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Substance and transparency in the context of the BEPS developments

Oliver Wehnert and Ivo Tankov of EY focus on the issue of substance and transparency.

Significant changes in the international tax scene have arisen throughout 2013 and 2014. The release of the action plan on base erosion and profit shifting in July 2013 (BEPS action plan) clearly set the direction in which the discussion between national ax authorities and multinational enterprises (MNEs) will be heading. According to the latest BEPS OECD webcast, broadcasted on May 26, the BEPS initiative focuses on several themes specifically: coherence, substance and transparency. In our article we would like to focus and further analyse the aspect of substance in the context of the BEPS action plan discussions. We will begin by examining the BEPS action plan contents in the context of the substance issue as well as the corresponding developments pertaining to the new transfer pricing documentation approach set forth by the OECD, and finally concluding with a German perspective on the substance developments.

Substance in the BEPS action plan and its significance

In line with OECD discussions, member states have been increasingly focusing on the issue of substance and the location of companies in so-called preferential tax jurisdictions. Tax authorities, often through the use of the EU Directive on Mutual Assistance as well as double tax treaties, will exchange information on the types of activities taking place in various jurisdictions with the intention of analysing whether an MNE's supply chain value drivers are indeed located in the so-called preferential tax regime jurisdictions or not. Another method that is often applied by tax authorities is the application of local controlled foreign company rules (CFC) which allow local authorities to examine the MNEs in the context of substance. Depending on the jurisdiction, tax authorities may choose to apply CFC rules when there is no economic substance, for instance when profit has not been allocated in accordance with supply chain value drivers and/or if a subsidiary is located in a tax preferential jurisdiction as stipulated by local tax law. In these cases the CFC rules would allow the local tax authorities to apply local corporate tax rates to the income allocated to the subsidiary lacking substance thereby making the subsidiary transparent for local tax purposes. The issue of substance has been specifically addressed in actions five through to 10 of the BEPS action plan.

Action five the BEPS action plan stipulates that harmful tax practices need to be countered through increasing tax authority cooperation, transparency and substance analysis. Instruments such as compulsory exchange of court rulings between tax authorities and uniform requirements for significant substance in preferential tax jurisdictions should be applied to effectively minimise harmful tax practices. Furthermore, the BEPS action plan stipulates that rules which are already in place often will not take into account the use of multiple layers of legal entities such as branches that allow for the legal re-allocation of profits to tax preferential jurisdictions. Double tax treaties should also be modified to ensure that treaty shopping situations leading to a double non-taxation are avoided.

Treaty abuse is further expanded upon in action six, where the development of model treaty provisions preventing the granting of treaty benefits in false circumstances is carried out. This would ultimately lead to making sure that double tax treaties are not used for double non-taxation. Essentially the overall definition of a permanent establishment (PE) needs to be modified in such a way whereby abuses would not take place. The example used by the OECD is the use of commissionaire structures, by MNEs, instead of local distribution entities to shift profits resulting from local sales out of the country in which the sales were made. The BEPS action plan specifically argues that these profit shifts take place without a significant functional profile alteration of the activities previously carried out by local distribution entities.

The OECD examines the issues of artificial PE status avoidance in Action 7. The BEPS action plan argues that MNEs, often through the use of inappropriate transfer pricing mechanisms (intangibles transfer and/or over capitaliaation of low taxed subsidiaries), will tend to separate profit from the value generating economic activities and will then shift these profits to tax preferential jurisdictions. A potential resolution to this problem, as suggested by the OECD, could be the application of formula based systems that would allocate profit in an exact way leaving no room for interpretation. The ongoing discussions pertaining to the new transfer pricing documentation approach including the country-by-country reporting template could also open the door to further discussions on applying a formulaic profit allocation system to intercompany transactions.

Actions eight through to 10 of the BEPS action plan have been grouped together as they pertain to transfer pricing principles and the appropriate allocation of profits by ensuring the accurate amount of economic substance in each legal entity participating in intercompany transactions. Clear definitions of intangibles as well as hard-to-value intangibles and the corresponding profit allocated to these items need to be aligned with the value drivers of an MNE's supply chain. Furthermore a further analysis on risk and capital allocation should be carried out, according to action nine, to ensure that profits are not allocated to entities simply because these entities have contractually assumed risks for any given transaction. Action 10 further elaborates on ensuring that transactions that would rarely take place between third parties are thoroughly examined, that profit splits should be analysed in the context of global value chains and that protection against BEPS behaviour such as head office as well as management fee charges is avoided.

Transparency under the BEPS action plan and transfer pricing documentation developments

Action 10 further elaborates on the issue of transparency which seems to go hand in hand with the theme of economic substance. The OECD states that transparency is required at all levels to prevent BEPS. Furthermore, taxpayers should disclose more targeted information including their tax planning strategies. The OECD refers to several studies and data sources that have indicated there is a disconnect between the location where value creating activities are taking place and where the corresponding profits are actually taxed. As a result of the aforementioned hypothesis the OECD began investigating possibilities that would allow for greater transparency on the level of the transfer pricing documentation with a specific country-by-country reporting template being developed to provide a better understanding of the value driving functions and their corresponding locations.

