Taxes should not be expensive to collect and should not discourage business.
A “corporation” is a legal entity created under a state or other statute that allows “incorporation” by persons who become the “shareholders” of the corporation. In general, the corporation’s organizers complete appropriate forms and file them with the state (or other jurisdiction) in which the corporation will be incorporated. Those organizers become the corporation’s initial shareholders once the corporation is recognized by the state. Corporate shareholders may be individuals, other corporations, or other entities such as partnerships. In general, an entity recognized as a corporation under state law is also treated as a corporation for federal tax purposes.
For tax purposes, a corporation is a separate “taxpayer” from its shareholders, meaning that the corporate entity is subject to taxation on corporate - level events.4
The tax imposed on a company's income is known as corporate tax and it depends on its domicile. Indian companies are taxable in India on their worldwide income. Foreign companies are taxable on income that arises out of their operations in India and in certain cases, income that is deemed to arise in India.
Corporate taxes are usually levied by all levels of government. Corporate tax rates and laws vary greatly around the world, as different governments and countries view corporate taxation in different ways. For example, those in favor of lower corporate tax rates point to the possibility for greater economic production if companies are taxed less. While others see higher corporate tax rates as a way to subsidize government spending and programs for the nation's citizens. Corporate income is calculated after deducting all expenditures incurred for business purposes.
This includes interest on borrowings paid in the financial year and depreciation on fixed assets.5
Therefore, corporate tax is a tax which is paid by a corporation based on the amount of total income generated and computed under the various laws of the respective country. The rate of corporate income and amount of tax paid by business and how it is calculated varies depending upon the region where the company is located. Although corporations are legal entities distinct from their owners and operators, they are typically taxed as if they were people.
As the world becomes increasingly globalized it is becoming easier for all taxpayers to make, hold and manage investments through foreign financial institutions, something that not long ago was accessible only to a select few. Vast amounts of money are kept offshore and go untaxed to the extent that taxpayers fail to comply with tax obligations in their home jurisdiction. Offshore tax evasion is a serious problem for jurisdictions all over the world, Organization for Economic Cooperation and Development (OECD) and non OECD, small and large, developing and developed. Cooperation between tax administrations is critical in the fight against tax evasion and a key aspect of that cooperation is exchange of information.
Tax avoidance and tax evasion always has been threatened to government revenues. The US Senate estimates revenue losses from tax evasion by U.S.-based firms and individuals at around 100 billion dollars a year. In many other countries, the sums run into billions of euros (Crores of Rupees). This means fewer resources for infrastructure and services such as education and health, lowering standards of living in both developed and developing economies. Tax transparency and the fight against Cross-Border tax evasion have been key topics at G20 Summits.
There is a very thin line of difference between tax evasion and tax avoidance, both undermining the amount of revenue to be generated by the authorities by way of tax collection. Tax evasion is the illegal non-payment or under-payment of taxes, usually resulting from the making of a false declaration or no declaration at all of taxes due to the relevant tax authorities, resulting in legal penalties (which may be civil or criminal) if the perpetrator of tax evasion is caught Tax evasion amounts to an illegal method of avoiding tax by suppression of facts, misrepresentation and fraud and thus is unacceptable. Black's Law Dictionary states that tax avoidance is the "minimization of one's tax liability by taking advantage of legally available tax planning opportunities". This term is usually used to mean 'illegal arrangements where liability to tax is hidden or ignored i.e. the tax payer pays less than he is legally obligated to pay by hiding income or information from tax authority. Thus, here the tax liability is reduced by illegal and fraudulent means.
Some common examples of tax evasion include:
i) The failure to notify the taxing authorities of one’s presence in the country if he is carrying on taxable activities;
ii) The failure to report the full amount of income;
iii) Deductions of claims for false expenses;
iv) Falsely claiming relief that is not due;
v) The failure to pay over the proper amount of tax due;
vi) Departing from a country without paying a tax due with no intention of paying them; and
vii) The failure to report items or sources of taxable income, profits or gains where there is an obligation to provide such information or if the taxing authorities have made a request for such information
Tax avoidance is seeking to minimize a tax bill without deliberate deception (which would be tax evasion) but contrary to the spirit of the law. It therefore involves the exploitation of loopholes and gaps in tax and other legislation in ways not anticipated by the law. Those loopholes may be in domestic tax law alone, but they may also be between domestic tax law and company law or between domestic tax law and accounting regulations, for example. The process can also seek to exploit gaps that exist between domestic tax law and the law of other countries when undertaking international transactions.6
It is practiced by assessees to avoid their liability by designing a device the foundation of which lies in some lacuna that may have crept in the provisions of the Act, the intention of the legislature being otherwise. It cannot be termed as illegal because it is the outcome of acts which are not forbidden by law and it is an arrangement entered into primarily for the purpose of obtaining tax advantage.
Avoidance methods remain unaddressed except through express judicial decisions and specific anti-avoidance provisions.
Tax avoidance typically involves four basic techniques:
i) Deferred payment of tax liability;
ii) Re-characterization of an item of income or expense to tax at a lower rate;
iii) Permanent elimination of tax liability, an
iv) Shifting income from a high taxed person to a low taxed person.
Tax Mitigation is a situation where the taxpayer takes advantage of a fiscal incentive afforded to him by the tax legislation by actually submitting to the conditions and economic consequences that the particular tax legislation entails. A good example of tax mitigation is the setting up of a business undertaking by a tax payer in a specified area such as Special Economic Zone (SEZ).7
Tax Planning is defined as arrangement of a person's business and / or private affairs in order to minimize tax liability. It is a part of tax compliant behavior and not a part of tax avoidance. Tax law reflects the complexity of modern life and the multitude of choices and options available to all taxpayers when legitimately seeking to structure their affairs. This necessary offer of options within tax legislation creates the opportunity for choice on the part of the tax payer and means that determining the right amount of tax (but no more) that they seek to pay does necessarily requires the exercise of judgment on occasion.
