Kevin A. Bell,
Rick Mitchell and
Alex M. Parker
The OECD released its
final package of measures to tackle base erosion and profit shifting (BEPS) today, representing the most ambitious effort in history to harmonize tax laws across national boundaries.
A major achievement of the two-year project—undertaken by the Organization for Economic Cooperation and Development on the authority of the Group of 20 countries—is revised transfer pricing guidance that replaces guidelines from “pre-history,” according to the OECD's top tax official.
During an embargoed press briefing Oct. 2, Pascal Saint-Amans, director of the OECD's Center for Tax Policy and Administration, said reluctance to depart from the arm's-length principle by some “conservative” countries and the transfer pricing expert community made work “very difficult” under the project.
However, he added, “I think we've landed in a good place.”
The BEPS project is aimed at curbing tax avoidance by large multinationals, which are able to structure their operations around the world to accumulate large pools of foreign earnings at low effective tax rates through transfer pricing and other planning strategies.
The plan has 15 different action items, which range from “addressing the tax challenges of the digital economy” to “neutralizing the effects of hybrid mismatch arrangements,” to setting “mandatory disclosure rules” to instituting “country-by-country reporting” so that individual countries can see and understand how multinational companies are operating across nations and where they are paying or escaping taxes.
Tax practitioners have said they anticipate more aggressive audits around the world as countries implement the OECD's recommendations—and a huge increase in double-tax disputes as a result. One of the action items in the BEPS project that could mitigate that is Action 14, intended to improve dispute resolution under the mutual agreement procedure (MAP) in tax treaties.
Agreement on Arbitration
In another major accomplishment of the project, 20 nations—Australia, Austria, Belgium, Canada, France, Germany, Ireland, Italy, Japan, Luxembourg, the Netherlands, New Zealand, Norway, Poland, Slovenia, Spain, Sweden, Switzerland, the U.K. and the U.S.—have “declared their commitment to provide for mandatory binding MAP arbitration in their bilateral tax treaties as a mechanism to guarantee that treaty-related disputes will be resolved within a specified timeframe,” the OECD said in its report on Action 14.
Saint-Amans described the final package of guidance as a mix of minimum standards, best practices and instructions that will eliminate so-called cash boxes, bring transfer pricing in line with value creation and enhance tax cooperation around the globe.
“We have an agreement. We have an agreement on a consistent, comprehensive, holistic package that reflects a strong political commitment from our member countries and non-members,” Saint-Amans said. “We have something that is strong and substantial.”
Minimum Standards in Four Actions
Saint-Amans said four of the items—Action 5, on harmful tax practices; Action 6, on preventing the inappropriate granting of treaty benefits; Action 13, on transfer pricing documentation and country-by-country reporting; and Action 14, on improving the efficiency of mutual agreement procedures and dispute resolutions—are considered “minimum standards,” which countries would feel “peer pressure” to adopt or comply with.
“This sends a strong message,” Saint-Amans said. “This goes beyond what was expected.”
Other measures—such as Action 4, on limiting earnings stripping through interest deductions, or Action 2, to eliminate hybrid mismatch arrangements—are considered best practices, which countries could choose to use, unilaterally, to protect their tax bases.
Saint-Amans said the BEPS process has already begun to dismantle so-called cash boxes, or highly capitalized subsidiaries with few employees or physical operations.
“We expect the cash boxes to suffer badly from BEPS. What we hear from our colleagues in the U.S. is that a number of them are being dismantled, so it's happening,” Saint-Amans said.
But companies won't be able to get around the new rules by establishing token operations or staffing to justify huge profits in a low-tax jurisdiction, Saint-Amans added.
“We're going to look at real activities. We're going to look at where the value is created. We're going to look at the R&D. It's not 20 smart guys in Bermuda who are doing the R&D—it's a cluster, a cluster of people working in place that we don't move for tax purposes,” he said.
The new rules would work together toward this goal, Saint-Amans said, so the new transfer pricing guidelines would be complemented by a nexus requirement for the preferential treatment of returns from intellectual property.
The OECD will present the final BEPS package at the G-20 Finance Ministers meeting Oct. 8 in Lima, Peru.
Action 1: Digital Economy-Action
In its report on Action 1, the OECD set out an analysis of the tax challenges posed by the spread of the digital economy and concluded that because the digital economy is increasingly becoming the economy itself, it wouldn't be feasible to ring-fence the digital economy from the rest of the economy for tax purposes.
The report also described rules and implementation mechanisms to enable efficient collection of value-added tax in the country of the consumer in cross-border business-to-consumer transactions, something the OECD said will help level the playing field between foreign and domestic suppliers.
Action 2: Hybrid Mismatch Arrangements
Recommendations for countries to adopt domestic rules to neutralize the effect of hybrid mismatch arrangements were set out in the report on Action 2. Also included in the report were changes to the OECD Model Tax Convention to address such arrangements.
According to the OECD, once translated into domestic law, the recommendations in Part 1 of the report will neutralize the effect of cross-border hybrid mismatch arrangements that produce multiple deductions for a single expense or a deduction in one jurisdiction with no corresponding taxation in the other jurisdiction.
Part I of the report set out recommendations for rules to address hybrid mismatches regarding payments made under a hybrid financial instrument or payments made to or by a hybrid entity. It also recommended rules to address indirect mismatches that arise when the effects of a hybrid mismatch arrangement are imported into a third jurisdiction.
The recommendations are supported by a commentary and examples to illustrate how they should apply.
Part 2 of the report set out proposed changes to the model convention that, according to the OECD, will ensure the benefits of tax treaties are granted to hybrid entities—including dual resident entities—only in appropriate cases.
