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BEPS Approaches Key Milestone


By Tax-News.com Editorial
August 6, 2014


On July 3, 2014, New Zealand’s Revenue Minister Todd McClay revealed that the OECD has agreed the final recommendations for the first set of actions to tackle base erosion and profit shifting (BEPS) by multinational enterprises, which are due to be finalised in September. So as the BEPS project approaches a crucial juncture, this feature summarises key developments in its brief history and other issues which could have a major bearing on its outcome.


Introduction

It is unclear exactly when the term “base erosion and profit shifting” was coined to describe the tax mitigation strategies of multinationals. But it was used at the G20 conference in Mexico in November 2013 with corporate tax avoidance having been elevated to the top of the agenda that year. During this summit, the Governments of Germany and the United Kingdom issued a joint statement calling for "concerted international cooperation to strengthen international standards for corporate tax regimes."

On February 12, 2013, the OECD released its preliminary report on the problem of BEPS, which contained a series of observations about current shortcomings in the international tax system, and reaffirmed its view that current international tax standards have been left behind by changes in global business practices, especially with regards to companies which have a large presence on the internet, but a small “physical” presence on the ground and in the area of intangibles generally. The fact that it is possible to be heavily involved in the economic life of another country, for example by doing business with customers located in that country via the internet, without having a taxable presence there or in another country that levies tax on profits, was noted repeatedly throughout report.

“Domestic rules for international taxation and internationally agreed standards are still grounded in an economic environment characterised by a lower degree of economic integration across borders, rather than today’s environment of global taxpayers, characterised by the increasing importance of intellectual property as a value-driver and by constant developments of information and communication technologies,” the report stated.

The report conceded however, that the blame for BEPS may not lie exclusively with businesses. It acknowledged a prevailing sentiment among business leaders that they have a responsibility towards their shareholders to legally reduce the taxes their companies pay. "Some of them might consider most of the accusations unjustified, in some cases deeming governments responsible for incoherent tax policies and for designing tax systems that provide incentives for base erosion and profit shifting."

Furthermore, the report points out that multinationals often suffer at the hands of inadequate global tax rules, paying a greater share of taxes than should be required of them.


The BEPS Action Plan

Although the “Addressing BEPS” report acknowledged that cross-border businesses may suffer as a result of badly constructed international tax rules which can result in the double taxation of income, the BEPS Action Plan produced by the OECD in July 2013 for the G20 dealt more with the question of how to stop the double non-taxation of multinationals’ income occurring in the future.

The Action Plan contained 15 specific actions designed to give governments the domestic and international mechanisms to prevent corporations from paying little or no taxes, as follows:

  • Action 1: Address the challenges of the digital economy
  • Action 2: Neutralize the effects of hybrid mismatch arrangements
  • Action 3: Strengthen controlled foreign company rules
  • Action 4: Limit base erosion via interest deductions and other financial payments
  • Action 5: Counter harmful tax practices more effectively, taking into account transparency and substance
  • Action 6: Prevent treaty abuse
  • Action 7: Prevent the artificial avoidance of PE status
  • Action 8: Assure that transfer pricing outcomes are in line with value creation/intangibles
  • Action 9: Assure that transfer pricing outcomes are in line with value creation/risks and capital
  • Action 10: Assure that transfer pricing outcomes are in line with value creation/risks and capital
  • Action 11: Establish methodologies to collect and analyze data on BEPS and the actions to address it
  • Action 12: Require taxpayers to disclose their aggressive tax planning arrangements
  • Action 13: Re-examine transfer pricing documentation
  • Action 14: Make dispute resolution mechanisms more effective
  • Action 15: Develop a multilateral instrument

OECD Secretary-General Angel Gurría said that the Action Plan "marks a turning point in the history of international tax co-operation. It will allow countries to draw up the coordinated, comprehensive and transparent standards they need to prevent BEPS. International tax rules, many of them dating from the 1920s, ensure that businesses don't pay taxes in two countries - double taxation. This is laudable, but unfortunately these rules are now being abused to permit double non-taxation. The Action Plan aims to remedy this, so multinationals also pay their fair share of taxes."