However, of late, the court is asserting that any attempt to avoid the tax liability shall not be encouraged. Both these methods of avoiding tax liability seriously undermine the public finance function of the state, creating a hindrance in effectively collecting tax. The onus has been heavily placed on the revenue department while dealing with the matter of tax avoidance. In view of such thin line, GAAR has been under fire from the tax payers as tax authorities could misuse the provisions to harass the tax payers by including even the genuine cases of tax mitigation / planning to be methods for tax avoidance.
Therefore, all these reasons have consequently led to introduce the General Anti-Avoidance Rules which is intended to serve as a deterrent against avoidance.
1.1 International Taxation
“In the long run, the business unit or source will yield more revenue to the public treasury than the individual; and the place where the income is earned will derive larger revenues than the jurisdiction of the person.”8
T.S. Adams
International taxation generally refers to the tax treatment of cross-nation transactions. Since each nation has its own tax rules and the rules of one nation are rarely perfectly meshed with those of another, it is possible that income will be taxed more than once which is sometimes referred to as double taxation or that it will go untaxed by any jurisdiction. To prevent this, countries employ different methods. In principal, two methods of taxation have been distinguished for direct taxes such as personal and corporate income taxes: the territorial (or source) system of taxation and the worldwide (or residence) system. Under a pure source system, all income earned in a country is taxed by that country regardless of whether the earner is deemed to be foreign. A pure residence system taxes income regardless of where it was earned as long as the earner is deemed to be a resident of the country. An analogy to the familiar distinction between gross domestic product (GDP) and gross national product (GNP) may be helpful. GDP includes all income produced domestically, whether by domestic or foreign nationals, and is analogous to income taxed on the basis of Residential Status and Source of Income. GNP includes all income produced by nationals, whether at home or abroad, and is analogous to income taxed under the residence method.
As long as those receiving income are classified by all countries in the same mutually exclusive way as residents or nonresidents, and all countries use the same method of taxation, there is no problem of double taxation. Double taxation problems arise because countries have different residential provisions and tax systems. For example, some countries use a territorial system when defining income while others use a residence basis for determining what income is taxable. Further, no country uses the pure form of either of these systems. All countries claim the right to tax all income generated within that country’s border; that is, all countries begin with a source basis for taxation.
This is reasonable in terms of both tax administration and tax compliance. It is always easier to assess and collect taxes on income earned in the taxing jurisdiction. Source taxation also accords with the widely accepted principle of taxing individuals who receive benefits from public expenditures (the benefit principle of taxation). For the most part, the government of the country in which that taxpayer is physically present provides the public goods and services consumed by a taxpayer. Both efficiency and common concepts of fairness dictate that those who benefit from government should help to pay for it.9
The paramount issue underlying all international tax considerations is how the revenue from taxes imposed on income earned by the entities of a transnational corporate system is allocated among countries. The resolution of this issue is the main purpose of international taxation agreements, which seek, among other things, to set out detailed allocation rules for different categories of income. While international tax agreements deal foremost with the elimination of double taxation, they also serve other purposes such as the provision of non-discrimination rules, the prevention of tax evasion, arbitration and conflict resolution. The process of globalization, including growing transnational investment and trade, has increased the potential for conflict between tax jurisdictions. At the heart of jurisdictional conflict lies the issue of the jurisdiction to tax. There are no restrictions under international law to a legislative jurisdiction to impose and collect taxes. In most countries, the jurisdiction to tax is based on the domestic legislative process, which is an expression of national sovereignty. States apply their jurisdiction to tax, based on varying combinations of income source and residence principles. This, together with mismatches in definition, accounting and income recognition rules, may result in double taxation or, in some cases, in a jurisdictional vacuum.
A jurisdictional conflict arises when a taxable event falls under the jurisdiction of two or more sovereign powers. These are generally the source country and the country of residence. Jurisdictional conflicts can be, and often are, relieved unilaterally under both international investment agreements (IIAs) and double tax treaties (DTTs). The bulk of such arrangements are represented by bilateral agreements dealing exclusively with tax matters. However, taxation is also dealt with by a host of multilateral comprehensive or specific tax agreements, or bilateral agreements not dealing specifically with taxation.10
There are two main categories of case that international tax rules have to deal with. First, there is the taxation of persons from outside a country who work, enter into transactions, or have property or income in the country. Second, there is taxation of persons who belong to a country and work, enter into transactions, or have property or income abroad. The usual term used in international taxation to denote the concept of a person’s belonging to a country is “residence” (“resident” and “non-resident” being used to indicate whether a particular person belongs to a country or not); similarly the usual term for income arising in a particular place is “source” (“domestic” and “foreign” being used to indicate whether particular income is sourced inside or outside a country).11
The two classifications emerge in for all intents and purposes all zones and kinds of tax collection. For direct tax point of view, the issues are the tax collection from resident assessees on domestic income and foreign income. The primary issue is likely for double tax assessment or income getting untaxed. It means on the same income more than one country may charge tax without reference to tax demanded in other country, or no country may levy tax. Double taxation is likely to act as a barrier to international transactions, and the nations of the world are generally agreed on the desirability of removing such barriers as a means of increasing global welfare.12 13
For nations around the world, offshore tax evasion and avoidance is a pressing concern. Every year, wealthy individuals evade millions of dollars in taxes, depriving governments of all sizes of much-needed resources to fund public services and investments. To the average citizen, it seems like some of the most affluent use overseas accounts to avoid paying taxes with relative impunity, contributing to the perception that the tax system is unfair. Various features of the globalized economy have enabled an increasing number of individuals and companies to resort to tax evasion or tax avoidance.
These features include the ease and rapidity of communications, the progressive elimination of obstacles to the movement of persons and property, the expansion of international economic relations, the differences in national tax systems and hence in the tax burden from country to country, and the growing sophistication and aggressiveness of taxpayers and their advisers in developing legal and illegal techniques for taking advantage of weaknesses in national tax systems. Governments across the globe are recognizing the growing support for tax fairness, and with the United States at the lead, the world community is making important progress to expose these hidden financial accounts and stop offshore tax evasion.14
These goals can be accomplishes through the use of international tax shelters through artificial intermediary companies; excessive use of debt over equity; and non-arm’s length transactions.
