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Businesses must analyse impact of MLI before restructuring

Companies need to benefits with the risks of using tax treaties in a post-MLI world

Tax directors warn companies to analyse the impact of the Multilateral Instrument (MLI) before rushing into plans to restructure. Hasty changes could breach the principle purpose test (PPT) and create more problems.

The MLI enters into force in countries on different dates, depending on when the instrument is ratified by one nation and its treaty partners. In India, the MLI came into effect in India on April 1 2020 for the majority of the country’s covered tax agreements.

Rakesh Nangia, chairman of Nangia Andersen Consulting, said that if companies engaged in international operations have not assessed their business models yet, they are either too late or have very little time left.

“The message is clear. The way you do business is changing,” the chairman said. Nangia urged CEOs and tax directors “look, read and do a complete review” of how the MLI will impact the business, while speaking at ITR’s India Tax Forum.

“You will be drowned in treaties, different positions, and different countries [enacting the MLI at different times],” warned Nangia.

However, Amit Gupta, tax director at Dell Global, said it is “not easy to change structures overnight” and said companies need to be careful.

Gupta said that before the MLI enters into force and treaties are amended, if a company changes its structures, it could backfire because that could mean the company had something to be worried about. “Changing structures now is not wise,” Gupta said.

Rather than making structural changes, Vikas Aggarwal, head of tax at Home Credit, said companies should look through their documentation. “Any structure or transaction will get questioned, so what type of documentation do you have to defend your position? One should prepare using this direction,” he said.

Not all countries are signatories to the MLI, including the US, China and Mauritius. This is another factor driving greater complexity. While the MLI will amend approximately 1,500 treaties worldwide, it also means that the same number of agreements will require bilateral negotiations to align with the BEPS package of measures.

“The true impact of the MLI will be not understood for many years to come,” warned Nangia, because the inconsistencies will “create a web of additional complexity and confusion” and “become clumsy”.

A whole new world

Echoing Nangia’s warning of “drowning” in change, Haroon Qureshi, vice president of taxes at Genpact, said businesses are unprepared for the chaos the MLI creates.

Speaking a few weeks before the MLI entered into force in India, Qureshi said: “I think it's a whole new world out there” and “I don't think many of us, at least in the industry, have realised that this is just knocking at our door”.

“While this has been in the works for a long time, I don't think people with their own pulls and pressures and their day to day work have even realised that this is just around the corner,” said Qureshi.

“You really have to look at so many permutations and combinations as to which article, which country, which clause, you are covered by, or not covered by,” said Qureshi. “Companies will have to do all of that analysis at some point.”

The VP said that companies must assess their structures, group transactions, as well as the royalties, dividends and interests they pay. Many businesses fear that the risk of being caught out by the principle purpose test (PPT) across the countries that have adopted it.

Amit Gupta, tax director at Dell Global, said that in the context of the PPT and holding structures, there is no sunset clause or grandfathering available on holding companies. “I think that's where it will become interesting as to where it goes,” said Gupta. “The entire inter-play will become more important.”

‘Hundreds of overseas vendors’

Some taxpayers are not concerned about the difficulty of analysing the corporate structure because most of that work is done as part of the company’s transfer pricing strategy. However, the concerns arise with external businesses.

“We have hundreds of overseas vendors,” said Qureshi. “Many of those vendors are in their own right very large companies with very inflexible positions. They have their own corporate structures, they are set up all over the world.”

“Until now, we got bills from them and we just asked for a tax residency certificate (TRC) with no permanent establishments (PE) declaration and we moved on,” he said. “That is all going to change.”

For example, when a large business based in Singapore bills a company based in India, the Indian business will now be obliged to ask the Singapore company to provide evidence of why it set up its business in Singapore. This means explaining what kind of substance the company has in Singapore and whether the principle purpose was for operating from Singapore is its low tax rate.

“Why would they even share all the data with me? They will say that this all confidential data,” Qureshi said. “Ultimately, after a lot of back and forth, we might come to a situation where the Indian company actually will end up grossing up a lot of taxes.”

The VP said this issue is worrying for him because the tax function will have to invest a lot of time in doing this, while also increasing the cost of doing business in India.

Gupta agreed that companies will have to look at vendors, but said it “should not end in an indemnification game”, where both parties are asking for indemnity, but no one knows which way the indemnities are flowing, and whether it holds any value.

For Aggarwal, dealing with vendors brings additional complexities of whether withholding tax payments to foreign vendors pass the PPT and are eligible for treaty benefits.

As such, he suggested companies should seek a PPT declaration from vendors, similar to the no PE declaration. “We will have to take this in addition from these vendors so that there is a smooth transition to the new regime with less disruption to our functions,” Aggarwal said.

Qureshi, meanwhile, believes the impact on industry will lead to a “flurry” of Indian companies filing 195 applications to gain certainty. In India, a 195 application refers to section 195 of the Income-tax Act 1961 that cover the tax deducted at source on non-resident payments, identifying the tax rates and deductions.

Amit Maheshwari, partner at AKM Global, said even a simple treaty application will now become complex. He said businesses are now reaching out to consultants to understand the impacts of the MLI.

While companies should not rush into structural changes, they should assess the impact on their transactions and group structures. Taxpayers have to ensure they have the documentation to back up the business decisions for when the tax officer knocks at their door.

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