BASE EROSION PROFIT SHIFTING (BEPS)

Paul Fay, Head of Property Tax, Crowe Clark Whitehill

Recent years has seen significant media coverage of the tax affairs of large multinationals and particularly concerns over whether they are able to artificially shift profits to low tax jurisdictions.

The tax rules in nearly all jurisdictions are very complex and largely evolved in a pre digital economy era.  Domestic tax laws are not necessarily coordinated across different territories, and have not kept up to date with commercial developments, potentially opening up opportunities for international groups to move profits to territories where they face lower tax rates. It has been estimated that cross border tax planning activities by multinationals costs governments between US $100-240 billion a year.

In response to these concerns, the Organisation for Economic Co-operation and Development (OECD) last October published their recommendations in relation to Base Erosion and Profit Shifting (BEPS). The OECD’s findings run to some 2000 pages and represent a major change to the international corporate tax landscape. The changes are likely to affect all corporate groups that work cross border.

The OECD’s findings are set out in the form of 15 Actions which aim to minimise profit shifting through a variety of methods. Detailed consideration of the full recommendations is outside the scope of this article but some of the key issues addressed include.

• Hybrid mismatches: differences between tax systems in the various countries make it possible to design structures that give a tax deduction in one territory with no corresponding income in the other, or multiple tax deductions. These arrangements will be addressed.

• Interest deductions: to prevent using interest flows to artificially depress taxable profits, the OECD is recommending that interest deductions should be restricted to a proportion of Earnings Before Interest Tax Depreciation and Amortisation (EBITDA). The suggested proportion is in the range 10-30%.

• Treaty abuse: double tax treaties will include new tests to ensure they are not being used to aid avoidance. This is likely to include purpose tests and/or limitation of benefits rules, with a view to ensuring that treaty reliefs are focussed on genuine commercial situations.

• Permanent Establishments: there are significant changes to the definition of what constitutes a taxable presence. Under current law, where a company has a branch in another territory it is generally only taxable in that other country where it has the power to conclude contracts. It is proposed that this is extended to include scenarios where the overseas branch habitually pays a principal role leading to the conclusion of contracts. The tests on whether storage facilities or preparatory activities give rise to a taxable presence are also tightened.

• Intangibles and Transfer Pricing: intangibles is a difficult area. It is often difficult to value intangibles or to say where they belong, particularly where they have been developed across a number of territories. There is a proposed focus on which entities develop, enhance, manage, protect and exploit the assets rather than who legally owns them, with the conduct of parties more important than the contractual arrangements. This could significantly affect arrangements where intangibles have been put into low tax jurisdictions, but little real development or management is done there.

In relation to management charges, the OECD has made a distinction between low value services which are of a supportive nature, not part of the core business, do not recognise the use of unique and valuable intangibles or do not involving the assumption or control of substantial or significant risk. These services could fall within ‘safe harbour provisions’ and a 5% mark-up could be applied. For high value services which drive the business strategically and tactically a more objective decision will need to be made about how to value them.

• Country by Country Reporting: will include annual country by country reporting including revenue, profit, tax, number of employees and tangible assets.

In the UK, this will apply for accounting periods commencing on or after 1 January 2016 with the first information due on 31 December 2017. Groups with turnover of more than £750 million will be caught. UK subsidiaries of such groups will be required to provide their share of the information.

These are major changes which will affect many corporates. Those affected should be considering their impact at an early stage.