Tax departments of U.S.-based multinationals have a lot to think about right now. Not only is the global tax landscape in a state of flux, but the prospect of U.S. reform at the magnitude of the 1986 Tax Reform Act is very real. And as if that weren’t enough, the OECD’s base erosion and profit shifting (BEPS) actions are starting to take form. In the most recent global tax life event, over 70 countries signed onto the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (known as the Multilateral Instrument, or MLI) on June 7, 2017.
Perhaps not surprisingly, the U.S. has indicated it will not be signing the MLI. But, while it may be tempting to gloss over this recent development in favor of news closer to home, it is important to understand that the MLI could have significant ramifications for the tax provisions of U.S.-based multinationals by virtue of its potential impact on over a thousand current tax treaties across the globe. Even though the affected treaties will not apply to transactions by the U.S. parent or its U.S. subsidiaries, it is very likely that such treaties could apply to transactions between foreign subsidiaries. If any transactions between foreign subsidiaries have the kinds of beneficial tax effects that the BEPS treaty-related actions are intended to prevent, those tax effects may soon be going away, without the need for any changes in the domestic tax laws of any foreign countries. A few examples of transactions that fit that description and that are found in many multinational groups are mentioned below.
With 48 pages of text and another 86 pages of explanations, the MLI is almost certainly not a great bedtime read (except for insomniacs). So, without getting into the mind-numbing details, this edition of Tax Advisor Weekly provides our U.S.-based multinational readers with a basic understanding of what the MLI is, how it operates, how it may affect their global organizations and what they need to be doing and thinking about as we move forward.
The MLI: An Overview
While BEPS is attempting to solve many different types of concerns of national tax authorities, a rather significant portion of the BEPS actions deal specifically with tax treaty provisions. In that regard, these actions recommend several updates to tax treaties in order to create a certain level of consistency in the treatment of cross-border transactions and, thereby, minimize the possibility of double non-taxation.
While great in theory, the prospect of 70-plus countries renegotiating every bilateral tax treaty to which they are signatories could amount to literally thousands of one-on-one, country-to-country negotiations. The purveyors of BEPS, the OECD and the G-20 were astute in recognizing that there was not nearly enough time (or champagne and caviar) to successfully pull that off.
Much to the chagrin of the hospitality industry, the MLI may in fact provide the centralized, multilateral mechanism — a kind of clearinghouse, if you will — to dramatically expedite the bilateral renegotiation process. By providing what could be described as “model articles” that, when implemented, satisfy the treaty recommendations under BEPS, the MLI provides each signatory with a kind of checklist with which it can choose the types of treaty amendments it would agree to with each of its existing treaty partners. Thus, each signatory unilaterally decides whether to accept, reject or reserve (i.e., wait and decide later) each MLI article as it pertains to each of its treaty partners in this selection process, referred to as making notifications. After this step has been completed by a pair of treaty partners and each partner country has ratified the MLI under its local laws, any articles that were unilaterally accepted by both partners will be automatically implemented into the relevant bilateral treaty. The OECD anticipates that the first round of implementations will occur in early 2018.
Now of course, nothing related to tax can be quite so simple. On a more granular level, each step involves quite a bit more detail. Recently, our Taxand affiliate in Luxembourg, ATOZ, assisted industry bodies in making submissions on the notification process.
Since the MLI is a comprehensive convention that allows countries to implement a wide range of tax-treaty-related BEPS measures with many options and alternatives (including the option not to adopt certain provisions), the choices made by countries signing the MLI (including Luxembourg) are of utmost importance, given their potential impact on competitiveness and attractiveness for international investments. In our affiliate’s experience, industry bodies made recommendations on the choices to be made by Luxembourg, so as to ensure that its tax treaty network remains attractive with clear and practical tax rules for taxpayers. After reviewing the publication of Luxembourg’s approach, Atoz believes that Luxembourg took the recommendations into consideration and made the right choices.
Areas Potentially Affected by the MLI
BEPS Action 2 sets out to prevent and neutralize arrangements where the jurisdictions’ differing treatment of a particular arrangement results in deductions in one jurisdiction and no corresponding taxation in the other jurisdiction. A classic example might be a company with an instrument treated as debt for the purposes of Jurisdiction A but treated as equity for the purposes of Jurisdiction B. Payments on the debt would likely be deductible by the jurisdiction treating the instrument as debt, but the income would be treated as a return of capital and not includible as income in a jurisdiction treating the instrument as equity.
Action 6 aims to ensure that tax treaties do not inadvertently create opportunities for tax avoidance or evasion. The action additionally provides policy considerations for a country to consider prior to entering into a tax treaty with a new treaty partner. This action tends to be aimed at older treaties that have not been updated recently, and thus leave substantial wiggle room for tax avoidance or evasion. For the most part, this action requires only an affirmative statement within the treaty providing that actions purposefully taken in pursuit of tax avoidance or evasion will be outside the scope of the treaty. It is our understanding that many of current treaties already include this language, and, therefore, we do not anticipate this being a high priority for more recent treaties.
