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BEPS

The Conversation: Can the law catch up with the economy?

A discussion with Porus Kaka

In September, the International Fiscal Association (IFA) convened its annual congress in Madrid, Spain to tackle issues related to dispute resolution in international tax and eliminating double taxation, as well as to prepare for Base Erosion and Profit Shifting (BEPS) and taxes in the digital economy.

To discuss the role of these items on the global tax stage, Brian Peccarelli, president of Thomson Reuters Tax & Accounting business, interviewed Porus Kaka, president, IFA, to get his perspectives on the tax developments that are impacting countries and multinational enterprises.

BRIAN PECCARELLI: What are your thoughts on the state of play with BEPS? Are companies ready for it?

PORUS KAKA: I think I could probably answer the question in two parts. Firstly, yes – companies are getting ready, but that’s primarily for the reporting requirements. I think they’re getting their act together to try to get the Country-by-Country Reporting (CbCR) in place. Many countries are still getting aligned and getting on board. I think the US is probably one of the last to get on board on the CbCR rules.

Secondly, I think what companies, taxpayers and revenue are not ready for is the administration of BEPS, which requires many structures to change. These are sort of prehistoric structures with various layers: layers through tax-friendly jurisdictions, layers through tax treaty jurisdictions – and that may also need to change. Today, prudent corporations may need to collapse structures which have no purpose other than tax minimization in this day and age.

As we proceed from a formalistic approach to a more subjective approach, this will also be a challenge for the judiciary.

From the revenue point of view, there is a lot of subjectivity that’s going to come in and they will have to balance that with the desire of clarity for investors, etc. A lot of the things have to change, and I think people are still going to wait and see how that happens. The smaller multinational companies certainly have greater challenges because for them there’s a significant issue on costs.

I think something in the last 10 or 15 years that I’ve seen is that the costs of compliance are significantly rising no matter what people say, whether it’s transfer pricing, or whether it’s BEPS and now CbCR. In today’s world of tight margins, that is a concern. Again going back, companies are getting ready for reporting requirements but both sides are not really ready
for the administration of BEPS. Certainty is an oft- expressed desire but you can’t be certain when things become so subjective and the rules are still to form; the multilateral treaty still has to happen. A lot of the bricks have to fall in place, and then we will be able to see where things stand.

One brick missing in all these discussions is taxpayer rights. BEPS is about perhaps the few who are able to arbitrage the system in lowering their taxes. A great many taxpayers pay their fair share of taxes. Rights of taxpayers should be an important part of the discussion going forward also.

PECCARELLI: Do you think revenue authorities are prepared for the avalanche of data they will soon receive as a result of BEPS?

KAKA: Very simply, I just think no authority is prepared for the avalanche of data, especially for countries with small manpower. You must remember ultimately the OECD is trying to make this data in a readable form. Therefore, you have common reporting standards and there are attempts to make this data into a kind of common template. Even with that, ultimately a human mind will be required to analyze the data. You will need to tie the data to living human beings; you will need to tie the data to companies.

I’ve seen the difficulty in tying a name to an individual as beneficial owner and saying, “All right, this is your income, now you show the proof that it is legitimately earned and disclosed.” In the context of discretionary trusts, I think there’s going to be a huge challenge.
You will get a name, you will get a bank account, but then you need to tie that with an individual. Not only that, you’re going to need technology to be able to risk-analyze this data. I mean just getting a name is not the solution. I’ve seen this in India; when they got the details of the Panama Papers, they just published everybody’s name in the papers. I mean, many of them had fully legitimate accounts.

Once you get the data you’d have to have manpower to analyze the data. You need experts to risk-assess this data. I think that’s going to be a huge challenge. I think that countries will realize the challenge going forward, and the critical issue is to sort out what they are going to do with the onus of proof. Is the name sufficient to shift the proof to the individual to say, “All right, now you discharge the burden and then prove that this is not your money,” which the individual can never do, as you cannot prove a negative. This is where taxpayer rights should form part of the BEPS debate going forward.

PECCARELLI: Given developments such as Brexit and countries seeking to protect dwindling domestic revenues, do you think countries might seek to reinvigorate tax incentives to attract investment? Might that challenge some reforms underway?

