Practitioner Says Changes to Businesses Driven by BEPS May Cost Companies Millions

PARIS--Large multinationals seeking to retreat from aggressive transfer pricing positions in response to anticipated changes in international rules could face millions of dollars in costs, a Baker & McKenzie transfer pricing expert told BNA April 11.

John Peterson of Baker & McKenzie in Palo Alto, in an email follow-up to a March 12 panel discussion, said companies that have set up certain “aggressive” transaction structures in market countries could find it difficult, though not impossible, to change them now. He and others on the panel, including representatives from oil services firm Baker Hughes, the law firm Matheson, and the French government, discussed centralized business models and their impact on transfer pricing at Bloomberg BNA and Baker & McKenzie's transfer pricing conference in Paris.

The panelists observed that governments seem increasingly likely to revise international norms and rules, or make new interpretations of the rules, due to concerns that some multinationals are exploiting loopholes to shift profits away from locations where they are generated. The Organization for Economic Cooperation and Development's project on base erosion and profit shifting (BEPS) is designed to address those concerns (21 Transfer Pricing Report 1023, 2/21/13).

Peterson said that changes to the flow of a company's transactions--in any direction--typically involve significant modifications to its information systems and costs as well as the “general administrative nuisance” of contract and value-added tax changes.

“The cost of the necessary systems changes can be $10 million or more as modern business enterprise systems are extremely user-unfriendly when it comes to any midstream changes,” he said.

Harsh Light of BEPS

In his keynote speech opening the conference, Pascal Saint-Amans, who heads the OECD's Center for Tax Policy and Administration, warned that global consensus over the arm's-length principle could soon evaporate due to concerns over BEPS (21 Transfer Pricing Report 1099, 3/21/13).

Following its February report on these concerns to the Moscow meeting of the Group of 20 country finance ministers, the OECD is working on a BEPS action plan that it plans to submit to the G-20 by July, Saint-Amans said.

Moderating the panel on business models, Richard Fletcher of Baker & McKenzie in London noted that the BEPS project comes as the long economic and financial crises have caused many countries to raise taxes to reduce budget deficits, leading to political pressure to ensure that big companies pay their fair share.

In this environment, Peterson said, “you have the BRICS emerging economies, the market countries, and the United States all looking longingly at the same pot of gold” that a BEPS revision of tax rules and standards could bring in.

Panelists said that, as nongovernmental organizations and media have stoked intense, unprecedented, scrutiny of transfer pricing's role in base erosion, reputational risks loom for companies perceived as dodging taxes (21 Transfer Pricing Report 1141, 4/4/13).

“You know it's a brave new world for transfer pricing when you can turn on TV on Sunday and learn about the double Irish structure on 60 Minutes,” Peterson said.

In the double Irish maneuver, a multinational, for example Google Inc., routes profits through its European headquarters in Ireland, whose laws then allow the company to shift profits to zero-tax jurisdictions, such as Bermuda or the Caymans (21 Transfer Pricing Report 688, 11/15/12).

Confusing Times

Mark Freeman, tax director for Europe at Baker Hughes, said the United Kingdom is giving conflicting signals, offering incentives to lure business from other European countries while at the same time publicly attacking profit shifting (21 Transfer Pricing Report 741, 11/29/12).

“It's a confusing time,” agreed Fletcher, who also noted that transfer pricing experts at corporations are getting “far more interaction at board level then possibly they ever have. The board is asking to be made aware about what transfer pricing structures the company has in place” and questions are coming up at annual general meetings.

Freeman said that at some companies, transfer pricing and tax personnel are having to prepare for these meetings by spending time with public relations personnel. He added that he said his team at Baker Hughes do not feel “that same immediate pressure.”

In this context, if a company's tax structure is not “reflective of your business reality and what is best for your business, then you've got a problem and [the BEPS project] may just highlight that,” said Freeman.