Action 7 works to prevent the circumvention of permanent establishment classification where activities of an intermediary are being performed in another jurisdiction. For example, if a company residing in Jurisdiction A uses the services of a company in Jurisdiction B to complete contracts or perform sales activities, this action considers under what circumstances the Jurisdiction A company should be treated as maintaining a permanent establishment in Jurisdiction B and, thus, subject to tax in Jurisdiction B based on those activities. The action recommends that such an arrangement should be deemed a permanent establishment unless the company performing the activity in Jurisdiction B is truly an independent agent.
Mutual Agreement Procedures
Action 14 sets out measures to overcome obstacles inherent in dispute resolution between treaty partners so as to establish more certainty and predictability of treaty application. This action is more focused on enabling countries to communicate more effectively and resolve disputes when double taxation exists, and thus should not be a high priority for U.S.-based multinationals.
Considerations for U.S.-Based Multinationals
U.S.-based multinationals must consider domestic tax laws and tax treaties not only of the U.S. but of many other jurisdictions when planning and accounting for the tax consequences of foreign operations. Many such plans and strategies aim for tax-neutral or tax-beneficial treatment. As the BEPS actions related to tax treaties near fruition, existing tax planning strategies producing the effect of double non-taxation may be at risk. Now is the time to take stock of any arrangements that may fall within the changes implemented through the MLI and determine whether the arrangements are material enough to warrant preemptive action (e.g., quantifying the potential impact on the company’s financial statements and possibly unwinding and/or implementing alternative arrangements).
For example, if a company has a hybrid group financing structure that produces tax-deductible interest in some countries but little or no taxable interest in others, it will be important to determine whether any of those countries are signatories to the MLI and, if so, what selections those countries made and whether any of those selections match up with their treaty partners. Similarly, if the group has a principal company structure where the principal company has a tax residency in a low-tax country, but such company does not have permanent establishments in any of several other countries where activities are present, a review of the MLI is in order. Another fact pattern that may warrant review would be where the group has a substantial volume of cross-border intercompany payments of the type that typically attract withholding taxes (e.g. dividends, interest, rents, royalties, tech fees), but where treaty exemptions (or rate reductions) have been obtained by channeling the payments through one or more special purpose companies that do not conduct substantial business operations in their country of residence. But these are just a few examples.
Alvarez and Marsal Taxand Says:
The first step in staying ahead of the game when it comes to the MLI should be to identify any aspects of your foreign profile that may be affected by any of the BEPS treaty-related actions, which again include measures against hybrid mismatch arrangements (Action 2), measures against treaty abuse (Action 6), measures to strengthen the definition of permanent establishments (Action 7) and measures to make mutual agreement procedures (MAPs) more effective (Action 14).
Once the potentially affected transactions are identified, the next steps should be to assess the potential damage, to identify and assess the potential options for change and then to implement any selected changes. This process may warrant the designation of a special review team and the creation of a formal step-plan to ensure that all bases are covered in an efficient manner. And might we suggest that the team meetings be held at fancy hotels in suitable locations (e.g., Vienna or Geneva) with the afternoon breaks and dinners supplied with plenty of champagne and caviar. After all, such a process deserves the degree of decorum fitting for government-to-government actions.
The information contained herein is of a general nature and based on authorities that are subject to change. Readers are reminded that they should not consider this publication to be a recommendation to undertake any tax position, nor consider the information contained herein to be complete. Before any item or treatment is reported or excluded from reporting on tax returns, financial statements or any other document, for any reason, readers should thoroughly evaluate their specific facts and circumstances, and obtain the advice and assistance of qualified tax advisers. The information reported in this publication may not continue to apply to a reader's situation as a result of changing laws and associated authoritative literature, and readers are reminded to consult with their tax or other professional advisers before determining if any information contained herein remains applicable to their facts and circumstances.
About Alvarez & Marsal Taxand
Alvarez & Marsal Taxand, an affiliate of Alvarez & Marsal (A&M), a leading global professional services firm, is an independent tax group made up of experienced tax professionals dedicated to providing customized tax advice to clients and investors across a broad range of industries. Its professionals extend A&M's commitment to offering clients a choice in advisers who are free from audit-based conflicts of interest and bring an unyielding commitment to delivering responsive client service. A&M Taxand has offices in major metropolitan markets throughout the United States and serves the United Kingdom from its base in London.
Alvarez & Marsal Taxand is a founder of Taxand, the world's largest independent tax organization, which provides high quality, integrated tax advice worldwide. Taxand professionals, including almost 400 partners and more than 2,000 advisers in 50 countries, grasp both the fine points of tax and the broader strategic implications, helping you mitigate risk, manage your tax burden and drive the performance of your business.