KAKA: Today’s tax globe looks like a sieve. You have holes all over the place, there are ample leakages for people to exploit. For BEPS to succeed, let me put it simply that the sieve has to go. Globally, countries have to get their act together to prevent the ‘sieve’ continuing. Having said this, there will always be countries who want to attract investments. What are you going to do with that? Consider if you have a small country in Europe or a small country in Asia which desperately needs investments and has created a tax incentive. The way I look at what’s coming out of the OECD is that anything below a tax rate of 10% is probably a rate of tax that is unacceptable. What do you do with tax incentives?

Countries are sovereign, and they are going to have incentives when the need arises. It’s going to be a huge challenge for the people working on BEPS, to plug this sieve, without creating more loopholes and more holes. There’s going to be a continuous battle in trying to stop leakages. I think legitimately, countries can attract investments. The question is where do they cross that line from attracting investment to becoming a tax haven? I think that’s what the OECD is trying to stop.

PECCARELLI: The OECD has recognized the difficulties in taxing the digital economy. How do you see the taxation of the digital economy proceeding?

KAKA: When I look at BEPS Action 1, I think the greatest problem today is that the definition of Permanent Establishment (PE) is redundant. To have a concept like a ‘fixed place’ of business in today’s cloud-computing world is outdated. The economy has outpaced the law by decades. The economy has outpaced definitions by decades. It continues to do so.

To that extent, BEPS Action 1 is right when they say that the digital economy is not necessarily only a BEPS issue, but it gives rise to huge BEPS possibilities. This is where I think the consensus is elusive, and therefore you have BEPS Action 1 which does not propose any changes. But countries are not waiting. If you look at the UK, with its diverted profits tax, Australia with its diverted profits tax, India with its equalization levy – with this definition of Permanent Establishment, which is static and not moving, countries are now getting around it. They are setting up taxation systems which deal with the situation, where you do not have a Permanent Establishment, yet income will be taxed in what they consider the source jurisdiction, irrespective of a tax treaty. What is worse is these taxes are not creditable, a recipe for double taxation!

So, I think the digital economy requires a huge rethinking of the way we do international taxation. It’s a huge challenge, but I guess it’s not something that can be done within a space of two years for the OECD.

PECCARELLI: Do you think that indirect tax systems, such as value-added tax (VAT)/goods-and-services tax (GST), are better suited to tackling the digital economy (BEPS Action 1) than direct tax systems (e.g., corporate tax)?

KAKA: Well, the answer is no, because indirect tax systems, like VAT, tax where the consumer resides. So, they are greatly unfair to the manufacturing countries. And more importantly, I think they are politically unfeasible, because VAT is economically unfair to the lower classes. It is not based on the ability to pay. It cannot be based on the ability
to pay. It is not a progressive taxation. So, I think countries can’t just rely on the indirect tax. Further, the developing countries rely on corporate tax much more than the developed world. I think for them politically just to rely on VAT would be economically and politically indefensible.


Getting to know Porus Kaka

Porus Kaka, president of International Fiscal Association (IFA)Who influenced you the most growing up and made you into the person you are today?
I certainly believe it was my parents. My father was a Senior Advocate himself, in India. Also, I would say my senior, Mr. Soli Dastur. I think these are the people who have shaped me into what I am today. So, it’s a pretty easy answer.

What three famous people would you like to have dinner with?
This is the most difficult question of all (laughs). I think certainly Winston Churchill comes to mind. Not only do I find him inspiring, I just enjoy reading his speeches. I think they’re just so wonderful to read. It’s like living through World War II. Another name that easily comes to mind is Mahatma Gandhi because he’s such an important figure for all of us, and we have to be grateful to him for our independence.

And then the third … if I had to choose someone from Hollywood I would choose Robert De Niro because he’s excellent and the only actor whose movies I see only because he is starring in them. But if I had to choose a political figure it would probably be Abraham Lincoln. And whether it’s Gandhi or Churchill or Lincoln, I think it’s primarily because of the fact that they were able to get through tremendous odds and still come out victorious. And I think that’s an inspiration.

What is something about you that not very many people know?
Well, I’m extremely fond of my four-legged friends, and I’m very active in the prevention of cruelty to animals. I enjoy working with some charities and taking care of those who can’t speak for themselves.


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