Base Erosion and Profit Shifting

Also called: BEPS · Topic: Taxation: Direct and Indirect Taxes, GST and Global Tax Issues · NCERT: Beyond NCERT

Meaning

Base Erosion and Profit Shifting (BEPS) is tax planning by multinational companies. It uses gaps and mismatches between different countries' tax rules to move profits out of the country where they are earned and into low-tax or no-tax places.

• Base erosion means the taxable profit a country can see gets smaller.
• Profit shifting means that same profit is shown somewhere else, often in a tax haven.

It matters because countries like India lose tax revenue even when the real business happens on their soil. It also gives multinationals an unfair edge over domestic firms that pay full tax.

A simple way to measure it: Profit shifted = profit at the arm's-length price − profit actually shown in the country. The arm's-length price is the price two unrelated firms would charge each other.

Explanation

How profits are shifted

• Transfer mispricing
• Units of the same multinational trade with each other. The price they charge each other is called the transfer price.
• If the price is set too low or too high, profit lands in the low-tax unit.

• Example: an Indian unit sells to its sister unit in Singapore at a very low price.

• Treaty shopping

• A company sends its investment through a country that has a tax treaty with India. It does this only to get the treaty's tax benefit, not for any real business reason.

• Example: a shell company in Mauritius or Singapore invests in India and claims the treaty's capital-gains exemption.

• Using tax havens

• A tax haven has very low or no taxes and strict secrecy about who owns what.

• Profit and ownership are hidden there. The Panama Papers (2016), Paradise Papers (2017) and Pandora Papers (2021) exposed this.

• Avoiding a permanent establishment (PE)

• A PE is a fixed place of business, such as an office, branch or factory. It is what lets a country tax a foreign firm's business profits.
• Digital firms earn from Indian users without any office in India. With no PE, India usually cannot tax their business profits.

Worked example: transfer pricing

• An Indian unit makes software at a cost of ₹100.
• It sells the software to its Singapore sister unit for ₹105. An unrelated buyer would pay ₹150.
• Profit shown in India = ₹5. Profit at the arm's-length price = ₹50.
• Profit shifted = ₹50 − ₹5 = ₹45. This ₹45 moves to Singapore, where tax is lower.
• The Indian tax officer adjusts India's taxable profit up to ₹50.

The global response: OECD/G20 BEPS project and the Two Pillars

• BEPS project: run by the OECD and G20 from 2013 to 2015. It produced 15 actions.

• Action 1 deals with the digital economy, where firms earn from users in a country without having a PE there.

• MLI (Multilateral Instrument): an OECD tool that changes many bilateral tax treaties in one go. It added the Principal Purpose Test (PPT), which denies treaty benefits if getting them was one of the main purposes of a deal.

• Two-Pillar Solution (October 2021):
• Pillar One: gives market countries (where the users are) a share of taxing rights. Amount A is 25% of profit above a 10% margin, for MNEs with over €20 billion revenue. The convention has stalled.

• Pillar Two (global minimum tax): a 15% minimum effective tax rate in each country, for groups with €750 million+ revenue. It removes the gain from parking profit in a haven.

• Pillar Two worked example:

• A subsidiary earns €100 million in a haven and pays €5 million tax.
• Effective tax rate (ETR, the tax paid divided by the profit earned) = 5%.
• Top-up rate = 15% − 5% = 10%.
• Top-up tax = 10% × €100 million = €10 million (ignoring the carve-out for real activity).

• Formula: Top-up tax = (15% − ETR) × excess profit.

• Who collects the top-up tax, in order:

• QDMTT: the low-tax country collects it first.
• IIR: otherwise the parent company's country collects it.
• UTPR: a backstop, collected by other countries where the group operates.

• STTR: a separate treaty-based rule that lets source countries tax lightly taxed interest and royalty payments.

• Reach of the deal: the Inclusive Framework now has 147 countries and jurisdictions [1].

What makes BEPS rise or fall

• It rises when:
• tax rates differ widely between countries;
• income comes from intangibles (brands, software, royalties) that are easy to move;
• business is digital and needs no office;

• ownership records are secret.

• It falls when:

• arm's-length pricing is enforced;
• treaties have anti-abuse rules;
• countries share information automatically;

• a minimum tax floor exists.

• Weakening of the floor: the US withdrew in January 2025. The Side-by-Side package (January 2026) exempts groups headquartered in "eligible regime" jurisdictions from the IIR and UTPR in other countries [1][2]. The 15% floor survives, but it is weaker for these groups.

