While Companies are determining how the economic substance regulations applies to them, it is also very important to understand why the need to introduce economic substance regulations arouse.This article will set out the circumstance and situations that led to the introduction of Economic Substance regulations.
With introduction of Globalization, economies and markets have increased substantially in recent years. The Free movement of capital and labour, the shift of manufacturing base from high cost to low cost locations, the gradual removal of trade barriers, and technological and telecommunication developments are the examples of globalizationthataffected the way business are structured and managed.
Globalization has resulted in a shift from country specific operating models to global level. Moreover, development in information technology and growing use of internet have made it possible for the businesses to sale, market and advertise their product in geographical locations that are far from the actual locations of the business.
Many studies about base erosion and harmful tax practices has observed that there is increased segregation between the location where actual business activities and investment take place and the profits are reported for Tax purposes.
Many companies have started shifting their profits from High tax jurisdiction to low harmful tax regime. There are four factors which need to be considered in order to determine whether a preferential regime is potentially harmful:
Let us take example of harmful tax practices:
The changes in business practices brought about by globalization and digitalization of the economy have raised the question among the governmentsabout whether the domestic and international tax rules have kept pace with those changes. The government has come to realize that tax world is changing.
As per Data given by the organization for Economic Co-operation and Development (OECD), the harmful tax practices cost countries 100-240 billion USD in lost revenue annually, which is the equivalent to 4-10% of the global corporate income tax revenue.
To prevent harmful tax practice and to cop up with the changes brought about by globalization and digitalization,OECD has promoted dialogue and co-operation between governments on tax matters for years and came up with the solution with introduction of “Base erosion and profit shifting” (BEPS)tax strategies which exploit gaps and mismatch in rules to avoid paying tax.Under BEPS tax strategies 15 measures has been introduced to tackle tax avoidance and ensure a more transparent tax environment.
As per BEPS Actions 5 i.e. harmful tax practices, Economic substance regulations came into the existence. Economic substance regulation will ensure that mobile business income cannot be parked in a zero-taxjurisdiction without the core business functions having been undertaken by the samebusiness entity, or in the same location.
In order to make positive progress towards meeting the EU’s requirements and to be removed from the EU list of non-cooperative jurisdictions for tax purposes (the EU blacklist), the UAE introduced Economic Substance Regulation via Cabinet of Ministers Resolution No.31 of 2019, the “Regulations” on 30th April 2019.
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