On July 19 2013, the Committee on Fiscal Affairs (CFA) of the OECD published its action plan to address base erosion and profit shifting (BEPS). The action plan follows from directives given to the CFA by the G20 group of countries to better address global corporate taxation and builds upon the general concepts set forth in the OCED report on BEPS issued in January 2013.
The action plan asserts that "the BEPS project marks a turning point in the history of international co-operation on taxation". The plan calls for the OECD to issue guidance or action items in the Autumn of 2014 and to publish guidance on all action plan items in 2015.
The OECD CFA action plan on BEPS calls for a broad-based international effort to combat a comprehensive range of international tax reduction techniques. The action plan will require coordinating individual OECD member (and non-member) country actions on an individual country (for example, changes to legislation, regulations, administrative practices), bilateral (for example, changes to bilateral treaties), or multilateral (for example, multilateral treaties, changes to OECD guidelines) basis on a scale that is without precedent. The action plan has the support of the finance ministers of the G-20 group of the world's largest economies. Besides OECD member countries, G20 group countries actively participating in the BEPS project include China, India, Brazil, Russia and South Africa.
The CFA members have reached the following general conclusions with respect to BEPS:
- Fundamental changes are needed to effectively prevent double non-taxation, as well as cases of no or low taxation associated with practices that artificially segregate taxable income from the activities that generate it.
- New standards must be designed to ensure the coherence of corporate income taxation at the international level.
- A realignment of taxation and relevant substance is needed to restore the intended effects and benefits of international standards, which may not have kept pace with changing business models and technological developments.
- The actions implemented to counter BEPS cannot succeed without further transparency, nor without certainty and predictability for business.
The BEPS action plan sets forth 15 general areas for further action by OECD member and non-member interested countries. These 15 steps and a brief summary of each are set forth below:
1. Address the tax challenges of the digital economy
Identify the main difficulties that the digital economy poses for the application of existing international tax rules and develop detailed options to address these difficulties, taking a holistic approach and considering both direct and indirect taxation.
2. Neutralise the effects of hybrid mismatch arrangements
Develop model treaty provisions and recommendations regarding the design of domestic rules to neutralise the effect (for example, double non-taxation, double deduction, long-term deferral) of hybrid instruments and entities.
3. Strengthen CFC rules
Develop recommendations regarding the design of controlled foreign company rules.
4. Limit base erosion via interest deductions and other financial payments
Develop recommendations regarding best practices in the design of rules to prevent base erosion through the use of interest expense, for example through the use of related-party and third-party debt, to achieve excessive interest deductions or to finance the production of exempt or deferred income, and other financial payments that are economically equivalent to interest payments.
5. Counter harmful tax practices more effectively, taking into account transparency and substance
Revamp the work on harmful tax practices with a priority on improving transparency, including compulsory spontaneous exchange on rulings related to preferential regimes, and on requiring substantial activity for any preferential regime.
6. Prevent treaty abuse
Develop model treaty provisions and recommendations regarding the design of domestic rules to prevent the granting of treaty benefits in inappropriate circumstances.
7. Prevent the artificial avoidance of PE status
Develop changes to the definition of PE to prevent the artificial avoidance of PE status in relation to BEPS, including through the use of commissionaire arrangements and the specific activity exemptions.
8, 9 & 10: Assure that transfer pricing outcomes are in line with value creation
Develop rules to prevent BEPS by moving intangibles among group members.
9. Risks and capital
Develop rules to prevent BEPS by transferring risks among, or allocating excessive capital to, group members.
10. Other high-risk transactions
Develop rules to prevent BEPS by engaging in transactions which would not, or would only very rarely, occur between third parties.
11. Establish methodologies to collect and analyse data on BEPS and the actions to address it
Develop recommendations regarding indicators of the scale and economic impact of BEPS and ensure that tools are available to monitor and evaluate the effectiveness and economic impact of the actions taken to address BEPS on an ongoing basis.
12. Require taxpayers to disclose their aggressive tax planning arrangements
Develop recommendations regarding the design of mandatory disclosure rules for aggressive or abusive transactions, arrangements, or structures, taking into consideration the administrative costs for tax administrations and businesses and drawing on experiences of the increasing number of countries that have such rules.
13. Re-examine transfer pricing documentation
Develop rules regarding transfer pricing documentation to enhance transparency for tax administration, taking into consideration the compliance costs for business.