Therefore, globalization and the removal of impediments to the free movement of capital and exchange controls have promoted sustainable economic development. However, they have also increased the scope for tax avoidance and evasion with consequential substantial loss of revenue. International tax avoidance and tax evasion cause many problems. Governments lose significant amounts of revenue and hence the honest taxpayers who do not escape their liability to pay tax must bear an additional burden to plug the gap. Countries where the tax compliance is the highest lose out, since the trade flows are diverted elsewhere.
1.2 Base Erosion and Profit Shifting
As per the data released by Organisation for economic cooperation and development (OECD) approximately $240 billion tax has been avoided by multinationals through BEPS activities all over the world. Base Erosion and Profit Shifting (BEPS), is used to describe tax planning strategies that rely on mismatches and gaps that exist between the tax rules of different jurisdictions. These strategies are designed to minimize the corporation tax that is payable overall by either making tax profits “disappear” or by shifting profits to low tax operations where there is little or no genuine activity.15
Base Erosion and Profit Shifting mainly has two dimensions. It can occur when multinationals make aggressive use of the tax planning opportunities opened up by a mischaracterization of different vehicles and income sources and where tax treaties and transfer pricing are misused to shifts profits into low tax jurisdictions. Secondly, base erosion and profit shifting can also occur when governments compete aggressively for the tax base especially when they design regimes which are targeted at highly mobile activities.
In most cases Base erosion and profit shifting strategies are not illegal. Largely they just take advantage of current rules that are still grounded in a bricks and mortar economic environment rather than today’s environment of global players which is characterized by the increasing importance of intangibles and risk management.16 Some of the schemes used for this purpose are illegal and tax administrations are fighting them. It is relevant for a number of reasons.
Firstly , because it distorts competition, businesses that operate cross-border may profit from Base erosion and profit shifting opportunities, giving them a competitive advantage over enterprises that operate at the domestic level.17
Secondly , it may lead to inefficient allocation of resources by distorting investment decisions towards activities that have lower pre-tax rates of return, but higher after-tax returns.18
Finally , it is an issue of fairness, when taxpayers, including ordinary individuals, see multinational corporations legally avoiding income tax; it undermines voluntary compliance by all taxpayers.19
There is a growing perception that Governments are losing substantial corporate tax revenue because of multinationals enterprises or the individuals are planning to erode the taxable base or shifting profits to locations where they are subject to a more tax treatment or at favorable tax jurisdictions. Civil society and non-governmental organizations (NGOs) have been vocal in this respect, sometimes addressing very complex tax issues in a simplistic manner and pointing fingers at transfer pricing rules based on the arm’s length principle as the cause of these problems.20
Globalization and the digitalization of the economy have clearly put a strain on some of these rules, which were first designed more than 100 years ago. Existing rules work well in a number of cases but over time they have also revealed weaknesses. These weaknesses can often lead to Base Erosion and Profit Shifting (BEPS), with taxable profits being artificially shifted to locations where they are subject to more favorable tax regime or made to disappear altogether. Keeping cognizance of this situation, the OECD recommends a holistic and comprehensive planned approach to address the problems of Base Erosion and Profit Shifting (BEPS).
The Organization for Economic Cooperation and Development (OECD) on 12 February 2013 released its widely anticipated initial report on the issue of base erosion and profit shifting (BEPS) by multinational enterprises (MNEs). The report was released in connection with the week’s G20 Finance Ministers meeting in Moscow. The main aim of the Base Erosion and Profit Shifting Report is to present the issues related to BEPS in an objective and comprehensive manner. The Report, Addressing Base Erosion and Profit Shifting (the Report), describes the studies and data available regarding the perceived magnitude of BEPS and provides an overview of global developments that have an impact on corporate tax matters. The Report focuses on the key principles that underlie the taxation of cross-border activities, as well as the base erosion and profit shifting opportunities these principles may create.
The OECD has been providing solutions to tackle aggressive tax planning for years. The debate over BEPS has now reached the highest political levels in many OECD and non-OECD countries. The OECD does not see BEPS as a problem created by one or more specific companies. Apart from some cases of egregious abuses, the issue lies with the tax rules themselves. Business cannot be faulted for using the rules that governments have put in place. It is therefore governments’ responsibility to revise the rules or introduce new rules21.
Therefore, Base Erosion and Profit Shifting is a welcome fast-track project for the Organisation for Economic Co-operation and Development, and at present it is in the top of the mind of tax authorities and taxpayers. The step taken by the OECD represents an unprecedented effort to tackle perceived shortcomings and abuses related international taxation system.
BEPS strategies generally take shield of a combination of features of home and host jurisdictions’ tax systems. Corporate tax is chargeable at the native level. Thus it may be a possibility that an item of the revenue so earned may be taxed twice by the same assessee or that it may be taxed by multiple dominions resulting in occurrences of double taxation. Multinational companies all over the world have time and again insisted for bilateral and multilateral cooperation from various dominions so as to address this disparity among the taxation culture but on the other hand have exploited the same rules to avoid and evade taxes. The report on Addressing Base Erosion and Profit Shifting categorizes various conditions which, combined in various forms, give rise to instances and opportunities for BEPS.
It has become all the more difficult to tackle the issue of BEPS by any single country is because these BEPS strategies make use of the diverse tax rules of various nations at the same time. Therefore, the need of the hour is a universally synchronized tactic that facilitates and reinforces inland arrangements to safeguard tax bases and afford all-encompassing solutions to confront the matter in question. Independent and non-coordinated steps taken by governments retorting in segregation could result in multiple taxation regimes for economic activities carried out by global players. This would result in an adverse impact not only on investment, growth and employment at the global scenario, but also will deter those who pay taxes diligently. The BEPS Action Plan provides a plan wherein the countries come to a common consensus on the issues to ensure equitability and fairness of the global tax regime.
