Likely U.S., U.K. Opt-Out on Tax Change Hints at Complications

The Tax Management Transfer Pricing Report ™ provides news and analysis on U.S. and international governments’ tax policies regarding intercompany transfer pricing.

By Rick Mitchell

The OECD’s multilateral tax treaty was supposed to provide a smooth way for countries to rapidly implement the international BEPS project’s most important changes, but speakers at a recent conference suggested some bumps may lie ahead.

The Organization for Economic Cooperation and Development is due to hold a signing ceremony in June for jurisdictions that last November adopted the text of the multilateral instrument, which it said will cover countries’ adherence to the four minimum standards for the OECD project to combat global tax base erosion and profit shifting. Beyond that, a “flexible approach” will allow countries to select options for some individual treaty provisions.

It appears as though the U.S. and U.K. are leaning toward taking that flexible option for certain BEPS rule change proposals. Michael McDonald, a financial economist at the Treasury Department’s Office of Tax Analysis, said March 27 that the U.S. is concerned that the multilateral instrument’s language on artificial avoidance of permanent establishment through specific activities could lead to “finding PEs with very little profits” and, consequently, “we don’t plan on taking on the OECD position on that in the MLI.”

Timothy Power of the U.K.treasury agency’s corporate tax team, said the U.K. also doesn’t plan to adopt “the majority of the rule changes” regarding avoidance of PE, which the BEPS project proposes for articles 5.5 and 5.6 of the OECD Model Tax Treaty.

‘Surprised’ and ‘Concerned.’

McDonald and Power spoke during a session at the global transfer pricing conference in Paris sponsored by Bloomberg BNA and Baker McKenzie LLP. Also on the panel, Gary Sprague, a Palo Alto, Calif.-based Baker McKenzie partner, said the news that some countries will opt out of the changes on permanent establishment had him “very surprised” and “concerned” for the possible impact on business.

In October 2015, the OECD released recommendations from the 15-item BEPS plan, which was intended as a rewrite of international tax rules that allow multinationals to drastically reduce their tax bills. For example, some internet multinationals pay little or no tax on advertising or sales revenue in some countries by claiming that their permanent establishment is in another low- or no-tax jurisdiction.

The BEPS recommendations included major updates to transfer pricing rules to better take intangible assets into account, as well as documentation rules and requirements for the largest multinationals to report on their taxes paid and profits earned in each country of operation.

The four BEPS minimum standards required for the multilateral instrument are country-by-country reporting, countering harmful tax practices, preventing treaty abuse and improving the mutual agreement procedure—the procedure for resolving cases of double taxation between countries. The rule changes on permanent establishment are optional.

U.K. Diverted Profit Tax

Power said the U.K. feels strongly that the BEPS proposed changes to Article 5 of the model treaty “have yet to be tested, so there is still a lot of work for profit attribution guidance that needs to be done.” It also believes it doesn’t need the changes, because the diverted profits tax—or “Google tax”—the country implemented last year to fight tax avoidance by internet companies is already “effective, well-targeted and proportionate.”

Sprague said recent comments by Power, McDonald and others suggest that “several major treaty networks” may not include some of the BEPS project’s proposals for basic changes to the Model Tax Treaty language on permanent establishment, despite the two-plus years of work that went into devising the BEPS proposals by country delegates, practitioners and companies.

Sprague said some countries’ representatives said that the rule changes only expressed in “black and white” what they had believed they could do all along. So, “if you’re a party to a treaty network, like the U.K.’s., and you’re a country that really would prefer to have PEs in these cases, will your tax administration and national courts respect the fact that the treaty didn’t change?” Sprague said.

New Zealand’s ‘Honest, Overt Approach.’

Sprague said New Zealand, in an “honest, overt approach,” had officially announced that it favors adopting the PE rules, but if a treaty partner doesn’t adopt them, it will apply a diverted profits tax “variant” to that country’s companies. “That’s an interesting reaction. even though the OECD has expressly said that countries can choose” options, he said.

Jefferson VanderWolk, head of the OECD’s Tax Treaty, Transfer Pricing and Financial Transactions Division, said that even if some countries reject the multilateral instrument’s sections on permanent establishment, the instrument will still allow adopting large parts of the BEPS project much faster than through the process of changing thousands of bilateral tax treaties.

Some past changes to the Model Tax Treaty have taken “a hell of a lot of work” and then years of negotiations to get adopted in treaties, while some don’t get adopted at all. “You can’t force countries to make those changes,” VanderWolk said.

To contact the reporter on this story: Rick Mitchell in Paris at correspondents@bna.com

To contact the editor on this story: Molly Moses at mmoses@bna.com

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