Discussion Drafts and Consultations

After the Action Plan was endorsed by the G20 at last September's St Petersburg Summit, the first call for input from interested parties, on Action 7, abuse of permanent establishment status, was made in October. Action 7 calls for changes to the definition of PE to prevent the artificial avoidance of PE status in relation to BEPS, including through the use of commissionnaire arrangements and the specific activity exemptions. Work on these issues will also address related profit attribution issues.

In November the OECD requested comment regarding the OECD's work on tackling the challenges posed by the digital economy. The consultation in particular asked businesses how the Internet and new technologies have impacted their business models; the location in which value is created or monetized; what challenges are encountered when attempting to establish the location and extent of tax liability; and how business models and supply chains may evolve in the future due to advances in information technology. Consistent with its statement in this report, the consultation aims to "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." 

The BEPS project has had a heavy emphasis on transfer pricing. In this area, the Action Plan directs the OECD to develop a system of country-by-country reporting of group financial information about high-level Multinational Enterprises to tax authorities. On January 30, 2014, the OECD released its Discussion Draft on Transfer Pricing Documentation and Country-by-Country Reporting which included its proposal for a two-tier standardized format on transfer pricing documentation. The idea is that the master file would be in English while the local file could be in the local language. 

In March, three additional discussion drafts appeared on the following matters: prevention of treaty abuse; neutralizing hybrid mismatch arrangements; and the tax challenges of the digital economy. A further consultation on transfer pricing documentation and country-by-country reporting was launched in April and in May, a public consultation meeting was held at the OECD Conference Centre in Paris on neutralizing hybrid mismatch arrangements.

Generally, the response of the global business community to the BEPS Action Plan, as indicated by the various consultations and discussion drafts, has been cautious, with several respondents warning that the proposals will be difficult to implement and challenging to administer, may hinder international trade and have wider implications for the tax sovereignty of nations.


Developing Countries

Recently, attention has turned towards the potential impact of BEPS on developing countries and the capacity of these countries to implement the forthcoming recommendations.

On August 1, 2014, the OECD published part one of a report that seeks to map the impact of base erosion and profit shifting on low income countries.

The report highlights the numerous challenges faced by developing countries in tackling BEPS:

  • Some developing countries lack the necessary legislative measures needed to address BEPS;
  • Developing country measures to challenge BEPS are often hindered by a lack of information;
  • Developing countries face difficulties in building the capacity needed to implement highly complex rules and to challenge well-advised and experienced multinational enterprises; and
  • The lack of effective legislation and gaps in capacity may leave the door open to simpler, but potentially more aggressive tax avoidance than is typically encountered in developed economies.

As part of its interim conclusions, the report states: "BEPS has the potential to considerably impact on domestic resource mobilization in developing countries. The risks faced by many developing countries, however, may differ from those faced by more advanced economies. For these reasons, developing countries have highlighted some of the action items in the Action Plan are of more relevance than others."

However, the OECD’s approach to this issue has also attracted a great deal of criticism. For instance, in April 2014, the BEPS Monitoring Group (BMG), a network of international tax specialists, published a report expressed concern about the unsuitability of transfer pricing methodologies for developing countries proposed in the OECD Report, which was released for consultation in March.

The BMG warned that the use of methods based on "comparable profits" or "comparable prices" will likely lead to "over or under taxation."


United States

Obviously, if the BEPS project is going to have any chance of success then it must be wholeheartedly supported by the world’s largest economy, the United States. However, the signals coming out of the US Congress aren’t encouraging for the OECD.

In May 2014, two senior figures on the Congress’s tax committees released a statement questioning the current path of the Organisation for Economic Cooperation and Development's (OECD) work on base erosion and profit shifting (BEPS). 

As the OECD held a BEPS conference in Washington, Representative Dave Camp (R – Michigan) and Senator Orrin Hatch (R – Utah), expressed their concern that its project "is now being used as a way for other countries to simply increase taxes on American taxpayers."

"When foreign governments – either unilaterally or under the guise of a multilateral framework – abandon long-standing principles that determine taxing jurisdiction in a quest for more revenue," they stated, "Americans are threatened with an un-level playing field. Such actions put pressure on the US government to respond by asserting taxing authority over foreign activity generating US-source income on similar grounds."