The Base Erosion and Profit Shifting Action Plan set forth 15 actions to address BEPS in a comprehensive and coordinated way. These actions will result in fundamental changes to the international tax standards and are based on three core principles, i.e., coherence, substance, and transparency. The Action Plan also calls for further work to address the challenges posed by the digital economy. Looking toward innovative approaches to deliver change quickly, the Action Plan calls for a multilateral instrument that countries can use to implement the measures developed in the course of the work.
The involvement of third countries in the bilateral framework established by treaty partners puts a strain on the existing rules, in particular when done through shell companies that have little or no economic substance, example, office space, tangible assets and employees. In the area of transfer pricing, rather than replacing the current system, the best course is to fix the flaws in it, in particular with respect to returns related to over-capitalization, risk and intangible assets. Nevertheless, special rules, either within or beyond the arm’s length principle, may be required with respect to these flaws.
Because preventing Base Erosion and Profit Shifting requires greater transparency at many levels, the Action Plan calls for improved data collection and analysis regarding the impact of BEPS; taxpayers’ disclosure about their tax planning strategies; and less burdensome and more targeted transfer pricing documentation.
The current transfer pricing rules do not generally appropriately address the way modern businesses operate in a globalized domain, and taxpayers have thus been able to use or misuse the rules to falsely move the profits and other benefits. Specifically, the arm’s length principle faces challenges in addressing transfers of intangibles, risks, and capital, and other high-risk transactions. The Action plan incorporates three major actions to address these cases, which may include special measures either within or beyond the arm’s length principle. The Action Plan has been developed to settle the current framework quickly and efficiently, without previously established principles regarding the precise nature of the changes that may be required to address these critical transfer pricing issues.
The BEPS Action Plan calls for the development of techniques that countries can use to establish fair, effective and efficient tax systems and also information exchange mechanisms. Because BEPS strategies are generally based on the interaction of countries’ different systems, these tools tend to address the gaps and frictions that arise from the interface of these systems.
Addressing BEPS is critical for most countries and must be done in a timely manner so that material actions can be delivered quickly before the existing consensus-based structure unravels. The toil towards BEPS concentrates essentially on legitimate tax planning practices instead of offshore tax evasion, which is unlawful. However, other work being carried out by the OECD and the OECD’s Global Forum on the exchange of information and Transparency is typically focused on combating offshore tax evasion.
Based on this work, numerous jurisdictions have taken concrete measures to improve their legal framework and practices to ensure transparency and effective exchange of information to eliminate offshore tax evasion.
Existing studies provide abundant circumstantial evidence that BEPS is widespread. Various studies undertaken point out the fact that profits reported by enterprises for levy of taxes are generally earned at those places where no substantial activity takes place and rates of levy are varied and low.
Every country has the sovereignty to choose its own corporate tax system and to implement such measures that would raise their revenue. No or low taxation is not in itself a cause of concern by administrations except it is linked with practices that intentionally separate those incomes which is taxable anywhere from the transactions that generate it. In other words, tax policy concerns arise when there are gaps in the interaction of different tax systems or when, the application of bilateral tax treaties allows income from cross-border activities to go untaxed22.
With the Tax Information Exchange Agreements coming into existence, Base Erosion and Profit Shifting can be minimized up to a large extent.
A legal frame work is shaped by OECD for providing training, guidance and to set out technical standards to promote automatic exchange. At worldwide level, the 2009 G20 Countries’ announcement to end the period of banking concealment was an important breakthrough in achieving success. These are the main four outcomes:
I. Most of the Countries agreed to share information including bank account details on request as per standards.
II. Peer reviews were included to observe application and so on the Global Forum was restructured.
III. Now OECD is working towards enhancing the tax information relationships: In last few years all over the world more than 1100 agreements have been signed among 120 jurisdictions for exchange of tax information which was just around forty, four years ago.
IV. The OECD and the Europe Council originally signed the Multilateral Convention on Mutual Administrative Assistance in Tax Matters, was ranged to the global norms and available to all jurisdictions.
To ensure viable and efficient exchange of information, emphasis needs to be made on three primary constituents
i. Common reporting standards and due ingenuity rules;
ii. Mutual information exchange practices braced by attuned Information Technology frameworks; and
A legal basis for the exchange of information23 is inevitable for accomplishing the aim of operational exchange of information.
As the world becomes more globalized and resources become more internationally mobile, the issue related to international taxation is moving to the forefront of debates surrounding national tax system. As a result of globalization competition has been increased among businesses in worldwide. Corporates all over the world are busy in making international tactics in the countries to grasp the overall market. International financial markets continue to expand, a development that facilitates global welfare-enhancing cross-border capital flows. This process has improved welfare and living standards around the world by creating a more efficient allocation and utilization of resources.24
Globalization and technological innovation have not only leaded to tremendous economic benefits for some but have also created many serious negative side effects for others. Cross borders or national boundaries are becoming less important now days. Multinational enterprises and wealthy individuals are more easily able to avoid taxation by using tax havens. The increasing use of tax havens have resulted in an erosion of many countries' tax bases as well as a shift in the structure of taxation from more mobile capital to immobile capital.
However, by the time to time governments promote policies and regulations to curb and control the power of monopolies and cartels. So that government can avoid unnecessary competitions from the markets and provide healthy environment to the various corporations, multinational enterprises and individuals for their jobs. Sometimes, such policies are pursued because there is a technical understanding of the welfare losses that can arise from anti-competitive behavior. But underlying such intervention there is often a general concern about the power that can be wielded by firms or groups of firms that subvert competition. According to the need of the country and market, the government also modified or makes changes in the rules and regulations of their country so that they can avoid the various methods or techniques of avoidance of tax by the individuals or MNEs, etc. And can provide healthy tax competition so that the corporations or individuals who are not engaged in any kind of tax avoidance or tax evasion get motivated to do their jobs with honesty in future years. As well as the common people also do not get over burdened by the paying taxes and can get their money back in the form of beneficial policies, basic utilities like parks, hospitals, schools, etc.
