By James J. Tobin, Esq.
& 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.
written previously about the proposed country-by-country reporting (CBCR)
template. I was pleased to see the scope of the template narrowed a bit from
the draft proposal. The template now requires aggregate country-based
information rather than per legal entity information, which in my mind is much
more relevant and less cumbersome to produce.
The required country level information has been reduced to eight items
of economic data – revenues (broken down by related and unrelated party
revenues), profit before tax, income tax paid, current year income tax accrued,
stated capital, accumulated earnings, number of employees, and tangible assets.
This is still in my mind way too much data for the stated purpose of a high
level risk assessment and will be a very substantial burden on all
multinational corporations (MNCs) globally. However, I guess it could have been
worse. And at least the report clearly states that MNCs may choose which data
source to use – e.g., statutory accounting, local books and records, etc.,
based on which is less burdensome as long as the chosen source is disclosed and
used consistently. Given the political level interest in country-by-country
reporting, it's probably time for companies to begin to think about
implementation preparedness and assess the mechanisms needed – and cost
involved – to produce the data. It's also time for companies to anticipate
increased local tax controversy because of the many countries that may use the
data to conclude that their share of the worldwide profit pie should be higher
based on whichever of the disclosed metrics could produce a higher level of
local profit. I'd like to think I am too cynical on this point, but experiences
in the current environment do not allow me to be my usual optimistic self.
final recommended effective date and the exact delivery mechanism for the CBCR
template are still open issues. It's not clear to me when the OECD will finalize
its recommendations on these important issues. But guidance is needed. Concerns
over confidentiality of information were acknowledged by the OECD, but barely.
I expect some countries will start to adopt the template on their own schedule,
and the longer the OECD takes to recommend a delivery mechanism and to address
other implementation issues, the more likely that will be. The United Kingdom
has already issued a press release formally committing to implement the
template, but with no stated target date yet. I'm hoping for 2017 filing using
2016 information at the earliest so there is some time for companies to
prepare. We'll see.
Action 13 also includes final requirements for the transfer pricing
master file and local file — lots more information than is provided currently
in most MNCs' transfer pricing documentation. The new framework is likely to
require a complete re-look at a company's approach to its transfer pricing
documentation and perhaps also at many of its transfer pricing policies.
Action 5 release on Harmful Tax Practices is new to the BEPS project in that
there was no discussion draft for this action area. It represents a
continuation of work started in the late 1990s in this area involving the OECD
Forum on Harmful Tax Practices. This report is an interim report with two main
recommendations. The first is that any preferential tax regime be premised on
the existence of substantial business activity.
With a particular focus on intangible property regimes such as the
popular patent box or innovation box regimes, this is intended to require the
presence of significant development actions and not merely ownership of IP –
which could be a problematic standard for the regimes of some countries to
satisfy. The second recommendation, which is in the area of transparency, is
that countries spontaneously exchange information on all tax rulings that
involve geographically mobile income — interesting when considered together with
the requirement that the master file include a summary of all tax rulings
applicable to the particular taxpayer.
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.
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
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.
Turning to Action 6 on treaty abuse, consistent with the discussion draft,
this report still includes a recommendation for a U.S.-style Limitation on
Benefits (LOB) provision to be coupled with a principal-purpose-type GAAR
provision. The good news is that the report is somewhat softened on this point
in that it acknowledges that countries may just choose one or the other –
although the OECD prefers the adoption of both. As I've previously written, as
between the two approaches, I am a reluctant fan of LOB, not so much because I
love the LOB rules but because I shudder to think about how a principal purpose
test would be applied to holding and financing companies where inevitably a
country's tax treaty network will be an important criterion for selecting the
location of the entity.
Action 8 on transfer pricing for intangibles – again consistent with the
discussion draft (which in this case was a revised discussion draft) — would
directionally allocate IP returns based on value creation, not merely on
ownership or funding of IP. A new addition is that an additional criterion for
value creation could be the actual exploitation of the intangible. It's not
obvious to me that exploiting an intangible creates value. I worry that adding
this criterion leads to even more potential profit-grab controversies. The
report represents interim guidance – so more to come on how to allocate IP
returns and also on tough issues such as dealing with risk and hard to value
intangibles (but aren't they all hard to value?). And seems to me to be tough
issues to achieve country consensus on.
Action 1 on the digital economy correctly in my mind concludes that the
tax issues relating to the digital economy cannot be fenced off from the
regular economy, i.e., recognizing that digital issues really have broad
application to all industries as all companies have some digital element and
therefore the issues of concern – including permanent establishment, transfer
pricing, and indirect tax — are best dealt with in those other action areas.
report on Action 15 and the multilateral instrument report is very preliminary.
At a high level it discusses why such an instrument would be valuable,
considers how it could be applied to cover only BEPS-related issues so in
essence it could act as a supplement to existing bilateral treaty arrangements,
acknowledges some of the legal and practical difficulties in achieving this,
and generally concludes that such an instrument could be feasible. Not really a
big step forward. I think a vital element of any such instrument would be a
commitment to enhanced dispute resolution by the participating governments,
particularly in light of the spike in tax controversy that is likely to be
created by all the recommendations with respect to the other action items.
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:
statutory corporate tax rate would be reduced in both countries – from 30% to
25% in Spain and from 22% to effectively 16.5% in Sweden.
Additional interest deduction limits would be introduced in Spain. Spain already has an earnings-stripping-type
limitation for interest deductions equal to 30% of operating profit, similar to
Germany and France. New anti-abuse debt-creation rules also are proposed, which
would potentially disallow a portion of interest deductions for certain
leveraged intergroup transactions. Again not a new concept – for example,
France and the Netherlands have adopted similar rules.
Swedish proposals would go farther and would disallow deductions for net
interest and other financial costs, instead allowing all companies a deductible
financing allowance equal to 25% of taxable income (which is what in practice
would reduce the effective tax rate to 16.5% -- pre-interest!). The proposal
also contains an alternative approach which would allow deductions for net
financial costs including interest, up to a cap of 20% of taxable income, and
would reduce the statutory tax rate to 18.5%.
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.
the Spanish and Swedish proposals also would impact the deduction for tax loss
carryforwards. The Swedish proposal is to permanently reduce existing tax loss
carryforwards (as of January 1 of the year the law enters into force) by 50%.
The Spanish rules are positive – in that they remove the 18-year limitation on
loss carryovers and increase the limit for utilization of loss carryforwards in
the current year from 25% of taxable income (these limits only apply above
certain turnover thresholds) to 60% of taxable income. As with interest
limitations, lots of tweaking taking place by countries to limit the use of
NOLs in order generally to increase current cash collections. That's troubling
to me from an equitable point of view. I figure if I lose money I should not
have to pay tax until I at least break even? But the arbitrary permanent
disallowance proposed by Sweden seems really over the top and the type of tax
policy that the OECD should weigh in against.
also proposes to implement anti-hybrid rules very similar to the OECD proposals
– consistent with my concern about selective BEPS implementation in advance of
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.