In India

• Transfer pricing law: Secs. 92–92F of the Income-tax Act, in force since 2001. They require the arm's-length price.
• Advance Pricing Agreements (APAs), from 2012:
• An APA is a deal in which the firm and the tax department agree in advance on the pricing method for future years.
• CBDT signed 219 APAs in FY 2025-26, the highest ever, including 84 bilateral APAs (BAPAs). A BAPA is also agreed with the other country's tax authority [5].
• The total since the start of the programme reached 1,034 by FY 2025-26 [5].

• India signed its first bilateral APAs with France, Ireland, Indonesia and Sweden in FY 2025-26 [5].

• Closing treaty loopholes:

• India–Mauritius protocol (2016): capital gains on shares acquired from April 2017 are taxed in India.

• MLI, ratified in 2019: brought in the PPT.

• Taxing digital firms:

• Equalisation levy: 6% on online advertising (Finance Act 2016) and 2% on e-commerce operators (Finance Act 2020) [3].
• The 2% levy covered only supplies before 1 August 2024. The levy's provisions do not apply from 1 April 2025 [3].

• Significant Economic Presence (SEP), Finance Act 2018: a foreign firm is treated as present in India if it has ₹2 crore of payments or 3 lakh users here (thresholds from 2021). No office is needed.

• Information exchange:

• CRS: India's first exchange was in 2017.

• FATCA: agreement with the US in 2015.

• India's stance: India backed the Two-Pillar deal and gave up the equalisation levy [3].

Don't confuse with

• Tax evasion: this is illegal, such as hiding income or making false claims. BEPS mostly uses legal gaps and mismatches between countries' rules, so it is aggressive tax avoidance.
• Double taxation: this is the opposite problem. The same income is taxed twice, and DTAAs fix it. BEPS leads to income being taxed too little or not at all.
• Transfer pricing: this is simply the price charged between related units, and it is legal and normal. It becomes a BEPS tool only when the price differs from the arm's-length price.
• Equalisation levy vs income tax: the equalisation levy was charged on gross payments, not on profit, and sat outside the Income-tax Act [3]. SEP works inside the income-tax framework.

Prelims Hooks

• The OECD/G20 BEPS project ran from 2013 to 2015 and produced 15 actions. Action 1 covers the digital economy.
• Pillar Two: 15% minimum ETR for groups with €750 million+ revenue. Collection order: QDMTT → IIR → UTPR. The STTR is treaty-based.
• PPT entered India's DTAAs through the MLI, ratified in 2019. Trap: the MLI is an OECD tool, not a UN one.
• Equalisation levy: 6% on ads (Finance Act 2016) and 2% on e-commerce (Finance Act 2020). The whole levy ended on 1 April 2025 [3]. Trap: it was outside the Income-tax Act.
• Transfer pricing sits in Secs. 92–92F. CBDT signed a record 219 APAs in FY 2025-26 [5].
• CRS is an OECD standard. FATCA is a US law. Don't swap them.

Mains Points

• Tax sovereignty vs global coordination
• India gave up its own equalisation levy in return for a multilateral deal.
• But Pillar One has stalled, and the Side-by-Side package has weakened Pillar Two for US groups [1][2].

• So India's gains from the global anti-BEPS effort are uncertain. This strengthens the case for keeping SEP and for backing the UN tax convention track, where the negotiating committee meets from 2025 to 2027 [4].

• Tax incentives vs the 15% floor

• Tax holidays for IFSC (e.g. GIFT City) and data centres may lose value, because another country can collect the top-up tax on profit India leaves untaxed.
• India can adopt a QDMTT so that this revenue stays at home.

• It can also redesign incentives as substance-based ones (linked to real investment and jobs) or as qualified refundable tax credits, in line with the 2026 package [1].

• From disputes to prevention

• Retrospective taxes, as in the Vodafone and Cairn cases, cost India arbitration losses and hurt its image.
• Record APA numbers show a shift towards tax certainty [5].
• Together with CRS/FATCA data sharing and treaty fixes, this curbs BEPS and black money without scaring away investors. This links to GS-III themes of money laundering and black money.

Related concepts

• Tax haven
• Transfer pricing
• Double Taxation Avoidance Agreement
• Retrospective taxation
• Significant economic presence
• Equalisation levy
• Pillar One
• Global minimum tax
• Automatic exchange of information

Read more

• International taxation: treaties, profit shifting and the global minimum tax