Developments brought about by globalization and the digitalization of the economy has clearly put a strain on some of these rules, which were first designed more than 100 years ago. Existing rules work well in a number of cases but over time they have also revealed weaknesses. These weaknesses can often lead to the various problems of international taxation, amongst them there is a latest problem has been faced by the many countries i.e. Base Erosion and Profit Shifting (BEPS) under this taxable profits being artificially shifted to locations where they are subject to more favorable tax regime or made to disappear altogether. In addition to the loss of corporate tax revenue, this can result in unintended competitive advantages for MNEs over smaller or domestic companies, and to distortion of investment decisions to favor investment with lower pre-tax (but higher after-tax) returns.
Therefore, Base Erosion and Profit Shifting threatened citizen’s trust in the integrity of the tax system as a whole. Keeping cognizance of this situation, the Organisation for Economic Co-operation and Development (OECD) recommends a holistic and comprehensive planned approach to address the problems of Base Erosion and Profit Shifting.
Base Erosion and Profit Shifting (BEPS) is an initiative of the Organisation for Economic Co-operation and Development (OECD) launched at the request of G20 Finance Ministers. It is a new initiative to create a level playing field and prevent taxpayers benefiting from aggressive tax planning structures. Organisation for Economic Co-operation and Development is so confident and considers that the applicability of its proposed ideas on Base Erosion and Profit shifting that it has given only two years to agree on all of the issues to the participating States.
Base erosion and profit shifting (BEPS), means to erode the actual base of the profits which one has earned high tax jurisdiction and shift that profits to the low tax jurisdictions. In such a way individuals or corporations will go to avoid their tax payment to their countries. It is used to describe tax planning strategies that rely on mismatches and gaps that exist between the tax rules of different jurisdictions. These strategies are designed so that the individuals or multinational enterprises can minimize the corporation tax which is payable, by either making tax profits “disappear” or by shifting profits to low tax operations where there is little or no tax jurisdiction. In general base erosion and profit shifting strategies are not illegal; rather they take advantage of different tax rules operating in different jurisdictions, which may not be suited to the current global and digital business environment. Therefore, to curb the issues related to base erosion and profit shifting OECD has put forward Action Plan of BEPS after the report on “Addressing Base Erosion and Profit Shifting” which is approved by the G20 and seeks to identify, over a period to December 2015, ways of providing more standardized international tax rules.
Base erosion is a serious risk to tax revenues, tax sovereignty and tax fairness for OECD member countries and non-members alike. There are many ways in which domestic tax bases can be eroded, a significant source of base erosion is profit shifting.
Therefore, BEPS has become important and necessary, because it is a pressing and current issue for a number of jurisdictions.
The Organization for Economic Cooperation and Development (OECD) on 12 February 2013 released its widely anticipated initial report on the issue of base erosion and profit shifting (BEPS) by multinational enterprises (MNEs). The report was released in connection with the week’s G20 Finance Ministers meeting in Moscow. The main aim of the Base Erosion and Profit Shifting Report is to present the issues related to BEPS in an objective and comprehensive manner.
Base Erosion and Profit Shifting is a welcome fast-track project for the Organisation for Economic Co-operation and Development, and at present it is in the top of the mind of tax authorities and taxpayers. The step taken by the OECD represents an unprecedented effort to tackle perceived shortcomings and abuses related international taxation system.
In one of the conversation with Pascal Saint-Amans25 told KPMG26 that the OECD was prompted to tackle Base Erosion and Profit Shifting as a result of many factors:
“Political attention is growing because it is hard to explain why some profitable companies pay small amounts of tax at a time when taxes on individuals or small and medium-sized businesses have increased dramatically almost everywhere. For example, VAT rates have increased in 25 out of 33 OECD countries having a VAT system.”
Mr. Saint-Amans further commented that: “Because many BEPS strategies take advantage of the interaction between the tax rules of different countries, it may be difficult for any single country, acting alone, to fully address the issue. An internationally coordinated approach is needed that will not only facilitate and reinforce domestic actions to protect tax bases but will also provide comprehensive international solutions. Unilateral and uncoordinated actions by governments responding in isolation could produce the risk of double – and possibly multiple – taxation for businesses.”27
The Report provides an in-depth analysis of BEPS to identify the problems and the different factors that cause them, based on the available data and information. It first describes studies and data available in the public domain regarding the existence and magnitude of BEPS and contains an overview of global developments that impact on corporate tax matters. The Report sets out an overview of the key principles that underlie the taxation of cross-border activities, as well as the BEPS opportunities these principles may create. It also analyses some well-known corporate structures and highlights the most important issues that these structures raise. The Report concludes that, in addition to need for increased transparency on effective tax rates of MNEs there are a number of pressure areas that should be addressed.
1.3 Key Pressure Areas of the OECD Report
The Report identifies the following key pressure areas:
i. Mismatches in entity and instrument characterization.
ii. Issues of Transfer pricing in connection to the shifting of risks and intangibles, the artificial splitting of ownership of assets between incorporated entities and group transactions that would rarely happen between independent entities;
iii. Matters concerning ‘jurisdiction to tax’. The main issue here is that the rule determining the existence of a permanent establishment are not wide enough to cater for business involving the supply of digital goods and services;
iv. The fruitfulness of anti-avoidance rules such as, GAARs CFC regimes and thin capitalization rules; and
v. The availability of harmful preferential regimes.
These are the main areas focused upon in this thesis and they are identified in the OECD Report of Addressing of Base Erosion and Profit Shifting as the key pressure areas. These key pressures are the areas towards which the Report has to actually work and find out the solutions for these problems. Since these issues are the main source of increasing base erosion and profit shifting by multinationals and individuals, I have taken some of the important key pressure areas as main chapters of my thesis and discussed in detail, as these areas form the gist of the whole Report and are the key issues to be probed for dealing with the problem in hand. Therefore, it needs to be thoroughly discussed.