Action 3: Controlled Foreign Companies
The report on controlled foreign companies set out recommendations in the form of building blocks for effective CFC rules.
According to the OECD, the recommendations were designed to ensure that jurisdictions that choose to implement them have rules that effectively prevent taxpayers from shifting income into foreign subsidiaries.
Action 4: Interest Deductions
In the report on Action 4, the OECD said the mobility and fungibility of money makes it possible for multinational groups to achieve favorable tax results by adjusting the amount of debt in a group entity.
The report's recommended approach ensures that an entity’s net interest deductions are directly linked to its level of economic activity, based on earnings before interest, taxes, depreciation and amortization (EBITDA).
This approach includes three parts: a fixed-ratio rule based on a benchmark of net interest to EBITDA; a group-ratio rule that allows an entity to deduct more interest expense in some circumstances based on the position of its worldwide group; and targeted rules to address specific risks.
According to the report, a country may choose not to introduce the group-ratio rule, but then it should apply the fixed-ratio rule to multinational and domestic groups without improper discrimination.
Action 5: Harmful Tax Practices
In its report on Action 5, the OECD said preferential tax regimes continue to be a key pressure area. Current tax authority concerns are primarily about preferential regimes that can be used for artificial profit shifting and about a lack of transparency in connection with certain rulings.
The report set out a method for assessing whether there is substantial activity in a jurisdiction. In the context of intellectual property regimes such as patent boxes, the countries participating in the BEPS project agreed to the “nexus approach,” which uses expenditures as a proxy for substantial activity, and ensures that taxpayers can benefit from IP regimes only when they engage in research and development and incur actual expenditures on such activities.
According to the report, the same principle can be applied to other tax preferential regimes, requiring substantial activity where the taxpayer undertook the core income-generating activities.
In the area of transparency, the countries agreed to a framework for the compulsory spontaneous exchange of information on rulings that could give rise to BEPS concerns in the absence of such an exchange.
Action 6: Treaty Benefits
According to the OECD, the report on Action 6 included changes to the OECD Model Tax Convention that are intended to prevent treaty abuse.
The report first addressed treaty shopping through alternative provisions that form part of a minimum standard that all countries participating in the BEPS project have agreed to implement. It also included specific treaty rules to address other forms of treaty abuse and ensure that tax treaties don't inadvertently prevent the application of domestic anti-abuse rules.
Action 7: Permanent Establishment
The report on Action 7 included changes to the definition of permanent establishment in the OECD Model Tax Convention that will address strategies used to avoid having a taxable presence in a country under tax treaties.
These changes, the OECD said, will ensure that when an intermediary's activities in a country are intended to result in the regular conclusion of contracts to be performed by a foreign enterprise, that enterprise will be considered to have a taxable presence in that country unless the intermediary is performing the activities in the course of an independent business.
The changes will also restrict the application of a number of exceptions to the definition of PE to activities that are preparatory or auxiliary in nature. According to the OECD, these changes will prevent companies from taking advantage of the exceptions by fragmenting a cohesive operating business into several small operations.
Actions 8, 9 and 10: Transfer Pricing
According to the OECD, the report on Actions 8, 9 and 10 contains revisions to the OECD transfer pricing guidelines “to align transfer pricing outcomes with value creation.”
The revised guidance focused on:• transfer pricing issues relating to transactions involving intangibles;
• contractual arrangements, including the contractual allocation of risks and corresponding profits, that aren't supported by the activities actually carried out;
• the level of return to funding provided by a capital-rich multinational group member where that return doesn't correspond to the level of activity undertaken by the funding company; and
• and other high-risk areas.
Action 11: Monitoring BEPS
The report on Action 11 assessed currently available data and concluded that significant limitations severely constrain economic analyses of the scale and economic impact of BEPS. Thus, improved data and methods are required. The OECD is adopting its previously proposed dashboard of six BEPS indicators using different data sources and assessing different BEPS channels.
Action 12: Mandatory Disclosure Rules
In the report on Action 12, the OECD provided an overview of existing mandatory disclosure regimes and gave recommendations for a modular framework for use by countries wishing to implement or amend mandatory disclosure rules in order to obtain early information on aggressive or abusive tax-planning schemes and their users.
The report also set forth specific recommendations for rules targeting international tax schemes, as well as for developing and implementing more effective information exchange and cooperation between tax administrations.
Action 13: Transfer Pricing Documentation
This report revised the standards for transfer-pricing documentation incorporating a master file, local file and a template for country-by-country reporting of revenue, profits, taxes paid and specific measures of economic activity.
According to the OECD, the revised standardized approach will require taxpayers to articulate consistent transfer-pricing positions and provide tax administrations with useful information to assess transfer pricing and other BEPS risks. This will allow tax authorities to make determinations about where audit resources can most effectively be deployed and, in the event an audit is called for, provide information to help begin the audit and target inquiries.
Country-by-country reports will be disseminated through an automatic government-to-government exchange mechanism.
The implementation package included in the report set out guidance to ensure that the reports are provided in a timely manner, that confidentiality is preserved and that the information is used appropriately by incorporating model legislation and model competent authority agreements forming the basis for government-to-government exchanges of the reports.
Action 14: MAP
As noted, the report on Action 14 revealed the commitment by 20 countries to provide mandatory binding arbitration in their bilateral tax treaties.
Action 15: Multilateral Treaty
In 2016, OECD and G-20 countries are expected to finalize an inclusive multilateral instrument and develop a framework for monitoring “with all interested countries participating on an equal footing.”