The OECD Action Plan on Base Erosion through Profit Shifting (BEPS) is picking up momentum. This issue of Tax Adviser Update summarises the five discussion drafts released to- date and the likely impact on businesses.
Action 1 - Address the Tax Challenges of the Digital Economy
The discussion draft was released on 24 March 2014 with recommendations to address international taxation concerns raised by the speed of the conversion to a digital economy (the “Discussion Draft”). The paper commences with a useful comparison of the main changes that are relevant in comparison to the historic regime including:
1. The mobility of intangible assets, users and business functions
2. Greater reliance on data
3. The impact of network effects
4. The use of multi-sided business models
5. Tendency towards monopoly or oligopoly
The discussion draft recognises that many key issues will be addressed in part by other BEPS Actions (including treaty abuse, intangibles and transfer pricing outcomes). There will also be some overlap with ongoing OECD guidance on the place of taxation for B2B supplies.
There are recommendations to changes in guidance relating to permanent establishment exemptions and the introduction of a “tax nexus” principle based on digital presence/activities. The concept of a virtual fixed place of business is also considered.
Action 2 - Neutralise the Effects of Hybrid Mismatch Arrangements
Two discussion drafts were released on 19 March 2014 to counter tax advantages created by hybrid entities/instruments. These two drafts recommend (i) changes to domestic laws and (ii) amendments to the OECD Model Tax Convention respectively.
The main recommendation in the first discussion draft is that jurisdictions implement a two link rule (primary and secondary) to prevent effective non-taxation under hybrid mismatch arrangements. If the first rule denies deductions where income is not taxed as ordinary income with the payee, then the secondary rule would require the income to be included in the payee's taxable income (instead of being exempt) if the payer is not denied the deduction.
The main recommendation in the second discussion draft is to link treatment to Action 6 (see below) and there are also some proposed amendments to the Model Tax Convention to restrict benefits.
The use of hybrid mismatch arrangements has been reduced in recent years due to specific and general anti-avoidance regulations and should not impact the majority of businesses who engage in commercially-based planning.
Action 6 – Preventing Treaty Abuse
The discussion draft was released on 14 March 2014 and confirmed that Treaty abuse is one of the most important sources of BEPS’s concerns despite the fact that he commentary on Article 1 of the OECD Model Tax Convention already includes a number of examples of provisions that could be used to address treaty-shopping and treaty abuse, which may give rise to double non-taxation. Some jurisdictions have attempted to address this issue with a limitation of benefits (LOB) clause with treaty partners whereby treaty terms will not apply in tax avoidance situations. In practice, LOB clauses operate effectively to discourage aggressive tax planning and treaty shopping (the use of an artificial intermediate country in between an existing treaty framework to generate tax savings with no commercial rationale). It is for this reason that the OECD has recommended that these existing LOB provisions are used as guidance for anti-abuse rules (GAAR) within tax treaties. There is also a recommendation for a general anti-abuse rule based on the main purpose of a transaction (i.e. if the main purpose is to secure a treaty benefit then the GAAR should apply).
A significant amount of focus will also be on the balance between new “Entitlement to Benefits” provisions and amended “Limitation of Benefits” provisions. However, the main purpose of tax treaties is to relieve tax burdens (not to impose taxation) and to facilitate cross-border trade and investment. It should also be considered that a significant number of jurisdictions do not have tax treaties in place and addressing a consistent standard with those countries would be time better spent than hampering investment by overhauling existing treaty frameworks.
Action 8 - Assure that Transfer Pricing Outcomes are in Line with Value Creation/Intangibles
The update of transfer pricing guidance relating to intangibles had been in process prior to the release of the BEPS Action Plan. The discussion draft was published on 30 July 2013 and the key improvements have been to recognise the following:
- Intangibles are often fragmented into a significant number of classifications and the discussion draft sets this out in a coherent manner
- Improved guidance for the valuation of intangibles (although an update of the cost share/cost contribution agreement guidance is still long overdue)
- A consistent framework to isolate the economic significant persons responsible for the development-enhancement-maintenance and protection of intangibles
- Confirmation that valuations prepared for accounting purposes are prepared under significantly different assumptions and pressures when compared to tax valuations
We have had the opportunity to test the new intangible guidance in advance pricing agreements, international planning and in dispute resolution cases. Whilst still a discussion draft, the new intangibles framework is proving useful in resolving disputes and providing much needed consistency.
Action 13 - Re-examine Transfer Pricing Documentation
The update of transfer pricing guidance relating to documentation had also been in process prior to the release of the BEPS Action Plan. A white paper was published on 30 July 2013 and the discussion draft followed after a period of consultation on 30 January 2014.
The key objectives are as follows:
- Provide tax administrators with sufficient information to conduct an informed assessment of the taxpayer’s transfer pricing
- Provide that taxpayers give “appropriate consideration to transfer pricing requirements in establishing prices and other conditions for transactions between associated enterprises” and in preparing their tax returns
- Provide tax administrators with information which they require to conduct a thorough transfer pricing audit in their jurisdiction
The main recommendations to help achieve the above are the use of a two-tiered (master file and local file) structure to present a comprehensive picture of the global operations of a multinational entity – this includes recommendations to list titles for the most highly remunerated employees in a business. There is also a recommendation to include a country-by-country reporting template that has caused significant controversy with businesses concerned that this will be applied in increasing transfer pricing audits without the required attention to risk assessment, motive and substance. The template includes entity classification, revenue, taxable profits and employee numbers. It also includes items that extend further than transfer pricing such as place of effective management and withholding taxes paid.
The discussion draft affords due consideration to contemporaneity and to materiality and sets out a guide for updating financial information annually, although comparable sets apply only every three years (unless there are economic changes that are relevant to consider). It is also recommended that the master file document be prepared in English with translations of relevant sections of the master file and the local file being considered.
Despite the onerous requirement of the country-by-country reporting template, there are some positive changes. Companies operating in less volatile conditions should be able to refresh comparable sets only every three years with annual financial updates of the existing set, a procedure which may also help balance resources.
The recommendation to prepare the master file in English may not be appropriate for a large number of jurisdictions although this is also an important recommendation in helping to balance resources.
What Is Next?
Discussion drafts discussed above are in place for five of the 15 action points and a timetable is in place for completion of the project by the end of 2015. Whilst this is an ambitious and aggressive timetable, there have been many positive recommendations put forward. However, there are some significant changes that may increase the administrative burden on businesses (most notably the country-by-country reporting template requirement) and the additional concern of many businesses continues to be in relation to the 160+ jurisdictions worldwide that are not members of the OECD.
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