Testifying before the United States Senate Committee on Finance on July 22, 2014, Pascal Saint-Amans, head of the OECD's Center for Tax Policy and Administration indicated that full US participation in the BEPS project would be crucial if it is to succeed.

"If only a small number of countries attempt to solve BEPS, they may in fact further jeopardize their tax base as businesses move to jurisdictions that have not yet implemented preventive measures or that choose not to do so in order to gain a competitive advantage," he observed.

President Barack Obama is supportive of the BEPS project, and most Congressional Democrats are likely to follow the Government line on this issue. Yet as we have seen over the course of the last couple of years, Congress is deeply divided on tax issues and the Republican majority in the House of Representatives has prevented the President from forcing through his own legislative agenda. It is not going to be remotely easy therefore, for America to pass the necessary laws recommended by the OECD to prevent BEPS, and the country will only become more resistant to the project if there is an electoral swing towards the Republicans this November.


Deliverables

The Action Plan’s timetable is extremely tight. The OECD anticipates that the 15 actions will be finalised in three stages: September 2014, September 2015 and December 2015. Since the OECD wants the BEPS project wrapped up by the end of next year, this will leave just over a year for some potentially fundamental tax changes to be implemented across the world.

In May 2014, the OECD published a note showing how much progress is being made towards these ambitious deadlines.

The note identifies a total aggregation of 19 BEPS deliverables to be produced by the OECD over the course of three years until December 2015, in the form of reports, recommendations, changes, rules, and strategies. The remaining BEPS deliverables for 2014, planned for delivery by September 2014, include:

  • A report identifying tax challenges raised by the digital economy and the necessary actions to address them (Action 1);
  • Recommendations regarding the design of domestic and tax treaty measures to neutralize the effects of hybrid mismatch arrangements (Action 2);
  • The completion of the review of member country regimes in order to counter harmful tax practices more effectively (Action 5);
  • Recommendations regarding the design of domestic and tax treaty measures to prevent the abuse of tax treaties (Action 6);
  • Transfer pricing rules in relation to intangibles – phase 1 (Action 8);
  • Transfer pricing documentation and country by country (CbC) reporting template (Action 13); and
  • A report on the feasibility of a multilateral instrument to implement BEPS measures (Action 15).

According to the note, "the work to progress the deliverables on BEPS is now being undertaken at a rapid pace."

However, even the OECD has admitted that its chosen timetable is “extremely ambitious”. Indeed, many tax executives at many US multinational companies do not believe the OECD has allowed adequate time to accomplish the plan’s goals, according to a recent survey.

The survey of 220 US senior tax professionals by KPMG, which was conducted prior to the firm’s Cross-Border Tax Conference in Miami on May 6-8, 2014 revealed that 64 percent of respondents think that the OECD’s 24-month timetable was not sufficient to address concerns regarding profit shifting or “double non-taxation” and provide a “level playing field” among tax systems and taxpayers. Only 21 percent were positive on the issue of timing.

Similar conclusions were drawn from a recent survey of business leaders globally by Grant Thornton. Out of 3,000 businesses who took part in the survey across 40 countries, only 19 percent expect the BEPS Action Plan to have the desired effect.The survey reveals that although there was a great sense of countries working together at the start, some countries are stepping back from consensus as the BEPS project progresses. It indicates a widely held expectation that many countries may selectively implement only the changes that suit them, giving rise to added complexity and compliance burdens for business.

“It's as if, in an attempt to get rid of some traffic black spots, the authorities have decided to overhaul the entire road network and require every driver to modify their car,” observed Greg Thompson, Partner and National Director for Tax at Grant Thornton New Zealand. “Mid-size companies are going to be swept up in the tide of the changes and face extra work in complying, even though they're often not the ones using the avoidance schemes the Action Plan is seeking to eliminate."

Nevertheless, while tax leaders may be sceptical about the OECD’s bold timelines for BEPS, the reality is that with the significant political demand for immediate action, the deadlines are not likely to change.

What is less certain is what the post-BEPS international tax landscape will look like. But it’s shaping up to be a highly uneven playing field.

 

Tags: tax | business | transfer pricing | multinationals | standards | G20 | United States | Tax | environment | interest | New Zealand | internet | tax avoidance | intellectual property | United Kingdom | trade | professionals | legislation | tax planning | law | compliance

 

 

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