BEPS: A dramatic change in global tax policy landscape

Over the past two years, OECD initiated a fast-paced programme to develop 15 Action Plans under the banner Base Erosion and Profit Shifting (BEPS).

Mint: October 5, 2015

The last few years have witnessed growing attention from the media, public and non-governmental organizations (NGOs) on perceived international tax avoidance by high-profile multinational corporations (MNCs). Further, governments and revenue authorities around the world are worried about their respective tax base erosion due to MNCs allegedly allocating taxable profits to locations “different” from those where the valuable business activity takes place and the rise in double “non” taxation of transactions based on interplay of tax treaties and domestic laws.

In light of the above, G20 member countries requested the Organisation for Economic Cooperation and Development (OECD) to develop a tax policy to address perceived flaws in the current international tax rules. OECD initiated a massive fast-paced programme over the last two years to develop 15 Action Plans under the banner Base Erosion and Profit Shifting (BEPS). The OECD has issued the drafts and will release the final package of measures for a coordinated international approach to reform the international tax system on Monday, 5 October.

A broad overview of what the OECD Action Plans are attempting to achieve is as follows:

(A) Permanent Establishments

The plan identifies two specific areas to be addressed in relation to a Permanent Establishment (PE) test: (a) arrangements where there may be a shift of profit from one country to another, despite substantive change in the functions performed in the first country and (b) MNCs may artificially fragment their operations among multiple group entities to qualify for the exceptions to a PE status.

(B) E-commerce

Globalization of business has given rise to cross-border e-commerce, and hence, the action plan attempts to review different business models and get a better understanding of value in the “digital” sector—thus providing guidance for its taxation, including value added tax (VAT).

(C) Transfer Pricing

Fortunately, the Plan rejects the possibility for alternative income allocation systems (for instance allocation of global profits of a MNC on the basis of its turnover) and confirms that the preferred course of action is to correct the flaws in the current system. Accordingly it aims at:

—adopting a clear definition of intangibles and ensuring appropriate allocation of profits in accordance with value creation.

—ensuring that inappropriate profits do not accrue to an entity solely because it has contractually assumed risks or has provided capital. In other words, are there sufficient people of a relevant quality and experience at a particular location who assume and manage the relevant risks and capital to derive a quantified level of profit.

—developing rules for situations where it is unlikely that such transactions would realistically occur between third parties.

The proposed approach, for such situations, attempts to allocate returns by emphasising functions more than assets and risks. One expects that the final rules should consider “similar” if not “identical” third-party arrangements to avoid attribution of profits to a location where they do not belong.

—bringing transparency for tax administrations around the world by developing rules that allow them to get a “ big picture” view of an MNC’s global value chain, which is often not available. The plan has proposed detailed rules under country-by-country (CbC) reporting requirement where an MNC will be required to provide all relevant governments with needed information on their global value chain, economic activity and taxes paid under a common template.

(D) Hybrid Instruments and Interest expense deduction

The work around Hybrids is to neutralise the unintended double non-taxation generated from these hybrid instruments. Further, in terms of interest deductions, there are two perspectives—(a) in relation to in-bound investment situation, the concern is with excessive interest deductions for the borrower coupled with no corresponding taxation of interest for the lender and (b) in relation to an outbound investment situation, the concern is around use of debt to finance the generation of tax exempt income.

(E) CFC and Treaty Abuse

The action plan identifies a series of measures to ensure that taxpayers cannot inappropriately use bilateral treaties to achieve a position of double non-taxation in relation to any particular activity. Further, from a Controlled Foreign Corporation ( CFC) perspective, the plan attempts to achieve a situation where taxpayers would have a much reduced incentive to shift profits into a low tax jurisdiction. The expectation from the CFC rules is that it should not increase complexity, administrative burden and double taxation.

(F) Effective Dispute Resolution mechanisms and Multilateral Instrument

The attempt here is to create a platform, which acts as an enabler for a coordinated working of the tax policy framework between tax jurisdictions around the world. Bilateral treaties, generally, include a mutual agreement procedure (MAP) to eliminate double taxation of incomes. It works well when the competent authorities use their best efforts to reach an agreement. The action plan attempts to agree ways of resolving disputes where MAP does not work or is not applied. The OECD encourages the use of alternative dispute resolution options, such as bilateral Advance Pricing Agreements (APAs), which would proactively increase certainty and decrease the risk of double taxation. It is disappointing that the OECD has been unable to reach broad consensus on the need for mandatory binding arbitration. The Multilateral Agreement action focuses on the need for a legal basis for tax jurisdictions to implement the other action plans.

(G) Data and Transparency

The action plan attempts to require taxpayers to disclose their aggressive tax planning arrangements and sharing of the same between tax jurisdictions. The plan further proposes methodologies to collect and analyse relevant data from taxpayers as lack of such data in past did not allow governments to quantify the extent of tax base erosion.

(H) Countering harmful Tax Practices

Unlike other action plans, this one is concerned with the actions of States and not MNCs. This plan attempts to counter harmful tax regimes more effectively, taking into account factors such as transparency and substance. There have been recent instances where State aids have been challenged by the European Union (EU)

Conclusion: From the government perspective, it is important that the increased transparency is balanced by the need for taxpayer confidentiality and reduced administrative burden on business. From an MNC’s perspective, it is important to keep abreast with the developments around BEPS, identify significant risk areas and begin remediation, as required, and prepare for the increased transparency and compliance requirements. Importantly, MNCs would need to balance the growth ambition with the potential reputation risk under the new tax landscape.

Sanjay Tolia is partner, Price Waterhouse & Co. Llp

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