The Report addresses the fact that the changing global climate (i.e. the way multinationals conduct business) poses particular challenges for revenue authorities. This arises from the fact that existing domestic tax laws have not kept pace with current business practice. Another factor is that, in an increasingly global marketplace, the interaction of the tax systems of different countries leads to widespread opportunities for base erosion and profit shifting by multinationals. This latter point reinforces the need, in the OECD’S view, for countries to work together to tackle BEPS. As the OECD sees it, nothing short of coordinated action will suffice, given that the situation arises due to the interaction of different tax system – thus, no one country can solve the problem on its own.28
1.4 Purported Action of Organisation for Economic Co-operation and Development
The OECD Report shows that the OECD wanted to develop initial comprehensive action plans to be finalized in June 2013 in order to address or tackle the issues of base erosion and profit shifting, which is fundamentally due to a large number of interacting factors. The main reason of introducing those plans was to provide nations with instruments, domestic and international, aiming at better aligning rights to tax with real economic activity, and to provide strategies to detect and respond to aggressive tax planning and ensure better tax compliance. It has helped catalogue the various steps that are required to be undertaken to address the issue of BEPS on a multilateral platform. The broad theme highlighted in the Action Plan is the need for international community to take cognizance of the channel way of doing business in the digital age, so that alignment can be maintained between taxation and value creation.
Further, the Report focuses on the harmonization of the taxation rights and provides concrete solutions to change international standards with the current global business environment. The OECD has appealed to all stakeholders including non member countries, and especially G20 economies to come forth and contribute in this pursuit.
The purported action shall focus on the key areas of concern identified and shall strive to develop plans to overcome such pressure areas, such as:
a) Instruments or tools to neutralize or end the impacts of hybrid mismatch arrangements and arbitrage;
b) Improve to transfer pricing rules to reduce “undesirable results”; Updated “jurisdictions to tax” rules especially for digital goods and services;
c) Updated “jurisdictions to tax” rules especially for digital goods and services;
d) More effective anti-avoidance measures including GAAR, CFC, limitation on benefits rules and other anti-treaty abuse provisions;
e) Rules on treatment of intragroup financial transactions, the deductibility of payments and the application of withholding taxes;
f) Remedies to neutralize harmful tax regimes more effectively and efficiently, considering factors such as transparency and substance;
Therefore, the Organisation for Economic Co-operation has been an activist on International tax policy making. These whole efforts were made to mitigate the threatening problem of BEPS. And would provide some useful guidance to tax administers and MNEs.
The Organisation for Economic Co-operation (OECD) Action Plan describes 15 proposed actions plans to address BEPS in a comprehensive and co-ordinate way. These action plans will bring about major changes to the international tax guidelines, and are based on three core concepts: Coherence, Substance and Transparency.
1.5 Action Steps in OECD Action Plan
ACTION PLAN I - Address the tax challenges of the digital economy;29
ACTION PLAN II- Neutralize the effects of hybrid mismatch arrangements;
ACTION PLAN III- Strengthen controlled foreign companies (CFC) rules;
ACTION PLAN IV- Minimize BEPS activities by the means of interest deductions or other monetary disbursements and outflows;
ACTION PLAN V - Counter harmful tax practices more effectively;
ACTION PLAN VI - Neutralize treaty abuse;
ACTION PLAN VII - Neutralize the artificial avoidance of permanent establishment (PE) status;
ACTION PLAN VIII - Assure that transfer pricing outcomes are in line with value creation/ intangibles;
ACTION PLAN IX - Assure that transfer pricing outcomes are in line with risks/capital;
ACTION PLAN X - Make sure that transfer pricing results are in accordance with value other high–risk transactions;
ACTION PLAN XI - Launch various approaches and practices in order to gather and scrutinize the statistics available on BEPS and the corrective steps that need to be undertaken for overcoming it;
ACTION PLAN XII - Require taxpayers to disclose their aggressive tax planning arrangements;
ACTION PLAN XIII - Re-examine transfer pricing documentation and country by country reporting;
ACTION PLAN IV - Make dispute resolution mechanisms more effective;
ACTION PLAN XV - Develop a multilateral instrument;
The OECD Action Plan sets forth an ambitious 24-month timeframe for reaching consensus on changes and modifications necessary to modernize the international tax system. Today’s OECD action plan proposes significant changes to the international tax landscape in a very encouraging that the OECD is emphasizing the importance of consulting with a range of non-governmental stakeholders in moving forward.
Therefore, these were the some measures by which we can cure problem up to some extent i.e. Base Erosion and Profit Shifting. By following the key pressure areas of the Organisation for Economic Co-operation and Development Report on Addressing of Base Erosion and Profit Shifting, countries will go with the pace of the changing business environment and not going to face much huge problem if the countries deal with this issue in co-ordination. As the Report says that “There is no magic recipe to address Base Erosion and Profit Shifting issues, but the Organisation for Economic Co-operation and Development is ideally positioned to support countries efforts to ensure effectiveness and fairness and at the same time provide a certain and predictable environment for business.”30
CHAPTER TWO
TAX JURISDICTION AND TAXATION
2.1 Introductory
The past several decades have witnessed a dramatic increase in cross-border trade and investment, partly in response to a reduction in legal barriers (e.g., tariffs and capital controls) and technological improvements that lower transportation, distribution and communication costs. This trend has been accelerated by the advent of the internet and related information technologies, as well as the proliferation of digital goods and services. The upside of these developments is enhanced economic integration, raised productivity, and increased national and international wealth. The downside includes growing jurisdiction disputes in areas such as copyright, speech, privacy, and contract.