Substance and transparency was further discussed by the OECD in May of this year during the public consultation meetings between representatives of the OECD, non-governmental organisations (NGOs) and business. In accordance with the latest live webcast carried out by the OECD, the organisation has gathered 183 comment papers and more than 1,400 pages of comments from various organisations on their suggested approach for transfer pricing documentation as well as the corresponding country-by-country reporting template. Furthermore, an agreement on a three-tier approach using the country-by-country reporting template, master file and local file has been reached.

The transfer pricing documentation developments including the country-by-country reporting template can be seen as a direct result of the substance discussions first published in July of 2013. The OECD is taking the necessary steps to ensure that the subsidiary substance of MNEs can be tracked in the context of their global activities. Although the OECD has time until September 2014, MNEs should closely monitor the transfer pricing documentation and country-by-country template developments because these will certainly have an impact on their compliance as well as tax planning policies.

German approach and concluding remarks

The German Ministry of Finance (GMF) has been a strong supporter of the BEPS action plan and has provided significant input during the plan's preparation process. Germany has strongly supported, and also assisted with, the development of the BEPS action plan, from both a tax as well as a political standpoint. The coalition agreement signed in 2013 by the three largest German political parties – CDU, CSU and SPD – further outlined the political support for the BEPS action plan both in terms of MNEs as well as banking sector transparency. It is important to mention, however, that Germany already has a significant amount of local tax regulations in place, which allows for a high degree of transparency and substance determination.

Article 4 of the German regulations regarding the documentation of profit allocations already requires some of the information described in the new OECD transfer pricing and country-by-country template approach such as, for example, a list of intangible goods that the taxpayer owns and uses (Article 4.2b). Other tax law allows the German tax authority to request full tax and financial information from companies headquartered in Germany. Furthermore double tax treaty provisions, as well as the EU Directive on Mutual Assistance, make it possible for tax authorities (TAs) in Germany to request additional financial information from foreign TAs.

Even though the German Tax Law already has in place several mechanisms that allow for increased transparency and substance monitoring, for example through the local CFC rules, the OECD developments that have taken place in the last year will most likely allow for the further expansion of the local tax regulations in an effort to more effectively monitor cross border transactions.

Germany, as one of the world's leading export nations, also possesses several MNEs as well as small and mid-sized enterprises, which may potentially be affected by the current OECD developments. Over the past five years the percentage of tax to GDP revenue in Germany, according to OECD's statistical website, has remained relatively stable with fluctuations of roughly 1%. Furthermore, it is important to note that the tax revenue in Euros has, in fact, been steadily increasing since 2009. Based on the OECD's figures, despite remaining competitive on a global level, German companies do not seem to be engaged in overly aggressive tax planning with much of the taxable profit remaining in Germany as may be suggested by a historically high tax to GDP revenue percentage in 2012.

In spite of the aforementioned statistical results, current OECD developments may have an impact on all corporate German taxpayers if the new transfer pricing documentation and country-by-country reporting template would be adopted in to local law. It is important to note that under the current BEPS approach many corporate taxpayers may have to invest further time into re-analysing their international tax policies as well as future tax planning projects to ensure they are BEPS compliant. The BEPS action plan has laid out a set of deadlines for the substance developments to take place in the near future. For this reason it is particularly important that MNEs, not only in Germany, follow the developments pertaining to substance as well as transparency set to take place between September 2014 and December 2015.

Oliver Wehnert



Partner - ITS transfer pricing – EMEIA TP leader & head of practice GSA

Ernst & Young

Tel: +49 211 9352 10627


Oliver Wehnert is an international tax partner in the Düsseldorf office of EY. He is EY's EMEIA transfer pricing leader and also heads EY's transfer pricing practice in Germany, Switzerland and Austria. He joined EY in 1998 after spending six years at PwC. He is a certified tax consultant and completed his MBA at the University of Paderborn in 1992.

Oliver Wehnert has vast experience in client services on transfer pricing design, international tax planning for intangible transfers, operating model effectiveness projects as well as controversy cases in scope of mutual agreement procedures and bi- and multi-lateral advance pricing agreement projects. Oliver Wehnert is focused on German based multinational enterprises interacting with their subsidiaries in particular in North America, Asia & Pacific as well as Europe. His biggest clients are multinational enterprises in the pharmaceutical, chemical, consumer products and automotive industry.

Ivo Tankov



Manager - ITS transfer pricing

Ernst & Young

Tel: +49 211 9352 13996

Ivo Tankov is a transfer pricing manager within EY's EMEIA and GSA transfer pricing team. Ivo has been specialising in large scale projects including APAs, business restructurings and global transfer pricing documentation for both German DAX 30 and US Fortune 100 multinationals. Before joining the EY team in Germany, Ivo had also worked in the Big 4 consulting sector in Poland participating in projects for some of the largest Polish companies on the Warsaw Stock Exchange. Fluent in four languages he holds degrees from Boston University and Northeastern University and has also participated in government and business programmes at Tufts University, Harvard University and the University of Chicago Booth School of Business. Co-author of various articles on transfer pricing for several magazines, Ivo also works in the area of corporate operating model effectiveness.

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