By James J. Tobin, Esq.
*Ernst & Young LLP, New York, NY
The BEPS beat plays on. Congratulations to the OECD for meeting (mostly) the ambitious goals for release of their reports on seven action items in September 2014 – right on schedule on September 16. The documents released on September 16 relate to Action 1 – Digital Economy, Action 2 – Hybrid Mismatch Arrangements, Action 5 – Harmful Tax Practices, Action 6 – Treaty Abuse, Action 8 – Transfer Pricing for Intangibles, Action 13 – Transfer Pricing Documentation and Country-by-Country Reporting, and Action 15 – Multilateral Instrument. We have seen discussion drafts with respect to most of these action items before – only the reports on Actions 5 and 15 are "new" releases. However, all of the documents contain changes and new features. None are yet final final and all include indication of various areas of future work and refinement to be done in the coming months before the final set of reports on these action items and the remaining open action items are due to be delivered by the end of 2015.
This commentary will not go into detail on each report. But rather, as usual, I will pick and choose some items I find particularly interesting and then make some observations/express concerns/maybe whine a bit about the application of these recommendations in the real world or at least the real world as I see it.
The report is an interim report with a deadline of September 2015 for the so-called second output which is to assess specific country incentive regimes which no doubt will be more challenging to reach consensus on. Combined with the current EU state aid review of tax ruling practices in the Netherlands, Ireland, and Luxembourg, one would expect the playing field in this area to be changing over the coming years.
The Action 2 report on hybrid mismatches follows the earlier discussion draft with some minor modifications and is still very comprehensive and exceedingly complex. As in the draft, the September 16 report has as its primary recommendation that all countries adopt a legislative regime focused on eliminating in a comprehensive coordinated fashion the potential for outcomes involving double deduction (DD) or deduction with no corresponding income inclusion (D/NI). The drafters have included a virtual universe of the hybrid instrument and hybrid entity-type arrangements in the market. Many involve check-the-box type structures common in U.S. MNC worldwide structures. U.S. entity classification rules have always had the result that U.S. and foreign country classifications of business entities may differ, although admittedly this has escalated significantly in the post check-the-box area.
The report's proposals are extremely comprehensive. They clearly recognize that uncoordinated country actions against hybrid arrangements carry a high risk of double taxation, with both countries to a hybrid arrangement potentially attempting to tax the same income. Therefore, the report includes priority rules for which country — investor / investee, etc. — should act first to eliminate the benefit. In a perfect world the rules might actually work quite well. However, clearly countries will act, and have already been acting, unilaterally in this area – the latest example being Spain which I will discuss below. For U.S. MNCs, this will likely result in a one-way street of increased foreign country disallowance of interest expense on hybrid instruments and on most financing involving hybrid entities. This result can occur under the report as drafted currently even where all or a part of the so-called hybrid income may be taxed under U.S. Subpart F rules or upon repatriation to the United States. Further, as I have whined before, no effort was made in the report to address the reverse case and eliminate double taxation where there is a denial of a local country interest deduction based on earnings-stripping or thin-cap-type provisions and full taxation of the interest to the lender. As discussed below, this type of deduction limitation is proliferating worldwide as countries look for increased tax revenue – Spain and Sweden examples are discussed below. Maybe the OECD needs to follow the BEPS project with a companion project called Preventing Base Expansion and Deduction Denial (which would be BEDD). But I'm not optimistic about this either. For MNCs, a full review of their global treasury policies is urgently mandated.
So, overall, lots of guidance but more work to be done and lots of open questions in each of the action areas. Not surprising. Let's see how progress develops over the next 12 months.
My concerns from a practical standpoint relate to what anti-BEPS steps countries will take based on the incomplete guidance to date from the OECD. Of course, this has been ongoing even before the BEPS project, with many countries adopting more aggressive base erosion provisions, using local GAAR concepts to deny treaty benefits, and using various theories in tax audits to try to tax foreign IP profits. I fear that the September action item documents will further fuel such activity. I would have hoped that the OECD would do more to admonish against such unilateral action while the BEPS project is still a work in progress.
The latest two countries where I note some clearly tax-revenue-focused proposals are Spain and Sweden. Both have only proposed legislation at this date, but both would dramatically increase the local tax base for corporations operating in those countries. Some highlights:
The Swedish proposal is the most dramatic approach I've seen for limiting interest deductions, but the Spanish proposal and recent limitations enacted in France and Germany and some other countries all continue the trend of potential disallowance of group financing costs, which will inevitably lead to some level of double taxation. Addressing this eventuality is unfortunately not at all a focus of the BEPS action items so far. Maybe good news will be coming when the recommendations under Action 4 on interest deductions and financial arrangements are issued next year? Or maybe not? Hard to be too optimistic here either.
So what's it all mean? First, we have an ambitious, hard-working, more empowered OECD producing lots of detailed reports with lots of open questions and further work to be done before the final versions are released. The extent of the open questions in each of the areas seems to me to evidence some degree of non-consensus among the extended OECD group, so it would appear that final versions may well contain some optionality or other compromises. But the reports produced to date can and are serving already as a basis for legislative change on a country level and are potentially viewed as a global imprimatur for action by local governments for revenue-raising legislation. To date such legislation and proposals all seem to go the same direction – increased local tax and reporting burdens. What to do – I'd encourage more proactive business involvement with the OECD, where we need more balance and support against unilateral local country actions with likely double tax outcomes. At the same time, I'd also encourage businesses to carefully monitor country actions and to try to be more nimble in reassessing their global tax strategy and options. All of which easier said than done, of course.
This commentary also will appear in the December 2014 issue of the Tax Management International Journal. For more information, in the Tax Management Portfolios, see Isenbergh, 900 T.M., Foundations of U.S. International Taxation, and in Tax Practice Series, see ¶7110, U.S. International Taxation: General Principles.
Copyright©2014 by The Bureau of National Affairs, Inc.
The views expressed herein are those of the author and do not necessarily reflect those of Ernst & Young LLP.
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