14. Make dispute resolution mechanisms more effective
Develop solutions to address obstacles that prevent countries from solving treaty-related disputes under MAP, including the absence of arbitration provisions in most treaties and the fact that access to MAP and arbitration may be denied in certain cases.
15. Develop a multilateral instrument
Analyse the tax and public international law issues related to the development of a multilateral instrument to enable jurisdictions that wish to do so to implement measures developed in the course of the work on BEPS and amend bilateral tax treaties.
The action plan sets forth an aggressive timeline, with deadlines that generally range from 12 to 24 months.
Nearer terms goals (September to December 2014) include actions relating to:
Hybrid mismatch arrangements, treaty abuse, transfer pricing of intangibles, documentation requirements for transfer pricing purposes, a report on identifying issues raised by the digital economy and possible actions to address them, and part of the work on harmful tax competition.
Actions to be delivered in two years (September 2015) include:
CFC rules, interest deductibility, preventing the artificial avoidance of PE status, the transfer pricing aspects of intangibles, risks, capital and high-risk transactions, part of the work on harmful tax practices, data collection, mandatory disclosure, and dispute resolution.
Actions that may require more than two years include:
The transfer pricing aspects of financial transactions, part of the work on harmful tax practices and the development of a multilateral instrument to implement changes to bilateral tax treaties.
Country-by-country reporting (CbCR)
Action Item 13, CbCR, is perhaps the most controversial agenda item under the BEPS action plan. A preliminary report issued earlier this year by the OECD CFA recommends that a multi-tiered system of transfer documentation be adopted by OECD members and BEPS participating countries. Under this approach, transfer pricing documentation would consist of:
- Local country documentation that would support that controlled party transactions that affect a specific country's tax base were conducted at arm's-length.
- A master file transfer pricing report containing information on a company's global transfer pricing policies and positions.
- A transfer pricing template that would provide global details, among other things, of the location of employees, assets and taxes paid by country and business line.
Business groups commenting on the proposed CbCR recommendations have raised serious concerns over the increased burdens that will be imposed on business to comply with the proposals, as well as with the confidentiality of sensitive, non-public business information (such as business segment information) that would be required to be disclosed. In addition, many wonder whether the information being required regarding the location of employees and assets is necessary to enforce arm's-length transfer pricing rules or, rather, is a first step towards recommendations to adopt a global formulary apportionment of income tax.
Some business groups argue that, rather than filing a master report and CbCR template with all countries where the company does business, the parent company instead should file the information with the tax authority in the parent company's home jurisdiction, and that this jurisdiction should share the information with other countries under the information exchange provisions of the jurisdiction's bilateral tax treaties.
According to published reports, the US favours the treaty disclosure approach because of the protection afforded to companies under treaty confidentiality rules. However, the CFA is still discussing the best way for countries to obtain the template and master file and the CFA has yet to make a final decision.
Selective country reactions to BEPS
Given the commitment of G20 Finance Ministers and Heads of State to the goals of the BEPS project it is not surprising that some countries have already begun adopting steps to react to the BEPS initiative.
Ireland passed a law eliminating double Irish stateless structures, which were perceived as an example of the type of legal framework that facilitated BEPS. Under the new legislation, companies incorporated in Ireland, which are managed and controlled in another country, will be treated as tax resident in Ireland unless such companies are tax resident in the country where they are managed and controlled. Notwithstanding enactment of this legislation, Ireland has no plans to increase the 12.5% general corporate tax rate or to eliminate the Irish non-resident tax regime.
The Netherlands has codified substance requirements for obtaining treaty benefits, including requiring declarations regarding substance on tax returns.
Because of concerns that it may run afoul of rules on harmful tax practices, Switzerland has indicated it will move away from granting cantonal tax rulings. However, Switzerland may replace such rulings with an IP Box regime, similar to the UK Patent Box regime.
The French government published a commissioned report written by two economists, which recommended that the treaty definition of a permanent establishment (PE) be expanded to include users of social media websites.
The Italian parliament passed legislation requiring that Italian companies purchase internet advertisements from companies registered for Italian VAT. Due to controversy engendered by this law, Italy first delayed implementation of, and then repealed the law.
Australia has strengthened its general anti-avoidance rules, modernised its transfer pricing regime, and now requires publication of taxes paid by the largest Australian companies.