The world of tax law is witnessing a similar growth in jurisdiction disputes. Walter Hellerstein’s paper makes a valuable contribution by bringing clarity to an issue of growing importance in the world of tax: when does a country or sub national government have the legal and practical jurisdiction to impose and enforce its tax laws on cross-border economic activity? Hellerstein divides tax jurisdiction into two related but distinct concepts: “substantive jurisdiction” (i.e., the power of a state to impose its tax laws on transactions that have a relationship to economic actors within the state) and “enforcement jurisdiction” (i.e., the power of a state to collect taxes related to transactions over which it has substantive jurisdiction). In his view, governments should take steps to ensure that enforcement jurisdiction is properly aligned with substantive jurisdiction (as long as it is practical to do so).31
2.1.1 Substantive Jurisdiction to Tax
There are two fundamental, but alternative, predicates for a State’s substantive jurisdiction to tax income: residence and source. These principles are widely accepted at the international, national, and sub national levels.
They underlie the international tax treaty structure; they are embodied in national taxing regimes; and they are reflected in constitutional restraints on sub national taxing powers.32
2.1.1.1 Residence
A State has substantive jurisdiction to tax income on the basis of residence. This means that a State has power to tax the income of an individual or entity based solely on the fact that the individual or entity is a resident of that State and without regard to the source of that income. There is no single definition of residence for tax purposes. For example, with respect to individuals, a State may define residence by reference to domicile, citizenship, presence in the State for a specified period of time, or presence of an abode in the state.33 Similarly, with respect to corporations, a State may define residence by reference to the commercial domicile, place of incorporation, location of corporate headquarters, or place of ‘effective’ or ‘real’ management.
In short, substantive jurisdiction to tax income on the basis of residence is conferred by the relationship of the State to the person with the right to the income. Once that relationship is established, the State possesses the power to tax all of the resident's income regardless of the location of the activities that produced it.34
2.1.1.2 Source
A State has substantive jurisdiction to tax income on the basis of source. This means that a State has the power to tax the income of an individual or entity based solely on the fact that the income has its source in the State and without regard to the residence of the person with the right to the income. Like the concept of residence for tax purposes, the concept of source for tax purposes has no single definition. Rather, it is a collection of definitions with a common theme, namely, the geographical location of property or activities that produce (or are deemed to produce) the income.
For example, the source of income from real property is generally considered to be where the real property is located; the source of income from dividends is often considered to be the State of the corporate payer’s residence; the source of income of royalties from the license of intellectual property is commonly considered to be the State where the intellectual property is used; and the source of income from business profits is typically considered to be the location of the activities giving rise to the business profits. This territorial relationship confers upon the State the power to tax the income arising out of that relationship without regard to the residence of the person with the right to the income. The source principle and its theoretical underpinnings are as ‘universally recognized’ as the residence principle and its theoretical underpinnings.35
2.1.2 Enforcement Jurisdiction
Assuming that a State has substantive jurisdiction to tax income on the basis of either residence or source, the question then arises whether the State has jurisdiction to compel collection of the tax. This inquiry has both theoretical and practical aspects. A State may have the theoretical power to enforce a tax but nevertheless lack an effective enforcement mechanism because the theoretically sound path to tax collection is administratively or economically impractical.36
The power to tax is one of the attributes of sovereignty; and the jurisdiction to exercise the power is coterminous with the bounds of the sovereign’s jurisdiction. “It is obvious that it is an incident of sovereignty, and is coextensive with that to which it is an incident. All subjects over which the sovereign power of a state extends are objects of taxation, but those over which it does not extend are, upon the soundest principles, exempt from taxation. The sovereignty of a nation reaches out to everything which exists by its own authority or is presented by its permission. The power to tax involves the power to destroy.” The power of taxation, however vast in its character and searching in its extent, is necessarily limited to subjects within the jurisdiction of the state. These subjects are persons, property and business. The taxing power of the state cannot reach over into any other jurisdiction to seize upon persons or property for purposes of taxation. Mr. Justice Holmes said that “The boundary line is the line of sovereignty. . . Boundary means sovereignty since in modern times sovereignty is mainly territorial, unless a different meaning clearly appears.”
On the other hand, where land within a state is ceded to the United States for federal purposes the complete sovereignty passes away from the state, which can no longer levy taxes within the ceded territory.37
2.2 The Jurisdiction to Tax
In most countries, the jurisdiction to tax is based on the domestic legislative process, which is an expression of national sovereignty, thus heightening the sensitivity of the surrounding issues. There are no restrictions under international law to the legislative jurisdiction to impose and collect taxes. In principle, international tax agreements do not restrict the contracting parties’ legislative jurisdiction (although they may restrict the application of tax rules enacted pursuant to that jurisdiction). It is only in unusual situations that such tax game plans may affect directly on the legislative jurisdiction. Nevertheless, the impact of a country’s legislative jurisdiction is restricted by the obvious limitations on its enforcement powers beyond its own national boundaries (Sandler, 1998). In other words, the unrestricted exercise of the right to impose and collect taxes is rather limited if the resulting rules cannot be enforced outside the regulating state's own territory. Thus, most countries exercise their jurisdiction to tax by reference to factors that assume a sufficient connection between the relevant country and the taxable person and/or the taxable income. Taxation systems based on a sufficient connection between the relevant country and the taxable person apply the principle of “residence-based taxation”. Countries applying such a principle tax their residents (and sometimes their nationals) on their worldwide income, wherever derived. One technique of assessing the distribution of income, which has been the subject of some discussion on jurisdictional grounds, is the “unitary taxation” method Taxation systems based on a sufficient connection between the relevant country and the taxable income apply the principle of “source-based taxation”. Countries applying such a principle tax income derived from sources in their territory, regardless of the residence of the person deriving the income. Most countries apply a combination of residence-based and source-based taxation. Thus, residents are taxable on their worldwide income under what is generally referred to as an “unlimited tax liability”.
In contrast, non-residents are taxable only on income derived or deemed to be derived from sources within the territory, under what is generally referred to as a “limited tax liability”.38
The right to tax is traditionally based on a factor that determines connection to a jurisdiction. Jurisdiction to tax is exercised on an entity by entity basis, not on a group-wide basis, subject to the exception of the availability of domestic group consolidation regimes, in broad terms, tax systems are often divided into worldwide and territorial ones. A worldwide taxation system generally subjects to tax its residents on their worldwide income, i.e. derived from sources within and outside of its territory (including the income earned through controlled foreign subsidiaries) and non-residents on the income derived from its territory. On the other hand, a territorial system generally subjects to tax both residents and non -residents only on the income derived from sources located in its territory. In the majority of countries, neither the worldwide nor the territorial system is employed in a pure form and no two tax systems are exactly the same.
