The Best Job in the World

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By Gary D. Sprague, Esq. 

Baker & McKenzie LLP, Palo Alto, CA

This is going to be the plum job for any international tax practitioner: Competent Authority for the Republic of Ireland. 

It seems pretty clear that the Base Erosion and Profit Shifting (BEPS) project will meet its announced deadline of the end of 2015 to produce final reports on all of its 15 Action Plan items. The multilateral instrument called for in Action 15 will consolidate the recommendations requiring treaty amendments into a single agreement (with perhaps alternatives available depending on national treaty policy preferences) involving all participating countries.  There also will be a flurry of legislative actions around the world as national legislatures enact anti-hybrid, dual consolidated loss, GAAR, and other rules necessary to implement the policy goals of the BEPS project which operate outside the treaties. Taxpayers and tax administrations then will settle down to apply the new rules in a transparent, consistent, and coherent manner. 

From that point on, the Irish Competent Authority is going to lead a very active life. One can speculate that a conversation with the Irish Competent Authority, from around 2019 or so, would go something like this:*  

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"We always expected a lot of activity on the cross-border disputes front. From the beginning, many of the examples of business structures to which the BEPS project was responding seemed to describe businesses operating in Ireland. We thought we were ready, but the workload has been pretty overwhelming." 

A large part of the workload is all the Permanent Establishment (PE) cases. As it turned out, the final report on Action 7, issued right on schedule in September 2015, proposed that States have a choice of two different changes to the Article 5(5) dependent person rules. Some chose the more ambiguous approach, so their treaties now cause a PE to exist if the dependent person "habitually engages with specific persons in a way that results in the conclusion of contracts which … are on the account and risk" of the Irish taxpayer. Other States chose the relatively more precise rule, so their treaties now call for a deemed PE to exist if the dependent person "negotiates the material elements of contracts, that are … for the transfer of … property … or for the performance of services" by the Irish taxpayer. Ireland, anxious to maintain its good standing in the international community, willingly agreed to all proposals as proposed by its treaty partners. 

It is the first group that is causing most of the difficulties. Various market jurisdiction tax administrations have asserted that a dependent person is engaged in "habitual engagement" in cases ranging from hosting annual trade shows to engaging in customer focus group research to sales solicitation.  The qualification that the habitual engagement must be with "specific persons" hasn't proven to be much of a limitation, as some tax administrations looking to expand the outer boundaries of the PE threshold simply have interpreted that clause to refer to persons who are potential customers.  

The second group of treaties calling for negotiations to trigger a PE has turned out to be more challenging in one respect. The language seems clear; actions short of concluding contracts can create a PE only if they constitute the negotiation of material terms.  It is remarkable, however, how many sales solicitation or demand-generating activities some tax administrations regard as "negotiation." 

Ireland also agreed to allow any treaty partner to add to their treaty the main proposal of Action 7 regarding the specific activity exemptions of Article 5(4), so that all such claims to avoid PE under those exemptions are now qualified by a requirement that the "overall activity… is of a preparatory or auxiliary character" for the Irish enterprise. Even though the "preparatory or auxiliary" concept has been an important part of the international tax law from about the time that Saint Patrick banished the snakes from Ireland, extending this subjective qualification to activities that historically have not been regarded as justifying the imposition of direct tax has opened a free-for-all discussion as to what activities are preparatory or auxiliary to other activities, given that all activities of a business are valuable and contribute to the overall profitability of the enterprise. 

What takes the most time to address and resolve, however, is the hugely vexing issue of profit attribution. Unfortunately, neither the final report on Action 7 regarding the determination of a PE, nor the multilateral instrument which amended Art. 5(5) of Ireland's treaties, provided any guidance on how one attributes profits to a notional presence, namely, the deemed PE created by revised Art. 5(5).  Many hours are being spent dealing with how to define which profits (or losses) arise from the functions, assets, and risks that are hypothetically allocated to the notional PE. 

The Knowledge Development Box (KDB) cases also comprise a large part of the caseload. Despite the Anglo-German agreement that their versions of a patent box would essentially follow the R&D "nexus" approach recommended in the Action 5 final report on Countering Harmful Tax Practices, the Da´il E´ireann charted an independent course and authorized a KDB regime whose benefits are available to entities that employ in Ireland regional management personnel who supervise various aspects of the group's European market development or exploitation. Tax administrations of countries without IP box regimes, and especially those with more restrictive regimes which are proving not to be very popular with foreign investors, have been looking for ways to undermine the Irish KDB regime. The new country-by-country reporting template has given all tax administrations good visibility into the income that Irish enterprises are reporting in the KDB.  As a consequence, a fair number of transfer pricing cases making their way into the MAP process have at their bottom a challenge to the allocation of income to the entity qualifying for the KDB. The consequence of reducing the income reported in the KDB, these administrations argue, is that the dislodged income must flow downstream through the distribution chain, bypassing any Irish operating entity, to come to rest in their jurisdictions. These tax administrations are finding great comfort in the revisions to Chapter VI of the OECD Transfer Pricing Guidelines, as ultimately made final as part of Actions 8 - 10 dealing with transfer pricing, by asserting that the KDB entity must be the tested party and be allocated only a risk-adjusted rate of return on its investments in the business. 