Saint-Amans has said the project could lead to revision of the OECD Model Tax Convention on Income and on Capital--which has served as the model for more than 3,000 bilateral tax treaties--in an effort to close gaps in the rules. In particular, he said this could mean changes to the Model Convention's Article 9 on the taxation of associated enterprises, and possibly Article 7 on taxing business profits.

'Double Non-Taxation' Concerns

Peterson said most companies are likely to wait to see the actual changes in the rules before making significant changes to their transfer pricing structures. He said it is “fairly obvious” that BEPS will lead to new rules or new interpretations of old rules that seek to broaden the permanent establishment definition under Article 5 of the Model Convention. There will be a campaign against “double non-taxation” and companies have to anticipate that, he said.

“I wouldn't say there is a systematic reaction to this in the United States, but on an ad hoc basis we're beginning to see [companies] pull in their horns a little bit” by hardening their existing structures or anticipating changes in new structures.

For example, he said one company had decided to “forgo the double Irish [maneuver] and stick to the single Irish and just let the entire pot fall to Ireland at its 12.5 percent [tax rate], instead of having two-thirds or three quarters of [profits] come out the back to a zero-tax environment.”

Joe Duffy of Matheson in Dublin noted that Ireland often is perceived as benefiting from profit shifting due to its 12.5 percent corporate tax rate and its generous transfer pricing rules.

The Irish government is highly aware that multinationals have invested “huge” sums in Ireland, with a “huge” impact on employment, and consequently is careful to keep corporate tax and transfer pricing rules consistent, simple, and transparent, Duffy said.

Ireland as 'Real Onshore Alternative.'

Nevertheless, there has been grumbling in Ireland that companies making high revenues in the country are paying very low margins there, Duffy said.

“It's the hope within the Irish government that perhaps one of the outcomes of [BEPS] is that Ireland can be seen as a real alternative for an onshore regime,” said Duffy.

Peterson said that if the BEPS project ends up concluding that double non-taxation of companies is a “huge problem,” companies may decide to abandon their use of zero tax jurisdictions by collapsing transactions into “intermediate” jurisdictions such as Ireland or Switzerland.

“If the choice turns out to be pay 35 percent or 40 percent in your home jurisdiction, 30 percent in the market jurisdiction, or 12.5 percent in Ireland, I think Ireland is going to win that one,” he said.

Fletcher agreed that multinationals are seriously reconsidering their business models and structures in cases where these could be difficult or awkward to justify in the new BEPS context. For example, companies are questioning whether it is worth the risk to maintain certain license structures that may lead to arguments with tax authorities, even when the structures are reasonable.

These companies are considering pushing the risk into the local entity and having that entity develop the brand, “and then deal with the consequences. At least that way it won't be a transfer pricing issue over the license,” he said.

Ten-Year Fight?

Fletcher questioned whether today's business structures will survive. “Are groups going to be willing, for example, to battle it out for 10 years based upon their current business structures?”

Peterson said that if a BEPS revision changes the definition of permanent establishment in the Model Convention's Article 5, “maybe people will change the way they operate. But it's not so easy to change the transaction structure.”

He noted difficulties faced about 20 years ago by companies that initially were buy-sell distributors and attempted change their status to commission agents or commissionaires “for U.S. Subpart F purposes in the pre check-the-box era.”

Companies that “have already gone in that direction, which is probably the most aggressive transfer pricing approach for the market countries … may not find it so easy to turn back” due to costs, administrative problems, and other “nuisances,” Peterson said.

For example, changing the party that contracts with customers requires communicating that fact to customers and possibly asking them to enter into new contracts, and VAT reporting may also be different. Whether a company became a commissionaire or commission agent for Subpart F reasons or adopted that structure from the beginning as best corresponding to its business model, the costs of switching business enterprise systems can be excessive, he said.

“Such companies are not completely stuck, they just face significant cost and inconvenience if they wish to now implement a change,” Peterson said.

By Rick Mitchell