This article first appeared in the October 15, 2014 edition of Worldwide Tax Daily.
The need to restore India's luster, the imperative of reestablishing the country's preeminence as an offshoring destination, and the importance of presenting a more business-friendly image of its government were all palpable as the weeklong 68th Congress of the International Fiscal Association got underway October 12 in Mumbai, India's financial nerve center.
Land of Mouse Charmers
Speaking two weeks earlier to a throng of cheering expatriate Indians and a sprinkling of bemused Americans at Madison Square Garden in New York, newly elected Indian Prime Minister Narendra Modi gently chastised the West for clinging to outdated notions of his country and countrymen. India is no longer the land of snake charmers, he declared September 28. Amid laughter and applause, Modi said the world should now visit India to watch its youth charm the mouse -- referring to the computer peripheral.
Modi's turn of phrase was both an acknowledgment and celebration of the role that offshoring has played in driving the country's economic resurgence. The availability of a cheap trained workforce to staff call centers, help desks, software sweatshops, and business processing offices has been a magnet for multinational enterprises of all hues and stripes. That allure has, however, been dimmed lately by a slew of news stories describing extortionate tax bills premised on preposterous theories. Vodafone, Accenture, Samsung, SABMiller, and Cairn are among the many MNEs to have been perplexed by the creativity of Indian taxing authorities.
Offshoring, or "cross-border outsourcing," as the IFA calls it, is one of the two main subjects to be examined in detail at the congress; the other is eligibility of treaty benefits for partnerships and other fiscally transparent entities, the underlying cause of some of the friction between Indian tax officials and MNEs.
Speaking October 12 at the congress's opening ceremony, which was equal parts essential monotony and elective Bollywood kitsch, Shantikanta Das, a career civil servant recently appointed as revenue secretary in Modi's administration, offered a mea culpa of sorts. According to Das, when the country opened up its economy to the rest of the world at the turn of the century, officials feared aggressive tax planning. They responded with "aggressive assessment," he said. He appealed to the international business community to forget the past and look forward to a new beginning, marked by "transparency and predictability."
Tax Implications of Offshoring
The congress's official proceedings commenced October 13 with a plenary session on the subject of offshoring, titled "Cross-border Outsourcing -- Issues, Strategies and Solutions." Chaired by Bruno Gibert of CMS Bureau Francis Lefebvre, a panel discussed the business of offshoring and the related tax issues and presented the IFA's general report on the topic. The report notes that "historically, cross-border outsourcing has never been considered as a major or key issue under the international tax arena." Panel members observed that this stemmed from the relatively low value added by offshored functions in the past. Now, "however, an increasing trend representing outsourcing of core activities such as management functions is noted amongst various multinational groups," the report observes.
The panel highlighted various tax considerations emanating from an MNE's decision to offshore core activities, which can be broadly categorized under the rubric of transfer pricing or permanent establishment. Transfer pricing-related issues arise from offshoring research and development and other similar functions that add a high proportion of the final delivered value. An aggregation of both high- and low-value adding functions can raise the question of a PE in the state of the service providers. The IFA report points out that "certain tax treaties explicitly provide for creation of PE in prescribed outsourcing situations, for instance, a PE qualification for toll manufacturing or for services."
Recognizing the potential of tax planning that offshoring offers, the report surveys the responses available to the states of the service recipient and provider. "The initial response can be the application or extension of standard [controlled foreign corporation] rules." The report goes on to note "that specific anti-outsourcing provisions have been adopted in cases where the cross-border outsourcing involves a business restructuring that leads to a transfer of existing activities out of a State." One of these measures, the exit tax, generated considerable discussion, with panel members noting that Chapter IX of the OECD transfer pricing guidelines on business restructurings is relevant in this context. The panel seemed to agree that an exit tax is warranted only in those instances when "major intangibles" and "organic risk" are transferred to the service provider and when the recipient receives an "entrepreneurial return."
