By Pankaj Bagri and Prashant Deshmukh
If January is a month of New Year resolutions, February can be said to be a month of New Financial Year expectations with Indian Government announcing its fiscal policy strategy, including taxation regime for the next financial year.
The Union Budget of 2015-16 was the first full budget presented by the current Government and it had a major focus on infrastructure development. With the previous Union Budget setting the right tone, there is increased expectation from upcoming Budget in the infrastructure sector.
However, during the current financial year, the Organization for Economic Co-operation and Development (OECD) released final reports on Base Erosion and Profit Shifting (BEPS) in the form of 15 Action Plans with the objective to reform international tax system and ways to tackle tax avoidance.
Since India has been one of the active participants of the BEPS project, it is expected that the Indian Government would come out with significant enactment and amendments in its domestic tax laws in the forthcoming Budget 2016.
The expected amendments could be in line with some of the critical BEPS recommendations impacting India. As such, the infrastructure sector is anticipating huge burden of additional tax cost due to BEPS action plan.
BEPS Action Plan 2 intends to neutralize effects of hybrid instruments, such as Compulsory Convertible Debentures, which will result in denial of interest expenditure or alternatively taxing the same, not otherwise required in India.
Further, BEPS Action Plan 7 takes into account various cases where a person tries to abuse domestic tax laws by using treaty benefits. Hence, it has recommended restricting some of the tax treaty benefits by ensuring prevalence of domestic tax law over treaty benefits claimed by infrastructure players through splitting of contracts.
Similarly, BEPS Action Plan 4 intends to address base erosion through use of interest and economically equivalent payments. The recommendation is that it should cover all interest, whether related party or third party, cross border or domestic.
Action Plan 4 recommends an approach based on a fixed ratio rule (limiting interest to fixed percentage of EBITDA), with a potential range of ratios (between 10 percent-30 percent) to take into account that not all countries are in equivalent position.
BEPS report recommends that a combination of preparatory or auxiliary activities which may result in cohesive business operation would not be eligible for exclusion and would result in PE exposure for foreign players.
BEPS has also expanded the scope of Agency PE, which will make more non-resident infrastructure companies pay taxes in India.
Further, BEPS Action Plan 6 has proposed to prevent treaty shopping and use of conduit companies.
It will be interesting to see whether the Government amends GAAR / CFC provisions or introduces additional provisions, negotiates tax treaties or multilateral treaty provisions in order to give effect to BEPS recommendations.
The approach on ‘Leap day Budget’ may either provide a leap to infrastructure or may leave it limping. Only time will tell.
(Pankaj Bagri is Director, Business Tax and Prashant Deshmukh, Manager, Business Tax, Deloitte Haskins & Sells LLP)