The cases inspired by Action 6, Preventing Treaty Abuse, are not as numerous, but they are among the most threatening to Ireland's position as an attractive jurisdiction for inward investment.  Another of the alternatives available to States in the Multilateral Instrument was a choice of Limitation on Benefits (LOB) articles.  Most of Ireland's treaty partners chose the more ambiguous, and more ominous, "one of the principal purposes" test (PPT) over the more objective, albeit more complex, U.S.-style LOB rule. Unfortunately, the final work on Action 6 did not include commentary to define the limited circumstances in which the PPT could properly apply. As a result, some tax administrations have quickly focused on the fact the PPT can be triggered even if the desire to obtain treaty benefits is only one of the principal purposes for establishing an Irish principal company to supply goods and services on a pan-European basis. There have been a worrying number of cases where tax authorities have used this argument to attempt to deny treaty benefits altogether to an Irish entity, for purposes such as imposing royalty withholding tax on payments that would be regarded as business profits under the treaty, and removing PE protection to allow the application of domestic law nexus standards.  These cases have been among the most difficult to resolve, as the issue presented is an all-or-nothing one, on which it has been difficult for the respective Competent Authorities to find common ground for compromise in the absence of an agreement at the OECD on clear, practical guidance on how this test should operate in real-life cases. 

Action 1, Addressing the Challenges of the Digital Economy, has exercised an atmospheric influence over some cases, despite the fact that ultimately the BEPS project adopted none of the options proposed for discussion in the September 2014 report. Cases arising in several jurisdictions dealing with the character of cloud computing transactions pointed to language in the Action 1 report asserting that the character of such payments was not clear. Unfortunately, the further work in 2015 on digital economy issues neglected to reiterate the conclusions of the OECD's own 2001 TAG report from the Treaty Characterisation of Electronic Commerce Payments that such payments constitute business profits. Perhaps encouraged by agitation from the PRC, India, and other countries in various fora to impose withholding taxes on a wide variety of cross-border payments for digital goods and services, a flurry of cases has arisen involving withholding tax assertions on payments received by Irish suppliers of digital goods and services, especially those services hosted in the cloud. The absence of clear guidance for the BEPS project that these payment streams constitute business profits has made these cases difficult to resolve, since the fact that these payments reoccur every year makes this issue a very high-stakes one. Administratively, the Competent Authority's workload also has increased since many of the withholding assertions have been made at the level of the customer for the cloud computing services, resulting in a multiplicity of claims relating to the business of a single Irish supplier. 

Despite the firm rejection in the supplemental report of the Task Force on the Digital Economy of the notion that an enterprise that collects user data thereby has taxable nexus in the State of the user, the idea of user data having some tax significance has not gone away, and has been reappearing in the form of arguments that the aggregated data is a valuable asset owned by local sales entities, to support the use of profit splits in transfer pricing cases. 

While most of the caseload deals with transactions involving Irish subsidiaries of groups headquartered outside Ireland, quite a few Irish-based multinationals have lodged their own cases with the Competent Authority office for resolution. A surprising number of cases seem to have been inspired by the notion expressed in Action 10 that management fees and head office expenses reflect base erosion strategies. The theories for disallowance of charge-outs by the Irish HQ entity have varied, from challenges to the allocation key, assertions of lack of proof of benefit, assertions of a reverse location savings concept that the costs must be adjusted down if charged to a lower cost jurisdiction, or just a general hostility to the idea that a group parent typically incurs global management expenses that benefit the operations of its foreign affiliates. Given the intensely factual nature of these cases, this surprising issue has consumed a disproportionate amount of Competent Authority office resources lately. The final guidance under Action 10 resulting in modifications to Chapter VII of the OECD Transfer Pricing Guidelines dealing with low-value-adding, intra-group services has been helpful in reducing some controversies in this area, but the absence of buy-in to that guidance from some countries, even though they were full participants in the OECD/G20 BEPS process, has been frustrating.  

All of this might seem to be an overwhelming burden, except for one saving grace. The final report under Action 14, Improving Dispute Resolution Mechanisms, included thoughtful and practical recommendations on how to streamline the Mutual Agreement Procedure. The drafters of the Action Plan were farsighted in their observation in the Action Plan that "[t]he interpretation and application of novel rules resulting from the work [of the Action Plan] could introduce elements of uncertainty that should be minimised as much as possible." Especially in areas like the new PE standards where the law was only recently changed, the Action 14 innovations have proven to be some of the more important results of the BEPS project.  

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A stimulating job indeed. It's time for a well-earned pint of Guinness. 

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 Frias, 940 T.M., U.S. Income Tax Treaties -- U.S. Competent Authority Functions and Procedures, 6890 T.M., Income Tax Treaties:  Competent Authority Functions and Procedures of Selected Countries (H – K), "Ireland"and in Tax Practice Series, see ¶7160, U.S. Income Tax Treaties.

 The author notes that while two of his great grandparents sailed from County Cork to San Francisco in the late 1870s, that is as close as he comes to having actual knowledge of how the Irish government plans to implement the BEPS proposals.

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