By Rob Wagner, Chair of Praxity’s Global Tax Working Group and managing partner, National Tax Services at US-based BKD, LLP
In October last year, the OECD issued its 15 point Action Plan, recommending how to curtail multinational companies shifting profits among differing tax jurisdictions. The OECD’s report, endorsed by the G20 nations plus India, represented two years’ intensive work to tackle Base Erosion and Profit Shifting (BEPS).
Fast forward to March 2016 and in an update submitted to G20 finance ministers and Central Bank governors, the OECD reports countries are already making legislative changes in order to implement its BEPS measures, particularly points 2, 8, 10 and 13 of the Action Plans.
Nations are keen to follow the OECD’s recommendations; 32 countries have already signed the Multilateral Competent Authorities Agreement which provides the legal mechanisms to exchange automatic country-by-country reporting and more have confirmed their intention to sign this year.
Given the pace at which change is occurring, it’s important businesses know what the 15 Action Plans are, how they will be implemented and what this means for emerging economies.
In some cases, countries are already tackling the recommendations, while others already have anti-abuse rules in place; for example, the US already has rules to tackle Controlled Foreign Corporation and treaty benefit abuse etc.
As far as implementation is concerned, some measures, such as the revised guidance on transfer pricing, may be immediately applicable; others require changes to bilateral tax treaties – achieved via the multilateral instrument under Action 15.
Others require domestic law implementation. For example, Luxembourg has withdrawn its patent box regime, Ireland announced what it considers the world’s first OECD-compliant patent box regime and the UK is reviewing its patent box regime for compliance with Action 5.
The OECD confirms there will be monitoring, including targeted monitoring of the minimum standards on treaty shopping, on dispute resolution and on the implementation of country-by-country reporting.
BEPS recommendations are not legally binding. While they are soft law legal instruments, there is an expectation that countries will implement them accordingly. Areas are likely to converge over time, ie, hybrid mismatch arrangements, transfer pricing documentation and country-by-country reporting; and it appears we can look for changes to US law or regulations in these areas.
It is highly unlikely, however, the US would adopt any transfer pricing legislation that significantly deviates from the arm’s length standard currently used (indeed Actions 8-10, reaffirm a commitment to the arm’s length standard).
A post-BEPS world
Under this new framework, a key concern is whether governments will enact laws that are politically motivated and inconsistent with BEPS. An example being the UK-diverted profits tax system. Another worry is whether tax authorities around the world will be adequately staffed and trained on BEPS so that the rules are appropriately applied.
Realistically, there could be more potential conflict in a post-BEPS world with some tax authorities not accurately understanding the rules and asserting BEPS as their means for posting tax adjustments against multinational companies. Many US businesses and political leaders are concerned US taxpayers may end up subsidizing the BEPS measures as US multinationals could be subject to higher foreign tax which may be available for credit against US tax liability, thus reducing US government revenues.
There’s also concern BEPS recommendations may embolden tax authorities to overstep their bounds, forcing taxpayers to seek relief from double taxation through costly and time-consuming dispute resolution provisions. Finally, many businesses and legislators are concerned confidential information may be put at risk from competition.
Most mid-size businesses do not have overly-complicated tax structures so the impact should be minimal on these businesses. But in order to evidence their tax structures, firms will have to demonstrate compliance which brings with it additional costs. Larger multinationals with more complex tax structures will have more work to do to comply with BEPS-related law changes. Businesses should therefore seek advice early on; it will make the process simpler and reduce costs.
Country-by-country reporting is unlikely to have an initial impact on smaller and mid-size businesses as the measures have been crafted to exclude companies with revenues below a certain de minimis threshold (the new country-by-country reporting template does not apply to groups with annual consolidated revenue in the immediately preceding fiscal year of less than EUR 750 million). However, governments do have a tendency to reduce the thresholds over time with new rules creeping in.
This fairer system will be positive for emerging economies, particularly as it was perceived profits were being stripped out of developing countries and transferred to the parent company. Some advocate using formulary apportionment to determine the profits of an enterprise in a particular country, but this disregards legal distinctions, risks and functions and simply looks at a company as a single unit and divides its income based on some agreed-upon factors. Using formulary apportionment, allocating profits largely on headcount, assets etc without taking into account valuable intangibles, does not seem to be a fair way to allocate profits.
The OECD has a FAQ section on its website, available in English, French and Spanish. http://www.oecd.org/ctp/beps-frequentlyaskedquestions.htm
BKD LLP is a member of Praxity – the world’s largest alliance of independent accountancy firms www.praxity.com
OECD Action Plans
|1. Address the tax challenges of the digital economy.||Examine; a company’s ability to have a significant digital presence in another country’s economy, without being liable to tax and the attrition of value created from the generation of marketable location-relevant data via digital products and services.