The offshoring theme continued with a seminar October 13 titled "VAT Implications of Outsourcing and Cost-Sharing Arrangements." Headed by Satya Poddar of EY, a panel examined the conditions for a VAT that is neutral in its treatment of outsourcing and cost-sharing arrangements. After discussing the cascading effects of these arrangements, panel members focused on the OECD guidelines on neutrality. If offshoring involves related parties, as a consequence of a deemed PE or otherwise, transfer pricing considerations would arise. Thus, to ensure neutrality, a VAT would have to account for any transfer pricing adjustment, but most VAT systems around the world are silent on this, the panel noted.
Domestic Law and Treaty Interpretation
Having raised the profile of offshoring and its tax implications among practitioners and policymakers on day 1, the congress on day 2 moved to issues concerning judicial construction of treaty provisions.
The congress broached its second subject, eligibility of treaty benefits for partnerships and other fiscally transparent entities, with a plenary session titled "Qualification of Taxable Entities and Treaty Protection." A panel chaired by Carol Dunahoo of Baker & McKenzie began by considering some of the key factors in various jurisdictions and their respective governing laws that lead to differences in entity classification. Panel members then discussed the conflicts across jurisdictions in granting treaty benefits to different types of entities based on these classifications.
The discussion quickly degenerated into OECD bashing, with the organization's 1999 report, "The Application of the OECD Model Tax Convention to Partnerships," being singled out for especially harsh treatment. Professor Michael Lang of the Vienna University of Economics and Business Administration, along with other panel members, criticized the report for its inconsistencies and limited acceptance by member countries. That prompted an intervention by Jacques Sasseville of the OECD's Centre for Tax Policy and Administration, who pointed out that OECD reports often represent an aspiration goal toward which member countries "move over time."
Panel members also discussed the OECD's recent report on BEPS action 2, "Neutralising the Effects of Hybrid Mismatch Arrangements." Lang characterized that report as "similar to the 'old' OECD approach but applied to all fiscally transparent structures" and not just limited to partnerships. He cautioned that by using the phrase "fiscally transparent," the OECD runs the risk of rendering it a legal term, susceptible to dispute.
Pramod Kumar, a member of India's Income Tax Appellate Tribunal, the country's only prepayment forum for resolving income tax disputes, discussed the tribunal's decisions granting treaty benefits to Linklaters LLP, a U.K. partnership, and A. P. Moller, a Danish partnership. He argued that OECD reports and other interpretation guides have limited utility and that the question of entity eligibility should be resolved at the bilateral level between treaty partners.
Issues of treaty provisions were also discussed October 14 in a judges' seminar at the congress. Participants included Judge James S. Halpern of the U.S. Tax Court, Associate Chief Justice Eugene Rossiter of the Tax Court of Canada, President Philippe Martin of France's Conseil d'Etat, and Justice Vineet Kothari of India's Rajasthan High Court.
Halpern pointed out that although the United States does not have a statutory general antiavoidance rule, judicially developed doctrines, including the sham transaction doctrine and the economic substance doctrine, enable U.S. courts to police the boundary between legitimate business transactions and those entered into solely for avoiding taxes. Rossiter and Martin recounted the experience of Canada and France, respectively, each of which does have a GAAR. Kothari informed the audience that India has enacted a GAAR effective April 1, 2016. That provision, which will apply to entities claiming treaty benefits above a threshold amount, has already raised hackles among Indian tax practitioners and taxpayers.
Reining in the Bureaucracy
India's judiciary is often seen as the country's only bulwark against revenue-hungry tax officials. On October 10 the Bombay High Court ruled in favor of the taxpayer in the vexing Vodafone transfer pricing case, a dispute that many observers believed the Indian government should never have initiated. Several observers told Tax Analysts that once a GAAR is in place, Indian judges may find their hands tied. The country's ability to continue to attract foreign capital could then become critically dependent on the Modi administration's ability to deliver on its promises of greater transparency and predictability.