BEPS Action 5: Countering Harmful Tax Practices More Effectively, Taking into Account Transparency and Substance

Preferential Tax Regimes, providing for no or low taxation, implemented by certain Countries can induce MNCs to artificially shift profits to those Countries, even though no substantial economic activities are carried on in those Countries. Preferential Tax Regimes can be a viewed as a Harmful Tax Practice which leads to Harmful Tax Competition among Countries.

To counter such Harmful Tax Practice, the OECD, in BEPS Action 5 has made two-pronged recommendations -

1. Nexus Approach: Substantial Activity Requirement

This approach seeks to realign taxation of profits with the substantial activities that generate the profits.

the substantial activity requirement ensures that taxpayers benefiting from the preferential tax regimes actually undertake the core income-generating activities required to produce the type of income covered by the preferential regime, and incur actual expenditures on such activities.

2. Improving Transparency

The BEPS Action 5 Report acknowledges that a lack of transparency, due to non-exchange of tax-related information, in the operation of a Preferential Regime can give rise to mismatches in tax treatment and instances of double non-taxation. So, in the area of transparency, a framework covering all Rulings that could give rise to BEPS concerns, in the absence of compulsory spontaneous exchange, has been agreed upon by Countries participating in the BEPS Project.

Economic Substance Regulations enacted by UAE

As part of the UAE’s commitment as a member of the OECD BEPS Inclusive Framework, and in response to an assessment of the UAE’s tax framework by the European Union Code of Conduct Group on Business Taxation, the UAE has issued Economic Substance Regulations.

These Regulations incorporate recommendations made in the BEPS Action 5.

The Regulations require UAE onshore and free zone companies, and certain other business forms, that carry out any of the defined “Relevant Activities” to maintain and demonstrate an adequate “economic presence” in the UAE relative to the activities they undertake (“Economic Substance Test”).  

OECD/G20 Base Erosion and Profit Shifting Project has been attached herewith

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