US reactions to BEPS
US reactions to BEPS have largely been in the form of comprehensive tax reform proposals. In the past few years, President Obama has made a number of tax reform proposals and members of congress have held many tax reform related hearings. The tax reform plans generally involve lowering the US corporate income tax rate to some level in the mid-20% range, while overhauling the international tax system to eliminate the lock-out effect that occurs under current US tax rules that discourage US multi-nationals from repatriating foreign earnings and profits. Most pundits think that comprehensive US legislation to reform the system for taxing non-US income of US multi-nationals will be enacted in 2015.
A number of likely proposals to be included in final legislation (with modifications) include:
A repatriation holiday
A one-time mandatory 8.75% tax imposed on US shareholders (10% or more) of their foreign subsidiaries' earnings and profits accumulated since 1986 that have not previously been subject to tax. Non-cash earning reinvested in plant, property and equipment would be taxed at 3.5%. The tax could be paid in installments over eight years and foreign taxes paid on the earning would be credited against this tax.
A participation exemption
95% of dividends paid by foreign corporations to US corporate shareholders (10% or more) would be excluded from US income. At a 25% statutory rate, this provision results in a 1.25% effective tax rate on foreign earned income. Indirect foreign tax credits would no longer be allowed with respect to dividends paid to US shareholders.
US shareholders would be taxed under Subpart F on their, and their controlled foreign corporations' (CFC), foreign base company intangible income (FBCII) at a reduced 15% rate. FBCII is defined as the excess of a CFC's gross income over 10% of CFC's adjusted basis in depreciable tangible property. An exception to taxation of FBCII would apply for income subject to foreign tax at a rate of 15% or greater.
US corporations denied an interest deduction under §163(j) can no longer carry it forward. Also, the threshold for "excess interest expense" is reduced from 50% to 40% of adjusted taxable income
US withholding tax would not be reduced or eliminated if the payment is deductible in the US and both the payor and payee are controlled by the same foreign parent.
What it all means and what multinationals should do now
The BEPS project is aimed at low-taxed or non-taxed profits that have been artificially shifted away from the jurisdictions where value is being created – not at low taxed profits per se. Therefore, it should be possible, even after the BEPS recommendations are adopted, to support low-taxed profits, provided significant value-creating activities are conducted in tax-favorable jurisdictions. Although many countries will jump the gun and implement anti-BEPS initiatives before all the OECD work is completed, most of the BEPS action plan items will require local jurisdictions to adopt changes in laws, regulations or treaties. Multinationals should therefore monitor these develops to make sure that their views are heard and taken into account before final changes to existing rules and procedures are made.
In this vein, multinationals should expect:
- CbCR disclosures of complete taxpayer structures and legal entity profits to all relevant tax authorities;
- Increased tax controversy, including more tax authority assertions of PE issues;
- New country restrictions on the use of hybrid entities and hybrid transactions;
- Some enhanced US CFC rules, perhaps accompanied by some sort of territorial system; and
- Enhanced taxpayer reliance on tax treaty networks to eliminate the potential for increased double taxation.
The OECD plans to invite comments from business and civil society representatives as the action plan is implemented.
|Michael F Patton|
2000 Avenue of the Stars, Suite 400 North Tower
Mike Patton is a partner in DLA Piper's tax practice, based in Los Angeles. He focuses his practice on international transfer pricing.
Mr. Patton has assisted many multinational corporations in a variety of industries in resolving IRS or foreign tax authority transfer pricing and other tax disputes as well as in planning major cross-border transactions. He was instrumental in obtaining the world's first advance pricing agreement and he has assisted clients in negotiating more than 100 APAs.
Mr. Patton was previously an attorney in the IRS Chief Counsel's Office where he had national responsibility at IRS for technical issues, regulations and litigation of cases relating to transfer pricing. Mr. Patton was editor of, and a major contributor to, the Treasury/IRS Transfer Pricing White Paper. The White Paper laid the theoretical ground work for the profit-based transfer pricing methods adopted by the US and the OECD.
Mr. Patton has been named one of the Best of the Best US transfer pricing advisers as well as one of the leading Asia Pacific tax advisers by Euromoney and the Legal Media Group. He is an editorial advisory board member of Tax Management and is the author of the BNA portfolio Treatment of Advance Pricing Agreements.
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