Adoption of GAAR: To Enhance Economic Revival
GAAR in Nepal
Even though legal, the practice of tax avoidance used by Multi-national corporations generally goes against the notion of tax collection. Tax is collected by the government as a major source of income for the proper functioning of government, to take up its role of wealth redistribution and as a minimal charge for the safety, security, and infrastructure provided to support economic activities. The practice of Tax avoidance by using tax loopholes and various tax heavens across the world has been a major concern for taxing states. This has a lot of negative effects which by a huge margin outweigh any possible positive benefit.
Such practices of tax avoidance are also termed as Base Erosion and Profit Shifting (BEPS), which has been a major agenda of discussion among the G20 states. This practice was the cause of why GAAR was introduced by various jurisdictions around the globe such as Brazil, India, Australia, the United Kingdom, and others. Similarly, in Nepal, similar power has been granted to tax officials under the Income Tax Act, 2058.
Proper and sound taxation policy is an extremely important component in the context of the developing economy as of Nepal. The soundness of taxation policy in such nations is directly related to the rate of economic growth. A properly formulated and instigated tax policies can have 2 advantages. First, it can boost the efficiency of a system and adequately mobilize its revenues. It can help to assist nations via adjusting tax rates following the need for a nation’s revenue. Secondly, tax policies are major determinants of investment patterns in a state. A state having a more favorable tax policy for investment will certainly be having a positive pattern of investment.
One of the major intentions of GAAR in recent practice has been an advantageous and activist role played by its principles for developing effective tax policies in rising economies. The power it gives to tax officials to verify the intention of corporate action is supposed to curb the practices of Base Erosion and Profit Shifting (BEPS) adopted by Multinational Corporations. A major part of potential tax revenue is being shifted by corporations from developing nations. MNCs use the help of ‘tax havens’ and ‘treaty shopping techniques’ to get the most effective tax avoidance platform.
By use of corporate veil and establishment of various holding companies and subsidiaries, MNCs have been able to exploit legal loopholes of tax legislation. A large part of such practice has attributed to lowering tax revenue in developing nations. Such impacts can be detrimental to the overall income of such nations. Such a situation gives rise to the importance for nations to consider adopting GAAR principles in their tax economy.
Now, the question on all of the reader’s mind is, “Is it essential to adopt GAAR principles in Nepal? How can effective implementation be ensured of GAAR principles in Nepalese tax legislation?”. A direct answer to the first question is, “Yes, GAAR principles are essential for Nepal”. Nepal being a developing state is very much reliant in tax revenues as its income source. Income Tax Act, 2058 governs the principles of taxation in Nepal. The principle similar to the GAAR principle has been incorporated in section 35 of the Income Tax Act. This is an important provision and a proper interpretation of such provisions can lead to a better result in tax governance. In Nepal, taxation depends upon the yearly fiscal policy of the government. The rates of tax are revised every year, during the proposition of “annual budget”. Such rates will be applicable for the whole fiscal year. If we are to look at the intention and rates of taxes imposed by the government, it seems to be following the “practice of progressive taxation” in Nepal.
It is considered as most effective among principles to be adopted across various nations. So, if everything seems fine and smooth, where does the problem lie? Such question might arise in everyone’s head. The answer is on part of the implementation of laws and the loopholes in our legal system. It is important to note by loopholes, it doesn’t necessarily mean a bad practice. The intention behind giving exceptions or subsidy to various economic systems and players is governed with good practice. Similarly, Nepal has also concluded Double Taxation Avoidance Agreement (DTAA) with several nations intending to foster trade growth. Various other subsidies and exceptions are provided by domestic legislation, regional and bilateral treaties. The problem with such intention lies, when conducting a direct interpretation of such laws and legal loopholes, can result in unjust exploitation with corporate players. Such loopholes and exceptions were never intended to be used by the way corporate entities are using these days to avoid taxes.
A recent example of such exploitation can be seen in the infamous, “NCell tax case”, which remained a hot topic of discussion for over a year. The main reason for the emergence of such issue traces back to the previously mentioned practice of MNCs by creating numerous holding and subsidiaries across various nations, especially “tax havens”, to shift profit or make a transaction which can prevent the company from having to face taxes during any of its transactions. The problem seen in that case is related to the capital gain tax which is charged on profit made by selling any assets.
Here, there was an offshore transaction for buying and selling a company, which has its holding company, registered in Saint Kitts & Nevis, sold between two companies outside Nepali jurisdiction. In a direct interpretation of the law, the transaction would have easily been outside Nepal’s tax regime. The problem was with the effective management done in Nepal even if it was established outside Nepal. The transaction seemed to be specifically been designed to avoid paying taxes in Nepal even though Ncell gained a lot of its value from Nepal. In these types of cases, our nation’s judicial mechanism adopted principles presented by GAAR. This allowed the Supreme Court to resolve a dispute of such magnitude over tax issues.
The need for GAAR principles, its implementation as well as further strengthening is seen ever more during modern trade and commercial practices. Businesses are getting smarter over the exploitation of national tax legislation and start to use various schemes to get around legal loopholes created for a positive purpose. These schemes must be handled in the best possible way to prevent any negative damages which might result. Emphasis should be given on the effective implementation of legislation.
Tax authorities must be properly trained and kept on high alert for maximizing the effectiveness of GAAR principles. Every individual conducting any taxable transaction must be encouraged to adopt “arm’s length principle”. This will prevent any opportunity of undeserved “arbitrage”. Similarly, the state has to ensure that tax authorities aren’t misusing their taxation powers under GAAR. It can be disastrous if they are allowed to exercise unchecked taxation power. Hence, a proper mechanism of check-and-balance needs to be placed for preventing any misuse of power by tax authorities. Courts can be given an active role where any objection related to misuse of power/ unnecessary exercise of power by tax officials.
Author Divas Bashyal is Law student at Kathmandu University School of Law, Dhulikhel.
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