The collaboration of local fiscal laws may lead to situations wherein an item of income may be taxed twice (double taxation) by two jurisdictions at the same time or contrarily it may go untaxed in even a single country (double non-taxation)39.
Companies have asked bilateral and multilateral co-operation among jurisdictions to address differences in tax rules that result in double taxation, while simultaneously exploiting difference that result in double non-taxation.
Domestic and global rules to address double taxation, a significant number of which originated with principles developed by the League of Nations in the 1920s, aim at addressing overlaps that result in double taxation so as to minimize trade distortions and impediments to sustainable economic growth. Whilst there are significant differences between the more than 3000 bilateral tax treaties currently in force, the principles underlying the treaty provisions governing the taxation of business profits are relatively uniform. Under the norms of tax treaties, liability to a nation’s tax first depends on whether or not the assesse that derives the relevant income is a resident of that country. Residence, for treaty purposes, depends on liability to tax under the domestic law of the taxpayer.
An entity will be regarded as a resident of the state if its tax liability is arises in that state because of a host of factors like domicile, residence, place of management, etc. Treaties contains that any resident person may be taxed on its business income wherever arising (subject to the requirement that the residence country eliminate residence-source double taxation) whilst, as a general rule, non-resident taxpayers may only be taxed on their business profits when certain conditions are met.40
2.3 Organisation for Economic Co-operation and Development Report Views
The OECD’s Report on “Addressing Base Erosion and Profit Shifting” describes jurisdiction to tax as one of the key principle that underlie the taxation of profits from cross- border activities and it create an opportunities for base erosion and profit shifting among MNE’s by moving their profits to where they are taxed at lower rates and expenses to where they are relieved at higher rates.
Every nation is free to develop its corporate taxation layout as it chooses. Nations have the sovereignty to impose tax measures that raise revenues to pay for the expenditures they deem essential. A main challenge relates to the need to ensure that tax does not produce unintended and distortive effects on world-wide trade and investment or that it distorts competition and investment within each country by disadvantaging domestic players. In a globalized world where economies are increasingly integrated, domestic tax systems designed in isolation are often not aligned with each other, thus creating room for mismatches.
As already discussed, these gapes may result in double taxation and may also result in double non-taxation. In other words, these mismatches may in effect make income disappear for tax purposes. This result to a decrease of the gross tax paid by all parties involved as a whole. Although it is usually difficult to ascertain which of the Nation involved has unrecovered their tax revenue, it is clear that collectively the countries concerned lose tax revenue. Further, this undermines competition, as some businesses, such as those which operate cross-border and have access to sophisticated tax expertise, may profit from these opportunities and have unintended competitive advantages compared with other businesses, such as small and medium-sized enterprises, that operate mostly at the domestic level.
Considering how tax systems interact with each other is therefore relevant not only to eliminate obstacles to cross-border trade and investment, but also to limit the scope for unintended non-taxation.41 Further, double tax treaties, which are bilateral tools that countries use to coordinate the exercise of their respective taxing rights, may also create opportunities for taxpayers to obtain tax advantages in the form of lower or no taxation at source and/or lower or no taxation in the state of residence of the taxpayer.
[...]
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23 Retrieved from http : // www. oecd. org / ctp / exchange - of - tax information / the fight against tax fraud and tax evasion towards a new global standard on automatic exchange of tax information. htm, (last accessed on 10 April, 2016).
24 Available at https://www.ustaxcourt.gov/opinions/2017/148_TC_No_10_transparency.pdf
25 Mr. Pascal Saint-Amans, Director of the Centre for Tax Policy and Administration, OECD.
26 KPMG is one of the largest professional services companies in the world. KPMG in India is one of the leading providers of risk, financial services and business advisory, internal audit, corporate governance, and tax and regulatory services.
27 Available at https://www.oecd.org/ctp/beps-frequently-asked-questions.pdf
28 Belema R. Obuoforibo, “Base Erosion and Profit shifting: The Role of the Financial Centers and the OECD Report”, International Taxation, Vol. 8 June, 2013, p. 674.
29 Available at https://www.oecd.org/ctp/beps-reports-2015-executive-summaries.pdf
30 Organisation for Economic Co-operation and Development , “Addressing of Base Erosion and Profit Shifting”, February, 2013.
31 Arthur J. Cockfield, “Jurisdiction to Tax: A Law and Technology Perspective”, Georgia Law Review, 38 Ga. L. Rev. p. 85, 2003. available at < http :/ / heinonline. org>
32 Available at <unctad .org / en / docs / iteiit 16 _ en .pdf> (Last accessed on 30 March 2014).
33 Richard Doernberg Et Al., “Electronic Commerce and Multi-jurisdictional Taxation”, 2001, p.73-75 available at <unctad. org / en / docs / iteiit 16_ en. pdf> (Last accessed on 30 March 2016).
34 ibid
35 “Jurisdictional Framework for Taxation”, Georgia Law Review, 38 Ga. L. Rev. p. 3, 2003, available at < http : // heinonline . org > (Last accessed on 30 March, 2016)
36 ibid
37 Joseph H. Beale, “Jurisdiction to Tax” Harvard Law Review, Vol. 32 No. 6, April 1919, p. 587-588, available at < http : // www . jstor .org / stable / 1327994 > (Last accessed on 30 March 2016)
38 Available at < http : // unctad. org / en / docs / iteiit 16_en . pdf> (Last accessed on 31 March 2016).
39 Organisation for Economic Co-operation Development, “Addressing Base Erosion and Profit Shifting”, February, 2013, p. 33.
40 Ibid, p.34
41 Ibid, p. 39
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