Also investigate the characterisation of income derived from new business models, the application of related source rules and how to ensure the effective collection of VAT/GST following a cross-border supply of digital goods and services.
|2. Neutralise the effects of hybrid mismatch arrangements.||Design domestic rules to neutralise the effect of hybrid instruments and entities. This may include changes to the OECD Model Tax convention to ensure hybrids/entities are not used to obtain undue treaty benefits as well as domestic law provisions that (i) prevent exemption/non-recognition for deductible payments by the payor,(ii) deny a deduction for payments not included in the recipient’s income, or (iii) deny a deduction for payment that is also deductible in another jurisdiction.
Additionally where necessary, guidance will be given on co-ordination or tie-breaker rules if more than one country seeks to apply such rules to a transaction or structure.
|3. Strengthen Controlled Foreign Company rules.||Develop recommendations for the design of CFC rules; this will be co-ordinated with other work.|
|4. Limit base erosion via interest deductions and other financial payments.||Develop ‘best practice’ rules to prevent base erosion through the use of interest expense, e.g., using related and third-party debt to achieve excessive interest deductions or financing the production of exempt/deferred income and other financial payments economically equivalent to interest payments. Evaluate the effectiveness of different types of limitations and, in connection with foregoing work, develop transfer pricing guidance including the pricing of related party transactions such as financial and performance guarantees, derivatives, captive and other insurance arrangements.|
|5. Counter harmful tax practices more effectively, taking into account transparency and substance.||Revamp work on harmful tax practices and improve transparency, including compulsory spontaneous exchange on preferential regime rulings as well as requiring substantial activity for such regimes. A holistic approach is required in evaluating these regimes in the BEPS context.|
|6. Prevent treaty abuse.||Develop model treaty provisions and recommendations regarding domestic rules to prevent the growth of treaty benefits in inappropriate circumstances. Clarify tax treaties that are not intended to be used to generate double non-taxation and identify tax policy considerations before entering into a tax treaty with another country.|
|7. Prevent the artificial avoidance of Permanent Establishment status.||Develop changes to PE definition to prevent artificial avoidance of PE status in relation to BEPS, including use of commissionaire arrangements and specific activity exemptions.|
|8, 9 and 10. Assure that transfer pricing outcomes are in line with value creations.||8. Intangibles – develop rules to prevent moving intangibles among group members. This includes adopting a broad and clear definition of intangibles, ensuring profits associated with their transfer and use are allocated according to value creation, developing rules for transfers of hard-to-value intangibles, and updating guidance on cost contribution arrangements.
9. Risks and capital – develop rules to prevent risks transferring among, or allocating excessive capital to, group members. Adopt measures to ensure inappropriate returns will not accrue to an entity solely because it has contractually assumed risks or provided capital. Ensure returns align with value creation.
10. Other high-risk transactions – develop rules to prevent transactions which would not or rarely occur between third-parties. Adopt measures to clarify circumstances when transactions can be recharacterised and the application of transfer pricing methods (particularly profit splits in the context of global value chains). Protect against common types of base eroding payments, such as management fees and head office expenses.
|11. Establish methodologies to collect and analyse BEPS data and the actions to address it.||Develop indicators of the scale and economic impact of BEPS as well as tools to monitor and evaluate their effectiveness on an ongoing basis. Assess a wide-range of existing data sources, identify new types of data to collect and develop methodologies based on aggregate and micro-level data. Respect taxpayer confidentiality and tax and business administration costs.|
|12. Require taxpayers to disclose their aggressive tax planning arrangements.
|Design mandatory disclosure rules for aggressive or abusive transactions, arrangements or structures. Use a modular design to ensure consistency, allowing for country-specific needs and risks. Focus on international tax schemes and information sharing between tax administrations.|
|13. Re-examine transfer pricing documentation.||Develop transfer pricing documentation rules to enhance tax administration transparency while considering compliance costs. Require MNEs to provide governments with information related to their global allocation of income, economic activity and tax paid among countries.|
|14. Make dispute resolution mechanisms more effective.||Address obstacles preventing treaty-related disputes under Mutual Agreement Procedure, such as the absence or denial of arbitration treaty provisions.|
|15. Develop a multilateral instrument.||Enable jurisdictions to analyse the tax and public international law issues when developing a multilateral instrument and amend, where appropriate, bilateral tax treaties.|